Thursday, December 21, 2017

No. 245: Shadow Insurance and Cost-of-Insurance Increases—Recent Lawsuits Involving the Confluence of Those Topics

"Shadow insurance" (also called "captive reinsurance") and "cost-of-insurance (COI) increases" are topics on which I have blogged extensively. Recently I learned of five lawsuits—four in federal courts and one in a state court—involving the confluence of those two topics. Here I identify the cases, describe their general thrust, and quote from one of them.

The General Thrust of the Cases
For several years some life insurance companies have been engaging in transfers—through captive reinsurance subsidiaries—of large amounts of liabilities on universal life insurance policies. Some of the captive reinsurance subsidiaries are based offshore and some are based in states that have enacted laws and adopted regulations allowing the creation and operation of limited purpose subsidiaries (LPSs). To offset the liabilities that the LPSs acquire, the LPSs often use as assets items such as parental guarantees, letters of credit, credit-linked notes, and other phony assets that are permitted by the regulators in the domiciliary states of the LPSs but are not permitted under generally accepted accounting principles or under statutory accounting principles promulgated by the National Association of Insurance Commissioners. After unloading their liabilities, the parent insurance companies of the LPSs are able to pay large dividends to their ultimate parent companies, and the ultimate parent companies are able to pay large dividends to their shareholders. In that fashion the ultimate shareholders receive large dividends long before earnings materialize to justify those dividends. When the problem emerges, as it invariably does, the parent insurance companies try to survive by imposing large COI increases on their policyholders with the argument that future expectations are far below what had been anticipated.

The First Banner Case
In January 2016 Richard Dickman and one other individual filed a 79-page, four-count complaint against Banner Life Insurance Company and two Banner affiliates. Here, with italics as in the original and without citations, is the nine-paragraph introduction to the complaint:
  1. Banner Life Insurance Company ("Banner") is a for-profit life insurer organized under Maryland law. Legal and General America, Inc. ("LGA"), Banner's immediate parent, owns all of Banner's Class A common stock, Class B common stock, and preferred stock. Full control of LGA ultimately resides with Legal and General Group Plc ("L&G"), a United Kingdom company.
  2. Banner, LGA, and L&G, working in concert with each other, embarked upon a scheme to take funds, which were designated as support for reserves [liabilities] and set aside to pay American policyholders' death claims, and convert them to L&G's investors' and executives' benefit.
  3. For more than a decade, Banner, under the direction of its ultimate parent, L&G, put investors and executives ahead of their own policyholders. In doing so, Banner pretended to offload billions of dollars of liabilities, a la Enron, from Banner's balance sheet to its wholly-owned "captives" and other affiliates. As false "surplus" was created by this scheme, L&G caused Banner to pay more than $800 million in "extraordinary stockholder dividends."
  4. Importantly, L&G executives have stated, in press releases to its United Kingdom investor audience, that it was repatriating capital and profits from Banner, its American insurer, through an "internal reinsurance arrangement."
  5. This "internal reinsurance arrangement" has been called "financial alchemy" by New York's former Superintendent of Financial Services, Benjamin M. Lawsky. In reality, Banner merely dumped approximately $4 billion worth of liabilities into wholly-owned captive reinsurance companies that are incapable of satisfying their assumed obligations, thereby freeing up hundreds of millions of dollars Banner would otherwise be legally required to hold as reserves.
  6. Banner's captive reinsurance companies are strategically domiciled in jurisdictions that, amazingly, allowed the "reinsurers" not to file any public financials, hiding the true nature and details of these transactions.
  7. After engaging in this financial alchemy for a decade, Banner decided to embark upon a new scheme to take U.S. policyholder funds and send them to L&G, ultimately to benefit shareholders. In September 2015, Banner suddenly increased the Cost of Insurance ("COI") charged to certain universal life insurance policyholders; in some cases, by as much as 620 percent.
  8. Through mailers, press releases, and myriad other mediums, Banner has told policyholders that dramatic COI increases are necessary because "the company did not adequately account for future experience." Banner and LGA define "experience" as "the number and timing of death claims; how long people would keep their policies; how well the company's investments would perform; and the cost to administer policies." Apparently suffering from corporate amnesia, Banner, LGA, and L&G forgot that they told insurance examiners, policyholders, rating agencies, and shareholders the exact opposite for more than a decade to justify paying extraordinary dividends and encourage investment by both policyholders and shareholders.
  9. Since September 2015, Banner has systematically raided policyholder accounts, arguing that its action is permitted by the policies' terms. In reality, the justifications offered by Banner are false, and merely a guise to accomplish two objectives: (1) find new cash with which to fund future dividends, and (2) rid itself of near-term liabilities, and delay inevitable financial disaster.
In December 2016 the two affiliates were dropped from the case. The case is progressing. (See Dickman v. Banner, U.S. District Court, District of Maryland, Case No. 1:16-cv-192.)

The Transamerica Case
In November 2016 Tommy Hill filed an 86-page, nine-count complaint against Transamerica Life Insurance Company and three Transamerica affiliates. In January 2017 the three affiliates were dropped from the case. The case is progressing. (See Hill v. Transamerica, Circuit Court of Jefferson County, State of Alabama, Case No. 2016-6000401.)

The Voya/Lincoln Case
In February 2017 Monte Swenson and five other individuals filed a class action complaint against Voya Financial Inc. and one Voya affiliate, and against Lincoln National Corp. and two Lincoln affiliates. The case was filed initially in federal court in Washington State. In June the judge granted a motion by the defendants to transfer the case to New York. The number of plaintiffs expanded to 15 individuals. In August the plaintiffs filed a first amended complaint. In October the plaintiffs filed a 98-page, 14-count second amended complaint that included two RICO (Racketeer Influenced and Corruption Organizations Act) counts. In November the plaintiffs filed a notice of voluntary dismissal "without prejudice to Plaintiffs' right to refile." (See Swenson v. Voya, U.S. District Court, Eastern District of Washington, Case No. 2:17-cv-48, and Southern District of New York, Case No. 1:17-cv-4843.)

The Second Banner Case
In March 2017 irrevocable insurance trusts of Robert Appel and one other individual filed a 32-page, one-count class action complaint against Banner. In June the plaintiffs stipulated that the case was stayed until final resolution of the first Banner case. (See Appel v. Banner, U.S. District Court, District of Maryland, Case No. 1:17-cv-759.)

The William Penn Life Case
In July 2017 Lesley Rich filed a complaint against William Penn Life Insurance Company of New York. In October the plaintiff filed an 83-page, two-count amended complaint. The case is progressing. (See Rich v. William Penn Life, U.S. District Court, District of Maryland, Case No. 1:17-cv-2026.)

The Book about Enron
The third paragraph quoted above from the introduction to the complaint filed in the first Banner case refers to Enron. In 2003, two years after Enron filed for bankruptcy, a 435-page book about the Enron case was published. The book is entitled The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. The authors are Bethany McLean and Peter Elkind. A tenth anniversary edition was published in 2013; it includes a foreword by Joe Nocera and an afterword by the authors. Many view the book as the definitive account of the Enron scandal, and I strongly recommend the book.

General Observations
I refer to the use of shadow insurance as a shell game often used to impose large COI increases on the owners of universal life insurance policies. It is a shell game because the details of the phony assets are shielded from public scrutiny. I have tried to see those details, but have been rebuffed. In Iowa, where Transamerica Life is domiciled, I tried to examine the phony assets used by the company's Iowa LPSs. After the Iowa insurance division denied my requests under the Iowa open records law, I filed a lawsuit against the division seeking access to the documents. I lost the case on the grounds that Iowa laws and regulations (drafted by insurance company attorneys) render the documents confidential.

I do not know when or how, but there is no doubt that the shell game will collapse. When it does, I fear that the primary victims will be life insurance policyholders who placed their faith in the companies.

Available Material
I am offering a complimentary 103-page PDF consisting of the complaint in the first Banner case (79 pages) and the Lawsky report alluded to in the fifth paragraph of the complaint in that case. (24 pages). Email and ask for the December 2017 package about shadow insurance and COI increases.