Monday, June 22, 2015

No. 104R: Guardian Life Rectifies an Unsuitable Rollover (revised)

[Note: In this revision, Scott Witt is correctly identified as a fee-only insurance advisor. In the original version, I identified him as a fee-only financial advisor. I regret the error.]

In August 2013, Beatrice (not her real name), a 78-year-old resident of New York State, rolled over her retirement accumulation at College Retirement Equities Fund (CREF) into an individual retirement account (IRA) containing a variable annuity issued by Guardian Insurance & Annuity Company, a subsidiary of Guardian Life Insurance Company of America. The rollover was unsuitable. Guardian eventually rectified the situation to Beatrice's satisfaction.

Edgar Montenegro
Edgar Montenegro (CRD# 4768006) is a registered representative of Park Avenue Securities, a Guardian subsidiary. He sold Beatrice on the idea of using her CREF accumulation to buy the Guardian annuity.

Scott Witt
Scott Witt is a Fellow of the Society of Actuaries, a Member of the American Academy of Actuaries, a fee-only insurance advisor, and a Financial Services Affiliate of the National Association of Personal Financial Advisors. His website is at www.wittactuarialservices.com.

Several months after the rollover, Beatrice sought Witt's advice. In March 2015, Witt posted an article about the case on his website. The article, written before the case was resolved, was entitled "An Embarrassing Variable Annuity Sale—and Refusal to Make Amends." Witt did not identify Beatrice, Montenegro, or the companies.

The CREF Accumulation
CREF and its affiliate, Teachers Insurance and Annuity Association of America (TIAA), cater mainly to members of the academic community. Beatrice's retirement accumulation with CREF was $325,000. According to Witt, CREF's annual expense charges were 41 basis points. Because a basis point is one hundredth of a percentage point, the expense charges were less than one half of 1 percent.

Problems with the Rollover
In his article, Witt cited five problems with the rollover. First, a benefit of a variable annuity is that investment earnings are deferred for income tax purposes. However, Beatrice already had that benefit with her CREF accumulation. Witt considers it unnecessary and inappropriate to place a tax deferral vehicle inside an IRA, which is a tax deferral vehicle.

Second, according to Witt, the Guardian annuity imposed 110 basis points of annual mortality and expense charges, 75 basis points of annual investment expense charges, and 20 basis points of annual administrative expense charges. The sum of 205 basis points far exceeded the 41 basis points for the CREF accumulation.

Third, the Guardian annuity included a death benefit at an annual cost of 50 basis points. According to Witt, Beatrice did not need the death benefit.

Fourth, the Guardian annuity included a rider guaranteeing that the eventual lifetime income from the annuity would be enhanced significantly if Beatrice avoided making withdrawals for ten years. The annual cost of the enhanced lifetime income guarantee was 115 basis points.

Fifth, Witt cited "a mistake in the purchase paperwork." Beatrice applied to have $200,000 of her $325,000 CREF accumulation rolled into the Guardian annuity. However, when the annuity was issued, the entire $325,000 was rolled into the annuity. Witt said "it's unclear which financial institution was responsible but it clearly was not Beatrice's mistake." Witt told me CREF informed Beatrice that there were some unauthorized telephone calls regarding her account around the time of the rollover. The "mistake" caused Beatrice to forfeit the enhanced lifetime income guarantee because she had to take required minimum distributions from the Guardian annuity to avoid draconian income tax penalties.

Complaint and Rejection
On July 26, 2014, Beatrice, aided by Witt, registered a complaint with Guardian. She explained why the rollover was unsuitable and asked for a full refund without the surrender charge of about $31,000.

On September 10, 2014, Judy Cummins, a complaint analyst at Park Avenue Securities, rejected the complaint in a four-page letter. She mentioned such things as the information in the prospectus, Beatrice's statement that she had read the prospectus, her agreement to the contract terms, her failure to ask for a full refund during the ten-day free look, and her statement that she would not need access to the funds. According to Cummins, Montenegro said he spoke with Beatrice after the $325,000 rollover (instead of the originally requested $200,000 rollover) and Beatrice agreed to it. Cummins said Park Avenue Securities "found no evidence of impropriety on the part of your Representative" and "We therefore respectfully reject your request for remuneration."

My Letter to Guardian
I knew about Beatrice before Witt posted his article, because he had told me about the case. I felt that Guardian would not have rejected the complaint if the company had conducted a thorough investigation.

On April 24, 2015, I sent a two-page letter by regular mail to Deanna Mulligan, president and chief executive officer of Guardian. I said I was going to post an article about the case on my blog. I said I would not identify Beatrice, but would indicate her age and say she is a resident of New York State. I asked Guardian for a statement, suitable for inclusion in the article, explaining how Guardian will restore Beatrice to her original financial position, or, alternatively, why Guardian will not restore her to her original financial position. I sent copies of the letter to Beatrice, Montenegro, Cummins, Witt, and Roger Ferguson, chief executive officer of TIAA-CREF. I requested the statement by May 11.

Guardian's Response
Jeanette Volpi is head of external communications at Guardian. On May 8, I received this statement from her by e-mail:
Guardian is legally constrained by federal privacy laws, as well as the Company's privacy policy, from providing client information publicly, but can confirm we are working directly with the client identified to address her concerns.
Guardian conducted an investigation and resolved the matter to Beatrice's satisfaction. The settlement terms are confidential.

General Observations
It is unfortunate that the rollover ever took place, and that Guardian initially rejected Beatrice's complaint. However, the company is to be commended for eventually doing the right thing.

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Friday, June 19, 2015

No. 105: Phoenix Changes Its Independent Auditor

On June 11, 2015, Phoenix Companies, Inc. filed an 8-K (material event) report disclosing that it changed its independent registered public accounting firm. Phoenix dismissed PricewaterhouseCoopers LLP (PwC) and appointed KPMG LLP, effective June 11. Normally an auditor change at a large public company is major news, but in this case the change appears to have slipped under the media radar.

10-K Report for 2014
On March 31, 2015, Phoenix filed its 10-K report for 2014. Included was PwC's independent auditor report dated March 30. PwC expressed the opinion that the financial statements present fairly the financial position of the company in conformity with generally accepted accounting principles. PwC also expressed the opinion that the company did not maintain effective control over financial reporting in several areas.

Proxy Statement
On April 2, 2015, Phoenix filed its proxy statement announcing the annual shareholder meeting scheduled for May 14. The board recommended that the shareholders ratify the appointment of PwC as the independent registered public accounting firm for fiscal year 2015.

Audit Committee Report
The proxy statement included the report of the audit committee of the Phoenix board of directors. The audit committee report said:
Notwithstanding the Audit Committee's appointment of PwC for fiscal 2015 and the outcome of the shareholder vote on this proposal, the Audit Committee has authorized and directed management to engage in a request for proposal process to identify an independent registered public accounting firm for potential appointment to audit and report on our consolidated financial statements for fiscal year 2015... PwC has indicated to management its intention to participate in this request for proposal process. As a result of the request for proposal process, PwC may remain our independent registered public accounting firm for 2015 or another independent registered public accounting firm may be selected. The determination by the Audit Committee to retain PwC or appoint another independent registered public accounting firm is expected to be made subsequent to the 2015 Annual Meeting.
The audit committee said audit costs in 2014 and 2013 were $52.3 million and $58.3 million, respectively. Those amounts included audit fees of $33.8 million and $24.7 million, respectively, and additional fees associated with the restatement of financial statements for the periods included in the 10-K report for 2012.

Shareholder Meeting
On May 15, Phoenix filed an 8-K report about the shareholder meeting. The company said 3,408,701 shareholders voted for ratification of the appointment of PwC, 793,015 voted against, and 8,673 abstained.

8-K Report Filed June 11
Phoenix said in the 8-K report filed June 11 that there were no "disagreements" or "reportable events," as those terms are defined in the regulations. In a news release attached to the 8-K as an exhibit, the company said: "The change was not the result of any disagreement between the company and PwC on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure." Also. as indicated in the audit committee report, PwC participated in the request for proposal process.

General Observations
It seems clear that PwC did not resign and was not fired. I believe that the audit committee's request for proposal process and subsequent auditor change grew out of cost concerns.

Available Material
I am offering a complimentary 15-page PDF consisting of three items: the 3-page independent auditor's report by PwC dated March 30; the 4-page audit committee report included in the April 2 proxy statement; and the 8-page 8-K report dated June 11, including its two exhibits. E-mail jmbelth@gmail.com and ask for the Phoenix auditor change package.

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Monday, June 15, 2015

No. 103: Phoenix Moves to Settle Two Cost-of-Insurance Lawsuits

On May 1, 2015, Phoenix Companies, Inc. filed an 8-K (material event) report with the Securities and Exchange Commission disclosing that the company is moving to settle two of several long-standing class action lawsuits. The complaints were filed because of cost-of-insurance (COI) increases on variable universal life policies of the type used in stranger-originated life insurance (STOLI). Phoenix made the move when the cases were about to go to trial. (See Fleisher v. Phoenix Life Ins. Co. and SPRR v. PHL Variable Ins. Co., U.S. District Court, Southern District of New York, Case Nos. 11-cv-8405 and 14-cv-8714.)

The description of the settlement in the 8-K filed May 1 was very brief.  For that reason, I postponed writing about the settlement until I could see it.  Phoenix filed it in court on May 29, and as an exhibit to another 8-K on June 3.

 Background of the Dispute
Phoenix first imposed COI increases on the STOLI policies in 2010. The company rescinded the 2010 increases, but only for New York policyholders, when the New York Department of Insurance ordered the company to do so. The company then imposed COI increases in 2011 on New York policyholders without objection from the Department.

California and Wisconsin regulators ordered Phoenix to rescind the 2010 increases, but the company refused. California did not pursue the matter. Wisconsin began administrative proceedings and prevailed, but Phoenix appealed and the matter is in litigation.

Several class action lawsuits were filed against Phoenix by angry policyholders. I wrote about some of the cases in the October 2012, December 2012, and November 2013 issues of The Insurance Forum, and in blog post No. 9 (November 13, 2013).

Purposes of the Agreement
U.S. District Court Judge Colleen McMahon has been handling the two cases. In the recent filing, the parties sought her preliminary approval of the settlement, certification of a class solely for the purposes of the settlement, approval of the notice to class members giving them an opportunity to object to or opt out of the settlement, and approval of the plan for a fairness hearing. Judge McMahon promptly issued an order preliminarily approving the above items and appointing an administrator.

Thrust of the Dispute
The agreement, reached with the help of a mediator, includes brief descriptions of the parties' views. Here is the language:
The [Plaintiffs] alleged, in part, that Defendants' decision to raise cost of insurance rates on certain policies in April 2010 and on other policies beginning in November 2011 was unlawful and in violation of the terms of the Policies. These complaints further alleged that Defendants' rate increases did not apply uniformly to a class of insureds, discriminated unfairly between insureds of the same class, and were designed to recoup past losses.
Defendants deny any and all allegations of wrongdoing and do not admit or concede any actual or potential fault, wrongdoing, liability, or damage of any kind to Named Plaintiffs and the putative settlement class in connection with any facts or claims that have been or could have been alleged against them in the Actions. Defendants deny that they acted improperly or wrongfully in any way, believe that the Actions have no merit and contend that Named Plaintiffs' claims are improper as a matter of law. Defendants further contend that their decisions to implement the cost of insurance increases were, at all times, in accordance with the Policies' terms and accepted actuarial standards.
Structure of the Agreement
The basic document is a stipulation of settlement. Phoenix agrees to create a $42.5 million settlement fund and agrees not to object to a request for plaintiffs' attorney fees of one-third of the settlement fund (about $14.2 million). Phoenix agrees to pay plaintiffs' attorney expenses and the settlement expenses out of the settlement fund, leaving a net settlement fund of around $27 million. Phoenix agrees to pay an additional $6 million in plaintiffs' attorney fees outside the settlement fund, so that the total plaintiffs' attorney fees are about $20.2 million. No funds will revert to Phoenix, and the settlement includes broad releases. The parties entered into a separate, confidential agreement allowing Phoenix to terminate the agreement in the event too many class members opt out.

The system for allocating the net settlement fund among the class members is the responsibility of the plaintiffs' attorneys. Phoenix states that it is not insolvent, and that the payments required under the settlement will not render Phoenix insolvent. Phoenix agrees not to impose further COI increases on the class members until after the end of 2020.

There are three exhibits attached to the stipulation of agreement. Exhibit A is the notice to be sent to class members informing them of the settlement, offering them an opportunity to object to or opt out of the settlement, and inviting them to attend the fairness hearing.

Exhibit B is the proposed order for Judge McMahon to issue. She crossed out the word "proposed" and issued the order on June 3. She preliminarily approved the settlement as "fair, reasonable and adequate to the class," conditionally certified the class for purposes of the settlement, appointed Susman Godfrey LLP as class counsel for purposes of the settlement, appointed Rust Consulting as the settlement administrator. and scheduled a hearing for September 9, 2015.

Exhibit C shows proposed letters providing required notices to certain interested parties about the proposed agreement. Among those parties are the U.S. Attorney General, the coordinator of the federal Class Action Fairness Act, and state insurance regulators.

The Brief Initial Description
As mentioned earlier, the description of the settlement in the 8-K filed May 1 was very brief. Phoenix said it "will establish a Settlement fund," "will pay a class counsel fee if the Settlement is approved," "agreed to pay a total of $48.5 million," and "expects to incur a $48.5 million charge in the first quarter of 2015."

The brief description implied that Phoenix is proposing to create a $48.5 settlement fund. As explained above, the gross settlement fund is $42.5 million, and the other $6 million is an extra payment to the plaintiffs' attorneys.

General Observations
I am not sufficiently familiar with the cases to express an opinion about the fairness of the proposed settlement, or about whether the $20.2 million in fees for the plaintiffs' attorneys are reasonable. I also do not know whether the system the plaintiffs' attorneys will use to allocate the net settlement fund of around $27 million will be fair.

I am puzzled about the provision under which Phoenix promises not to impose further COI increases until after 2020. All the insureds were at least 68 years old when the policies were issued about a decade ago, and by 2021 the surviving insureds will be in their 80s and 90s.

It is impossible to know what will happen in the other COI lawsuits in which Phoenix is involved. However, the proposed settlement provides a template for settlements of those cases.

Available Material
I am offering, as a complimentary 77-page PDF, the version of the settlement filed in court on May 29. E-mail jmbelth@gmail.com and ask for the Phoenix COI settlement.

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Tuesday, May 26, 2015

No. 102: Life Partners—The Chapter 11 Trustee Lowers the Boom

On May 20, 2015, H. Thomas Moran II, the Chapter 11 Trustee in the bankruptcy case of Life Partners Holdings, Inc. and its subsidiaries (collectively, "Life Partners"), filed numerous documents. The key document is the "Declaration of H. Thomas Moran II in Support of Voluntary Petitions, First Day Motions and Designation as Complex Chapter 11 Case." The 39-page sworn declaration describes the background of the case and reports the results to date of the Trustee's investigation into the activities of Life Partners.

The Finding of Fraud
A major section of the declaration is the "Initial Findings of Trustee's Investigation." The Trustee said: "As a result of my investigation to date, I have concluded that Life Partners devised and executed a wide-ranging scheme to defraud its Investors." The Trustee also said the fraud "took place over the course of a number of years" and "occurred in a number of ways, including, but not limited to" these fourteen activities:

  • Use of artificially shortened life expectancies in the sale of its so-called "fractional investments";
  • Material misrepresentation of the returns Investors could expect;
  • Misrepresentations regarding whether policies had lapsed and resale of lapsed interests;
  • Use of so-called "escrow companies," including one with the word "trust" in its name, as instrumentalities of, and cover for, the fraudulent scheme;
  • Charging massive, undisclosed fees and commissions, the total of which, in many cases, exceeded the purchase price of the policies themselves;
  • Repeated misrepresentation of Life Partners' business practices in order to maneuver around securities regulatory regimes;
  • Egregious and continuous self dealing by insiders;
  • Failure to disclose CSV [cash surrender values];
  • Forcing Investors to abandon Contract Provisions, many of which were then resold for personal gain;
  • Systematic financial mismanagement, including improper payment of dividends;
  • Faulty and inconsistent record keeping, including with respect to the purported "escrow" companies and "trusts";
  • Commingling and unauthorized use of investor monies;
  • The offer and sale of unregistered securities; and
  • Implying the investment structure was a permissible investment for an IRA [individual retirement account], and failing to disclose the risks if it was not.
A major portion of the Trustee's declaration is devoted to detailed descriptions of the above elements of the "wide-ranging" fraud. The findings go far beyond the allegations by the Securities and Exchange Commission that led to what I referred to in No. 75 (posted December 10, 2014) as the "death sentence" imposed on Life Partners by Senior U.S. District Court Judge James R. Nowlin. The findings make clear why Life Partners and its senior officers fought so hard to continue operating the company during the bankruptcy proceedings and to oppose the appointment of an independent trustee who would have total access to the company's records of its activities.

The Trustee's Plans
At the same time, the Trustee filed eleven emergency motions. They include such items as joint administration of the Life Partners companies, payment of employee wages, payment of property and liability insurance premiums, payment for utilities, and payment of taxes. There is also a motion for authority to change the beneficiary designations on the policies that make up the fractional interests in the life settlements sold by Life Partners so as to eliminate the escrow companies and the expenses associated with the escrow companies. There is also a motion to approve a plan for paying premiums on those policies so as to make sure that those policies remain in force.

My Question
In earlier postings I expressed the opinion that the Trustee and the bankruptcy court judge would do everything possible to protect the owners of fractional interests in the life settlements sold by Life Partners. I am asking the Trustee a question about his plans for those policies, and I will report his answer.

Availability of the Declaration
Meanwhile, I am offering a complimentary 39-page PDF containing the Trustee's declaration. E-mail jmbelth@gmail.com and ask for the Trustee's May 20 declaration in the Life Partners bankruptcy case.

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Wednesday, May 13, 2015

No. 101: Life Partners and the Texas Supreme Court

On May 8, 2015, in a landmark opinion delivered by Justice Jeffrey S. Boyd, the Texas Supreme Court ruled that the life settlement agreements sold by Life Partners, Inc. (Waco, TX), an operating subsidiary of Life Partners Holdings, Inc. (LPHI), "are investment contracts, and thus securities, under the Texas Securities Act." No dissent was filed.

The opinion is the culmination of a 20-year struggle by the now bankrupt company and Brian D. Pardo, former chief executive officer and majority shareholder of LPHI, to avoid having to comply with securities laws. The impact of the opinion on the bankruptcy case is not known, but the ruling clears the air on the status of life settlement agreements.

The Opinion
The Texas Supreme Court opinion grew out of rulings by two Texas appellate courts. The trial courts had found in favor of Life Partners, and both appellate courts had reversed the trial court decisions. The Texas Supreme Court affirmed the rulings of the two appellate courts. (See Life Partners v. Arnold, Court of Appeals for the Fifth District of Texas, No. 14-0122, and LPHI v. State of Texas, Court of Appeals for the Third District of Texas, No. 14-0226.)

The elaborate 40-page opinion not only says Life Partners' life settlement agreements are securities under the Texas Securities Act, but also declines to give the ruling only prospective application. Life Partners had requested only prospective application in the event of an adverse decision on the underlying issue. This is important because it means that the ruling applies retroactively to all of Life Partners' past activities. Here is the first paragraph of the opinion:
The primary issue in these two separate cases is whether a "life settlement agreement" or "viatical settlement agreement" is an "investment contract" under the Texas Securities Act. We hold that the agreements at issue are investment contracts because they constitute transactions through which a person pays money to participate in a common enterprise with the expectation of receiving profits, under circumstances in which the failure or success of the enterprise and the person's realization of the expected profits is at least predominately due to the entrepreneurial or managerial efforts of others. We decline to give today's holding only prospective application, and we decline to consider the merits of the "relief defendants'" evidentiary arguments. In short, we affirm the courts of appeals' judgments in both cases.
The Trustee's Reaction
I contacted H. Thomas Moran II, the Chapter 11 Trustee in the Life Partners bankruptcy case. In response to my invitation to comment on the opinion, he said:
I respect the ruling by the Texas Supreme Court. The ruling brings clarity to the bankruptcy and ultimately will benefit those affected most by the Life Partners business model.
The 1996 Federal Appellate Ruling
I wrote many articles in The Insurance Forum over the years and posted many blog items about Life Partners. My first mention of the company was in the March 1999 issue of the Forum, which was devoted in its entirety to a 12-page article entitled "Viatical Transactions and the Growth of the Frightening Secondary Market for Life Insurance Policies." The article included a section subtitled "The Life Partners Case." Here is a shortened version of that section:
In 1995 the Securities and Exchange Commission (SEC) alleged that Life Partners had violated federal securities laws by selling unregistered securities. A federal district court ruled in favor of the SEC. Life Partners appealed. On July 5, 1996, a panel of the U.S. Court of Appeals for the District of Columbia Circuit reversed the decision in a 2 to 1 ruling. The majority said a viatical transaction satisfied two of the three necessary elements in the definition of a security, but did not satisfy the third element. The dissenting judge said a viatical transaction satisfied all three elements. The SEC petitioned for a rehearing; the panel denied the petition in a 2 to 1 ruling.
The 1996 Dissent
The 1996 dissent was written by Patricia M. Wald, a distinguished jurist. She served on the D.C. Circuit from 1979 to 1999, and was its chief judge from 1986 to 1991. She also has had an outstanding career before and after her tenure on the D.C. Circuit. She served as an assistant attorney general in the administration of President Jimmy Carter before he appointed her to the D.C. Circuit. Later she served as a judge on the International Criminal Tribunal for the Former Yugoslavia and currently serves as a member of the Privacy and Civil Liberties Oversight Board.

Many who cite the 1996 appellate ruling, including Life Partners, rarely if ever mention that it was a split opinion. Judge Boyd, in the ruling last week, included an exhaustive discussion of the judicial history of the issue and quoted extensively from Judge Wald's superb dissenting opinion. It is a classic example of a dissenting opinion that was later adopted by a majority of the judges who have studied the issue.

LPHI's Pre-Bankruptcy Views
Prior to its January 2015 bankruptcy filing, LPHI, in filings with the SEC, often discussed the litigation that led to the Texas Supreme Court opinion. For example, the appellate court handed down its decision in the Arnold case on August 13, 2013. LPHI disclosed it in an 8-K (material event) report filed a full month later, despite the fact that an 8-K is supposed to be filed within four business days after the event. LPHI disagreed with the ruling and cited, among other things, the 1996 D.C. Circuit opinion without mentioning that it was a split opinion. LPHI said:
Should the decision ever become final, it would result in a material adverse effect on our operations and require substantial changes in our business model.
Availability of the Opinion
I am offering a complimentary 40-page PDF containing the recent opinion by the Texas Supreme Court. E-mail jmbelth@gmail.com and ask for the May 8 Texas Supreme Court opinion in the Life Partners cases.

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Monday, May 11, 2015

No. 100: Shadow Insurance—A Chronology of What May Become the Worst Financial Scandal in the History of the Life Insurance Business

"Shadow insurance" usually refers to reinsurance used to weaken (reduce) life insurance reserves, which are liabilities that measure a company's obligations to policyholders. Shadow insurance also involves questionable financial instruments such as parental guarantees, letters of credit, and contingent notes. The details of such instruments are shrouded in secrecy, and the reasons for the secrecy have not been explained.

Shadow insurance may become the worst financial scandal in the history of the life insurance business. The chronology presented here may be useful for those interested in the welfare of the life insurance business, including those who depend on life insurance protection.

1858
Elizur Wright, later called "The Father of Life Insurance," is appointed insurance commissioner of Massachusetts, thereby becoming the first insurance regulator in the U.S., and begins his campaign to require life insurance companies to establish adequate reserves.

1863
August Zillmer, a German actuary, publishes article explaining a method (used in the U.S. beginning about 40 years later) by which to weaken life insurance reserves.

1932
State insurance regulators allow life insurance companies to use, in financial statements for the end of 1932, asset values as of June 30, 1931.

1979
Universal life insurance is introduced.

April 1993
Prudential Insurance Company of America, to save $100 million in federal income taxes, issues $300 million of surplus notes through a confidential private offering to qualified investors.

1994
National Association of Insurance Commissioners (NAIC) begins to require "Triple-X" reserves designed to offset efforts by companies to weaken reserves through clever policy designs.

February 1994
Article entitled "The Recent Flurry of Controversial Surplus Notes" appears in The Insurance Forum.

March 2004
Article entitled "Secondary Guarantees, Marketers, Actuaries, Regulators, and a Potential Financial Disaster for the Life Insurance Business" appears in The Insurance Forum.

2009
NAIC adopts model law that includes reference to so-called principles based reserves designed to allow actuaries to use judgment in establishing reserves rather than using formulas in insurance statutes.

February 2009
Article entitled "Capital Infusions into Life Insurance Companies by Weakening Statutory Accounting Rules" appears in The Insurance Forum.

March 2011
Frederick Andersen, a New York Department of Financial Services (NYDFS) actuary, sends a letter to NAIC concerning what NYDFS perceives as inadequate reserves for universal life policies with secondary guarantees.

February 2012
Article entitled "The Controversy over Reserves for Universal Life Policies with Secondary Guarantees" appears in The Insurance Forum.

July 2012
NYDFS begins investigation of shadow insurance.

March 2013
Article entitled "A Review of More Than a Century of Efforts to Weaken Life Insurance Reserves" appears in The Insurance Forum.

April 18, 2013
NYDFS Superintendent Benjamin Lawsky, in a speech, discloses the existence of NYDFS investigation of shadow insurance.

June 11, 2013
Article by Mary Williams Walsh entitled "Insurers Inflating Books, New York Regulator Says" appears in The New York Times.

June 12, 2013
NYDFS issues report entitled "Shining a Light on Shadow Insurance: A Little Known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk."

August 2013
Moody's Investors Service issues report entitled "The Captive Triangle: Where Life Insurers' Reserves and Capital Requirements Disappear."

September 30, 2013
Article by Alistair Gray entitled "Shadow Insurance Schemes Multiply to $360 Billion" appears in Financial Times.

February 2014
Rector & Associates, consulting firm retained by NAIC, submits report to NAIC concerning shadow insurance.

April 1, 2014
Paper by Ralph Koijen and Motohiro Yogo entitled "Shadow Insurance" is published by Federal Reserve Bank of Minneapolis.

April 22, 2014
Joseph M. Belth blog post No. 44 discusses certain notes to 2013 statutory financial statement filed by Iowa-domiciled Transamerica Life Insurance Company concerning a massive increase in surplus resulting from use of accounting practices permitted in Iowa.

April 23, 2014
Class action lawsuit is filed against AXA Equitable Life Insurance Company following NYDFS report on shadow insurance. (See Yale v. AXA Equitable, U.S. District Court, Southern District of New York, No. 1:14-cv-2904.)

June 2014
Rector submits to NAIC a modified report which, according to Superintendent Lawsky, "essentially defanged" the February 2014 report.

August 12, 2014
Superintendent Lawsky sends letter to his fellow insurance commissioners deploring weak response of NAIC to problems of shadow insurance and improper use of captive reinsurance companies.

August 17, 2014
NAIC Executive Committee issues recommendations based on modified report submitted by Rector.

November 6, 12, 19, 2014
Belth blog post Nos. 71, 72, and 73 discuss frightening accounting rules promulgated in Iowa.

December 18, 2014
Article by Mary Williams Walsh entitled "Regulators Deem MetLife 'Too Big to Fail' Institution" appears in The New York Times and discusses MetLife's designation as "systemically important financial institution" by Financial Stability Oversight Council.

April 12, 2015
Article by Mary Williams Walsh entitled "Risky Moves in the Game of Life Insurance" appears in The New York Times.

May 6, 2015
Belth blog post No. 99 discusses report released by American Academy of Actuaries on April 27, 2015 entitled "Key Ethical Concerns Facing the Actuarial Profession," in which by far the most serious ethical concern expressed by Academy members in 2012 survey was "responding to pressure from principals and/or management to select inappropriate assumptions used in pricing or reserving."

Available Material
Complimentary packages offered in Belth blog posts remain available. E-mail jmbelth@gmail.com and specify package(s) desired. All issues of The Insurance Forum are available in hard copy. E-mail belth@theinsuranceforum.com for ordering information.

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Wednesday, May 6, 2015

No. 99: Actuarial Ethics—The American Academy of Actuaries Releases a Significant and Timely Report

On April 27, 2015, the American Academy of Actuaries announced release of a 31-page report entitled "Key Ethical Concerns Facing the Actuarial Profession" and subtitled "Perceptions of Members of the American Academy of Actuaries." The report is based on a 2012 survey of Academy members by the Academy's Council on Professionalism (COP). Among the 18 potential ethical issues identified in the report, by far the most significant issue perceived by Academy members is "responding to pressure from principals and/or management to select inappropriate assumptions used in pricing or reserving."

The 2012 Survey
The 2012 survey was prepared by members of the COP, Professors Rahul Parsa and Garry L. Frank of Drake University, and the Academy. The cover letter on the survey was from Karen Fulton Terry, MAAA, FCAS, who at the time of the survey was vice president of the Academy and chairperson of the COP. She is listed in the current directory of the Society of Actuaries as assistant vice president and actuary in the home office of State Farm Mutual Automobile Insurance Company.

The key finding about pressure from principals and/or management with regard to assumptions used in pricing or reserving is timely in view of the ongoing controversy over reserve adequacy, shadow insurance, accounting practices permitted by individual states, and so-called principles based reserves. The other four of the top five ethical concerns are: (2) "false or misleading representation of products or services in marketing, advertising, or sales efforts," (3) "failure to take appropriate action when another actuary misrepresents information," (4) "conflicts of interest between opportunities for personal financial gain (or other personal benefits) and proper performance of one's responsibilities," and (5) "misrepresenting or concealing limitations in one's abilities to provide services."

More than 3,300 Academy members responded to the survey. The members were asked to rate each of 18 potential ethical concerns on a scale of 1 to 5, where 1 means it is not an ethical concern and 5 means it is a major ethical concern.

Availability of the Report
The Academy announced release of the report in a news item dated April 27, 2015, and provided a link to a PDF containing the full report. The following notice is at the bottom of every page except the cover page: "©2015 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission."

I immediately sent an e-mail request to the Academy for permission to offer a complimentary PDF of the full report to my readers. In my request, I mentioned the need for an immediate response.

Mary E. Downs, executive director of the Academy, responded promptly. She denied my request, but she also said:
We have, as you know, made the full report freely available on the Academy website, and you can refer your readers to our website for the complete report. We will also be having a webinar on the topic, and will be discussing it thoroughly in that venue on May 22. We will be continuing to have discussions about the report in Academy meetings and events.
A link to the report is on the home page of the Academy's website at www.actuary.org. I urge interested readers to read the report, and would welcome comments from those who read it.

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Tuesday, May 5, 2015

No. 98: Life Partners and the Improvement of the Bankruptcy Trustee's Website

In No. 95 posted April 27, I discussed the inadequacy of the website established by H. Thomas Moran II, the Chapter 11 Trustee in the bankruptcy case of Life Partners Holdings, Inc. (LPHI) to keep affected parties informed about the case. Three developments occurred the next day: (1) the Trustee sent a letter to those with interests in the life settlements sold by Life Partners, Inc. (LPI), the primary operating subsidiary of LPHI; (2) the Trustee significantly improved his website; and (3) LPHI filed an 8-K (material event) report with the Securities and Exchange Commission (SEC).

The Trustee's April 28 Letter
The April 28 letter was addressed to "LPI position holders," provided background, said there are well over 20,000 "parties in interest" in the bankruptcy proceeding, expressed the Trustee's understanding of how distressing the situation is for interested parties, and described the Trustee's undertakings since his appointment. The letter stated in part:
It is my goal to preserve your interests, reduce financial obligations and to provide you with information on an ongoing basis. However, please remember, this will not be a simple process and will take some time.
The Trustee said in the letter that he has reduced the ministerial service fees. He described the reduction and enclosed a bill covering the six-month period from September 2014 through February 2015.

The Improved Trustee's Website
The Trustee's significantly improved website (www.lphitrustee.com) includes extensive background on the bankruptcy proceedings and provides links to all recent LPHI filings with the SEC. The website also provides links to all major filings in the bankruptcy court case.

The April 28 8-K Report
On April 28 LPHI filed an 8-K report with the SEC. Attached to the report was an exhibit showing 19 frequently asked questions and the answers to them, as well as an exhibit showing the April 28 Trustee's letter to LPI position holders.

General Observations
The Trustee is to be commended in general for improving his communication with parties affected by the LPHI bankruptcy, and in particular for the improvement in his website. I think his actions are good news for the holders of fractional interests in LPI's life settlements.

I am offering a complimentary 11-page PDF containing the April 28 8-K report, which includes an exhibit showing the frequently asked questions and the answers to them, and an exhibit showing the Trustee's April 28 letter to LPI position holders. Send an e-mail to jmbelth@gmail.com and ask for LPHI's April 28 8-K report.

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Monday, May 4, 2015

No. 97: Senator Elizabeth Warren Investigates Annuity Sales Incentives

On April 28, 2015, U.S. Senator Elizabeth Warren (D-MA) sent a five-page letter to the chief executive officer of each of 15 major issuers of annuities seeking "information on rewards and incentives offered by your company to brokers and dealers who sell annuities to families and small investors." The response date is May 11. Senator Warren identifies herself in the letter as the Ranking Member of the Subcommittee on Economic Policy of the Committee on Banking, Housing, and Urban Affairs. Her office released copies of the 15 letters, a press release, and several examples of the incentives.

The Companies Contacted
Senator Warren sent her letter to the companies referred to in her press release as "15 of the largest annuity providers today." The companies, using the names shown in the letters, are AIG Companies, Allianz Life Insurance Company of North America, American Equity Investment Life, AVIVA, AXA Equitable, Jackson National Life Insurance Company, Lincoln Financial Group, MetLife, Nationwide Financial, New York Life, Pacific Life, Prudential Annuities, RiverSource Life Insurance, TIAA-CREF, and Transamerica.

The Information Requested
The second paragraph of Senator Warren's letter lays the foundation for her request. The paragraph reads:
A preliminary review by my staff reveals that annuity providers offer a vast range of perks—from cruises to international travel to iPads to diamond-encrusted "NFL Super Bowl Style" rings to cash and stock options—to entice sales of their products. I am concerned that these incentives present a conflict of interest for agents and financial advisers that could result in these agents providing inadequate advice about annuities to investors and selling products that may not meet the retirement investment needs of their buyers.
Senator Warren's specific request for information is near the end of her letter. The four components of her request are:
  1. A list of all incentives—including cash awards, cruises or other vacations, electronics, jewelry, and any other items of value—that are awarded by your company to agents, brokers, FMOs [field marketing organizations], or other sellers or middlemen involved in sales of your annuity products.
  2. Documents and information provided to agents, brokers, FMOs, or other sellers or middlemen involved in sales of your annuity products describing the incentives and the qualifications for earning those incentives.
  3. Information on the number of each of these incentives awarded to agents, brokers, FMOs, or other sellers or middlemen involved in sales of your annuity products, and the total value of each of those incentives.
  4. A copy of your company policies for disclosing and describing sales incentives and conflicts of interests to annuity purchasers. 
The ACLI Comment
Senator Warren's letter prompted the American Council of Life Insurers (ACLI) to issue a comment entitled "Comprehensive Regulations Protect Consumers' Interests In Annuity Sales." The ACLI comment describes "Product Content and Marketing Rules," "Sales Practices Requirements" including references to four model regulations promulgated by the National Association of Insurance Commissioners (NAIC), and "Federal Laws and Regulations." The ACLI comment does not mention the incentives that are at the heart of Senator Warren's investigation.

The NAIC Comment
When I saw Senator Warren's material and the ACLI comment on it, I asked the NAIC for a comment. In response, I obtained a short comment from Monica Lindeen. She is the president of the NAIC and the Montana commissioner of securities and insurance. The NAIC comment, like the ACLI comment, mentions various model laws, model regulations, and other materials, but does not mention the incentives that are at the heart of Senator Warren's investigation.

The DOL Proposed Rule
On February 23, 2015, President Barack Obama asked the U.S. Department of Labor (DOL) "to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests." On April 14, DOL issued a press release announcing a request for public comment on "a proposed rule that will protect 401(k) and IRA investors by mitigating the effect of conflicts of interest in the retirement investment marketplace." DOL also issued a "Fact Sheet" and other materials about the proposed rule. On April 20, DOL published the proposed rule in the Federal Register.

General Observations
The investigation launched by Senator Warren is long overdue. I agree with her that the widespread use of sales incentives is a serious problem. It is surprising that the insurance and securities regulators have not explored this area. It is disappointing, but understandable given the circumstances, that the vacuous comments by the ACLI and the NAIC merely call attention to existing rules and regulations without making any direct reference to the subject of Senator Warren's investigation. The comments therefore imply—incorrectly in my view—that there is no cause for concern because annuity sales activities are regulated. 

I am offering a complimentary 19-page PDF consisting of one of the five-page letters, the four pages of examples, the one-page press release, the three-page ACLI comment, the one-page NAIC comment, and the five-page "Fact Sheet" concerning the DOL proposed rule. Send an e-mail to jmbelth@gmail.com and ask for the Warren annuity incentives package.

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Wednesday, April 29, 2015

No. 96: STOLI and the Bazemore Criminal Case

On April 21, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit handed down a unanimous ruling in a criminal case against Vincent Bazemore. I did not write about the case previously, but the appellate ruling prompted me to do so at this time.

The Criminal Charges
On October 3, 2012, a federal grand jury indicted Bazemore on four counts of mail fraud in a scheme to obtain commissions by inducing insurance companies to issue stranger-originated life insurance (STOLI) policies to unqualified applicants. The counts relate to three policies issued by Principal Life Insurance Company and one issued by Transamerica Occidental Life Insurance Company. Other companies mentioned in the indictment are ING Annuity and Life Insurance Company, John Hancock Life Insurance Company, Sun Life Assurance Company of Canada, and Metropolitan Life Insurance Company. (See U.S.A. v. Bazemore, U.S. District Court, Northern District of Texas, No. 3:12-cr-319.)

The Allegations
According to the indictment, the applications Bazemore submitted contained materially false and fraudulent representations. They include but are not limited to these seven areas: (1) false and grossly inflated statements of the applicant's net worth and income, (2) forged and fraudulent letters from Certified Public Accountants verifying the false financial information in the applications and related financial documents, (3) forged signatures of the applicant, (4) false statements that the purpose of the insurance policy was for estate planning, (5) false statements that the policy was not to be transferred to third parties, (6) false statements denying third parties had promised to pay premiums in return for an assignment of the policy, and (7) false statements that the applicant was not borrowing money to pay the premiums.

Subsequent Developments
Bazemore was arrested shortly after the indictment was filed, and he has been in custody ever since. In July 2013, after a three-day trial, the jury found him guilty on all four counts in the indictment.

In March 2014 the district court judge sentenced Bazemore to 240 months in prison on each of the four counts, to run partially concurrently and partially consecutively for an aggregate sentence of 292 months, followed by three years of supervised release. The judge ordered Bazemore to pay restitution of slightly more than $4 million and a special assessment of $400. The judge did not order a fine because Bazemore does not have the resources or future earning capacity to pay a fine.

Bazemore appealed the verdict, the sentence, and the restitution. The appellate panel affirmed the verdict, vacated the sentence and the restitution, and sent the case back to the district court for proceedings consistent with the appellate opinion. The appellate panel ruled that the district court judge had erred in the calculation of the length of the sentence and the amount of restitution. The appellate opinion explains the panel's reasoning. (See U.S.A. v. Bazemore, U.S. Court of Appeals for the Fifth Circuit, No. 14-10381.)

General Observations
Bazemore's actions that led to the indictment and the guilty verdicts are outrageous. However, my impression, based on my review of actions taken by the defendants in many other STOLI cases, most of which were civil rather than criminal cases, is that Bazemore's actions are typical of actions taken by STOLI defendants.

I am offering a complimentary 32-page PDF consisting of the 15-page indictment, the one-page jury verdict, and the 16-page appellate opinion. Send an e-mail to jmbelth@gmail.com and ask for the Bazemore package.

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Monday, April 27, 2015

No. 95: Life Partners and the Inadequacy of the Bankruptcy Trustee's Website

As I reported in recent weeks, the bankruptcy court judge in the Life Partners Holdings, Inc. (LPHI) case approved the appointment of H. Thomas Moran II as the Chapter 11 Trustee to operate the company in bankruptcy, and the Trustee established a website (www.lphitrustee.com) to keep affected parties informed of developments. In this follow-up I discuss the inadequacy of the Trustee's website.

The April 17 8-K Report
On April 17 LPHI filed an 8-K (material event) report with the Securities and Exchange Commission (SEC). The report contains four disclosures, which are paraphrased below. The expression "LP Market" refers to "a password-protected, limited access, web-based platform where investors in life settlement policies could place their positions for sale to a third party." Here are the disclosures:
  1. On April 9 the Trustee suspended all company activities related to the resale of positions, including suspension of the LP Market.
  2. The Trustee is investigating the business and will determine whether to reopen the LP Market. Should he decide to do so, he will make an announcement.
  3. LPHI updated its website (www.lphi.com) to include a link to the Trustee's website. The LPHI website continues to provide access to all LPHI filings with the SEC.
  4. On April 17 the Trustee released a list of 19 frequently asked questions. They and the answers to them are in an exhibit attached to the 8-K. There are ten questions about life settlement policies, eight questions about the bankruptcy, and one question about the Official Unsecured Creditors Committee.
    5.
As of the end of the day on April 24, the Trustee's website had not disclosed the existence of the April 17 8-K, let alone its content. This is surprising, not only because the frequently asked questions and the answers to them are important, but also because the 8-K exhibit showing the questions and answers is entitled "LPHI Trustee Website FAQ."

Other Recent 8-K Reports
The April 17 8-K report was the fourth 8-K filed subsequent to the appointment of the Trustee. The first was filed March 31. It disclosed the suspension of trading in LPHI shares as of the opening of business on March 30, and also disclosed the March 25 resignations of Frederick J. Dewald and Harold E. Refuse as LPHI directors. The Trustee's website mentions the existence of the March 31 8-K and says "The filing can be viewed on the SEC's Edgar system." The reader who clicks "Read More" is given a link to the 8-K.

The second 8-K subsequent to the appointment of the Trustee was filed April 6. It disclosed the March 31 resignation of Tad Ballantyne as an LPHI director and the termination of the employment of R. Scott Peden as LPHI general counsel. The existence of the April 6 8-K is not mentioned on the Trustee's website.

The third 8-K subsequent to the appointment of the Trustee was filed April 9. It disclosed that the bankruptcy court judge held a hearing on April 6 on the Trustee's motion to amend company documents to appoint the Trustee as the sole director of LPHI's two operating subsidiaries and, if the Trustee so chooses, to place the subsidiaries in bankruptcy. It also disclosed that the judge granted the motion and that the Trustee is moving to place the subsidiaries in bankruptcy. The existence of the April 9 8-K is not mentioned on the Trustee's website, although elsewhere on the Trustee's website the reader is given access to the bankruptcy court documents relating to the Trustee's motion, the hearing on the motion, and the bankruptcy court judge's granting of the Trustee's motion.

General Observations
I still think the Trustee and the bankruptcy court judge will make their decisions in the best interests of all parties affected by the LPHI bankruptcy. However, I am disappointed by the inadequacy of the Trustee's website in keeping affected parties informed of developments.

In view of the importance of the frequently asked questions and the answers to them, I am offering a complimentary six-page PDF containing the April 17 8-K report and the exhibit showing the questions and answers. Send an e-mail to jmbelth@gmail.com and ask for LPHI's April 17 8-K.

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Monday, April 20, 2015

No. 94: The New York Times Article About the Life Insurance Shell Game—Further Observations

In No. 93 posted April 17, I discussed the April 12 article in The New York Times entitled "Risky Moves in the Game of Life Insurance." I also mentioned my writings about efforts to weaken life insurance reserves, including my recent blog items about some of the transactions mentioned in the Times article. Here I present some further observations.

Comment from Athene
In No. 93 I said Athene, one of the companies named in the Times article, released a two-page comment expressing disappointment with the article and the reporter. I am concerned about Athene's suggestion that everything is fine because the Iowa Insurance Division reviews and approves all the transactions. My concern stems from my belief that Iowa will approve anything. I am also concerned by the assertion that Athene is "well capitalized" because it has $59 billion of assets. My concern stems from the fact that Athene said nothing about liabilities or about the quality of the assets. I offered a complimentary PDF of the Athene comment, and that item remains available.

Comment from Accordia
Accordia, another company mentioned in the Times article, released a one-page comment telling its "key partners" it is "well capitalized and managed to meet its long-term commitments to policyholders." It mentions, among other things, its $7.7 billion of assets, its financial strength ratings, and its risk-based capital ratio. It also says its arrangements are approved by state regulators, reviewed by rating agencies, and assessed by an actuarial firm. Accordia does not directly criticize the Times article or the reporter.

More on Anagrams
I said in No. 93 that one of the phony entities mentioned in my No. 73 (posted November 16, 2014) and in the Times article is a Delaware-based LLC named Tapioca View, and that I learned recently the name of the entity is an anagram of "Iowa captive." I also mentioned several entities named Cape Verity, said "yer captive" was the best anagram I was able to see, and asked for help from readers who are good with anagrams.

One reader came up with "rye captive," but I think that is not much of an improvement. Another reader, with quite a sense of humor, came up with "creepy vatic." My dictionary says "vatic" is an adjective meaning "prophetic" or "oracular." I question such an anagram, because I think it should consist of an adjective and a noun rather than two adjectives. I remain open to further suggestions.

The Words of a Life Insurance Veteran
A few hours after No. 93 was posted, comments arrived from a person connected with the life insurance business for about 40 years. He called his comments a "rant," but I found them interesting. Here are some of them, which I edited without his permission.
Tax laws enacted for one reason are being used for a very different reason. But I guess it is the business of tax lawyers and CPAs to find every lawful means of reducing their clients' tax burdens, even if it means getting their clients into dubious and otherwise unnecessary business activities.
Buried deep in this is the fact that genuine captives, if any still exist, have a legitimate role for firms which would be tempted to self insure but want a degree of financial discipline behind self insuring—possibly to address concerns raised by nervous board members and others. The expression "captive insurer" is being used to describe wildly different things, which cannot be of much comfort to those with legitimate captives that have financial reality to them.
You mentioned Spencer Kimball, who wrote the insurance codes of two or three states. His philosophy of regulation differed from that in New York, where everything is prohibited unless specifically permitted. Kimball felt everything should be permitted unless specifically prohibited. Behind Kimball's philosophy was the idea that insurance companies would never do something to harm their own long-term interests. That is why codes developed by Kimball do not include insurable interest provisions. He asked why any insurance company would ever want to issue insurance that lacked insurable interest, not because of public policy, but because of bad claims experience. So there is no insurable interest statute in those codes, just common law.
I think Kimball did not anticipate a world of insurance companies run by non-insurance people. They do not understand reserves because the lines of business they came from have no reserves. They have no conception of long-term contractual obligations because the lines of business they came from freely and without consequence go out of business, or merge, or morph, and cease doing or making the things that gave their companies their names. Annuities with the name of a piano company on them [Baldwin United] were one of the first examples, and we saw how that turned out. I also think Kimball did not anticipate the rise of a class of actuary who is as much a loophole chaser as any tax and estate lawyer.
Even insurance companies that retain their fine old names are now run by folks from the securities business (you can blame or credit the rise in variable products for that) and they take a totally different view of long-term obligations and how they are funded. Ironically (and this may offend you and your lifelong crusade for rigorous disclosure) the securities business has become accustomed to doing whatever it damn well pleases, because no law tells them otherwise, so long as it can be obscurely but "lawfully" disclosed. But if those reading and actually understanding the disclosure do not care or react (Iowa Insurance Division, anyone?), a disclosure regime such as that on which securities laws are based can permit very adverse activity to go unchecked.
Disclosure is fine, but the history of the insurance business shows that what it needs is some substantive regulatory control and direction. I think most "real" insurance people understand that, but it is not a friendly or familiar concept to the many insurance company top officers who did not come from jobs in the insurance business. I think any number of regulatory problems facing the life insurance business are impacted by the fact that in cold reality there are precious few insurance people, as I would use the expression, left in charge or even in a position to act or speak.
The people running too many insurance companies today would be offended by the very thought of product design that rewards old customers who are no longer buying more stuff. And while they issue policies that in theory are good for 120 years, they do not look fondly on those who keep them in force for 40 years. In short, the world of life insurance has been turned on its head from everything I learned starting 40 years ago.
Available Material
In No. 93 I offered the Athene comment and mentioned the items I offered in my earlier related blogs. Those items are still available.

At this time I am offering a complimentary PDF containing the Accordia comment. Send an e-mail to jmbelth@gmail.com and ask for the Accordia response to the Times article.

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Friday, April 17, 2015

No. 93: The New York Times Examines the Life Insurance Shell Game

The Sunday, April 12, 2015 issue of The New York Times carried a 3,185-word article entitled "Risky Moves in the Game of Life Insurance." The subtitle is "Complex and mostly hidden maneuvers may end up costing taxpayers and policyholders." The article was written by Times reporter Mary Williams Walsh. It began at the bottom of the front page of the business section and the remainder filled the fourth page of the section. The article included a cartoon of a shell game, a chart, and a photograph of Elizur Wright. In 1858 Wright was appointed the insurance commissioner of Massachusetts, thereby became the first insurance regulator in the U.S., and is known today as the "Father of Life Insurance." The electronic version of the article was posted on the Times website on April 11.

Two Interesting Items
An interesting item in the Times article followed a discussion of details of transactions the reporter had seen in public documents. The discussion related to several companies controlled by Goldman Sachs and was followed by this sentence: "The company and its parent declined to confirm the details in those records or comment on the record." One can only wonder why a company would decline to confirm or comment on public information.

Another interesting item in the Times article was a statement that Nick Gerhart, the Iowa insurance commissioner, expressed in an e-mail to the reporter. He called captive reinsurance "a pragmatic approach to address the nationally recognized problem of redundant reserves." The expression "redundant reserves" is used by those intent on dismantling a regulatory system that has stood the test of time for more than 150 years. In other words, they want a system that allows them to reap short-term profits at the expense of long-term financial strength.

I am reminded of the views of the late Spencer L. Kimball, who during his career was the leading scholar in the area of insurance regulation. Kimball said the primary objective of insurance regulation is not the mere solvency of insurance companies, but rather the solidity of the companies. One can only imagine what he would say about promoters who embrace the expression "redundant reserves."

My Writings on the Subject
I wrote extensively in The Insurance Forum about efforts over the years to weaken life insurance reserves. I also wrote on my blog about some of the transactions mentioned in the Times article. See Nos. 44 (April 22, 2014), 66 (August 21, 2014), 71 (November 6, 2014), 72 (November 12, 2014), and 73 (November 16, 2014).

Anagrams
One of the phony entities mentioned in my blog post No. 73 and in the Times article is a Delaware-based LLC named Tapioca View. It issued a $499 million "contingent note," whatever that is, to be carried as an asset by an affiliate. I learned recently that the name of the entity is an anagram, the dictionary definition of which is "a word or phrase made by transposing the letters of another word or phrase." "Tapioca View" is an anagram of "Iowa captive." I think the name of the entity provides insight into the thought process of promoters of captive reinsurance. I do not know whether Commissioner Gerhart and his staff were aware of the anagram.

In No. 73 I also mentioned several entities named Cape Verity. I tried to figure out whether that name is also an anagram. However, all I could get out of it was "yer captive." I would welcome help from readers who are better than I am with anagrams.

General Observations
In my opinion, the Times article is an excellent study of a complex subject and an important contribution toward public understanding of captive reinsurance. Superintendent Benjamin Lawsky of the New York Department of Financial Services calls it "shadow insurance." It is a serious problem facing the life insurance business.

I think the Times article should be read by anyone with an interest in the welfare of the life insurance business and the millions of people who depend on life insurance to protect their beneficiaries. Many readers will find the article difficult to understand, but that is the fault of the perpetrators of the schemes rather than a shortcoming of the article. In other words, promoters of captive reinsurance schemes intend for the schemes to be opaque and incomprehensible, because they would not be permitted if they were disclosed and understood.

In my blog items mentioned above, I offered as complimentary PDFs some documents relating to matters discussed in the Times article. Those documents remain available upon request. At this time I am offering a complimentary two-page PDF containing an April 14 response from Athene, one of the companies mentioned in the Times article. The response apparently was prepared for agents who expressed concerns about the Times article. Send an e-mail to jmbelth@gmail.com and ask for the Athene response to the New York Times article.

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Friday, March 27, 2015

No. 92: Life Partners' Bankruptcy—A Few Recent Developments

As I reported in No. 90 posted March 17, H. Thomas Moran II has been appointed the Chapter 11 Trustee in the federal bankruptcy court proceedings involving Life Partners Holdings, Inc. (LPHI). I wrote extensively about LPHI in The Insurance Forum over a period of 15 years, and I posted 23 items about the company on my blog over the past 15 months. Here I report a few recent developments.

Trustee Appointment Status
On March 10, as I previously reported, Bankruptcy Court Judge Russell F. Nelms ordered the U.S. Trustee to appoint a Chapter 11 Trustee for LPHI. On March 13, the U.S. Trustee appointed Moran the Chapter 11 Trustee, subject to the approval of Judge Nelms. On March 19, Judge Nelms approved the appointment.

Delisting by Nasdaq
On March 18, Nasdaq announced it had halted trading in LPHI shares after the close of trading that day. The last price was 24 cents per share. Nasdaq said trading will remain halted until LPHI "has fully satisfied Nasdaq's request for additional information."

In an 8-K (material event) report that LPHI filed with the Securities and Exchange Commission (SEC) on March 12, LPHI said a hearing on the matter of delisting was scheduled for March 19. It is my understanding that Moran canceled the hearing.

First Posting by Moran
On March 20, Moran posted the first item on a new website at www.lphitrustee.com to communicate with interested parties. The item describes the background of the case, comments briefly on the current status of the case, identifies four attorneys from the Dallas firm of Thompson & Knight LLP, and invites interested parties to submit questions to questions@lphitrustee.com. Following that initial posting, additional material has been posted for the information of interested parties.

Seizure of Pardo's Property
On March 23, according to local newspaper and television reports in Waco, Texas, LPHI's home city, federal law enforcement officials seized luxury vehicles from the home of Brian Pardo, the former chairman and chief executive officer of LPHI. According to the reports, at least two Mercedes vehicles were confiscated. Pardo has not paid the $6.2 million civil penalty imposed on him by the federal district court and, as I reported in No. 88, the federal district court has placed liens on Pardo's property.

An Important Filing
On March 25, on behalf of Moran, attorneys at Thompson & Knight filed an emergency motion to amend LPHI's governing documents and to file voluntary Chapter 11 petitions for LPHI's two subsidiaries. They are Life Partners, Inc. (LPI), which is LPHI's operating subsidiary in the secondary market for life insurance, and the recently formed LPI Financial Services, Inc. (LPIFS).

The motion describes the background of the case, including the civil lawsuit by the SEC. Aside from the bankruptcy case and the SEC case, the motion says there are 11 open cases against LPHI/LPI in federal courts and 12 open cases against LPHI/LPI in state courts (seven in Texas, three in California, one in Florida, and one in Illinois). Also, LPHI is appealing the decision in the SEC case to the U.S. Court of Appeals for the Fifth Circuit, and is appealing decisions of two Texas appellate courts to the Texas Supreme Court. Here is the concluding paragraph of the motion:
WHEREFORE, the Trustee respectfully requests that this Court enter an order granting this Motion in its entirety and authorizing him to cause [LPHI], LPI, and LPIFS, as applicable, to (i) remove the current members of the boards of directors of LPI and LPIFS, (ii) amend the governing documents of LPI and LPIFS, entities wholly owned and managed by LPHI, (iii) elect the Trustee as the sole director of each of LPI and LPIFS, (iv) take such actions as are necessary to cause LPI and LPIFS to file voluntary chapter 11 bankruptcy petitions, seeking joint administration with the estate of [LPHI], and (v) granting such other and further relief this Court deems just and proper.
General Observations
The actions taken in coming weeks by Moran and Judge Nelms bear close watching. I think they will make their decisions in what they believe are the best interests of all parties affected by the LPHI proceedings.

I am offering a complimentary PDF containing the 18-page emergency motion that Moran just filed in the bankruptcy court. Send an e-mail to jmbelth@gmail.com and ask for the LPHI/Moran March 25 motion.

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Monday, March 23, 2015

No. 91: Northwestern Mutual—The Proposed Settlement of a Long Dispute over Annuity Dividends

On March 13, 2015, Marleen M. LaPlant, the plaintiff in a long dispute with Northwestern Mutual Life Insurance Company (Milwaukee, WI), filed in federal court a motion for preliminary approval of a settlement. The case relates to a change the company made in 1985 in its method for determining dividends on certain previously issued fixed dollar annuities. The company has agreed to the settlement.

Origin of the Dispute
Prior to 1985, Northwestern determined annuity dividends based on investment returns on the company's entire general account. In the early 1980s, the U.S. experienced an inverted yield curve, where short-term interest rates were higher than long-term interest rates. In 1985, the company introduced "MN annuities" that were credited with dividends based on the interest earnings from a portfolio of short-term bonds. At the same time, the company began crediting dividends on previously issued ("pre-MN") annuities based on the interest earnings from the portfolio of short-term bonds. In the short term, the change meant larger dividends on the pre-MN annuities, but over the long term—when interest rates returned to normal levels—it meant the dividends on the pre-MN annuities were smaller than if the dividends had been based on the investment returns on the company's entire general account.

A major problem was the manner in which Northwestern instituted the change regarding the pre-MN annuities. The company changed the method of determining dividends on the pre-MN annuities without advance notice to the annuitants, without disclosing the change to the annuitants, without offering the annuitants the opportunity to accept or reject the change, and by phasing in the change in such a way as to make it difficult for the annuitants to be aware of the change.

The LaPlant Lawsuit
In August 2008, LaPlant filed a class action lawsuit in state court in Wisconsin on behalf of herself and other pre-MN annuitants. She alleged that Northwestern, in determining dividends on the pre-MN annuities, had breached the contracts and breached its fiduciary duty. The company said it had not breached the contracts and had not breached its fiduciary duty. The company also said its method of determining dividends was consistent with the contracts, did not violate Wisconsin law, was in accordance with actuarial standards, and had been approved by insurance regulators. (See LaPlant v. Northwestern, State of Wisconsin, Milwaukee County Circuit Court, Case No. 08-cv-11988.)

In October 2009, Reserve Circuit Judge Dennis J. Flynn certified a state class. In November 2010, he presided over a two-week bench trial. In March 2011, he handed down a 97-page decision saying the company had breached the contracts and breached its fiduciary duty.

My Articles about the Case
I felt the case was important, and wrote about it in the lead article in the May 2011 issue of The Insurance Forum. I wrote follow-up articles in the July 2011, June 2013, and December 2013 issues. In the conclusion of the first of the four articles, I said:
Northwestern has long and justifiably prided itself on fair treatment of participating policyholders. That is why this case is a major defeat for the company.
The Recusal Motion
Three weeks after Judge Flynn's decision, Northwestern filed a motion that the judge recuse himself. The company had discovered that the judge owned a pre-MN annuity that he had surrendered in 1979, six years before the company made the change in its method of determining dividends on the pre-MN annuities. The cash surrender value of the judge's annuity was $1,456. Judge Flynn denied the recusal motion.

Northwestern petitioned the Wisconsin Court of Appeals to hear an appeal of the denial of the recusal motion. The appellate court denied the petition.

The Regulatory Issue
Northwestern said it had obtained regulatory approval of the 1985 change in the method of determining dividends on the pre-MN annuities. In 1984, the company informed the New York Department of Insurance of the change. The company said it intended to disclose the change in releases to its agents and the media, in its annual report, and in dividend notice stuffers sent to annuitants. The Department approved the change conditioned on those disclosures. However, the company did not make the disclosures.

Northwestern informed the Wisconsin Office of the Insurance Commissioner of the change and the New York Department's approval of the change. The Office raised no objections, and the company viewed the change as having been approved by the Office.

Recent Developments
In 2010, the parties, with the help of a mediator, attempted to resolve the dispute by reaching an agreement. The effort failed.

In September 2011, LaPlant filed a motion to expand the state class (about 3,300 annuitants) to a national class (about 33,000 annuitants). Northwestern removed the case to federal court. LaPlant filed a motion in federal court to return the case to the state court. In August 2012, the federal district court granted the motion to return the case to the state court. (See LaPlant v. Northwestern, U.S. District Court, Eastern District of Wisconsin, Case No. 2:11-cv-910.)

Northwestern appealed the federal district court decision. In November 2012, a three-judge appellate panel vacated the federal district court decision and sent the case back to the federal district court to decide whether to expand the state class to a national class. (See LaPlant v. Northwestern, U.S. Court of Appeals, 7th Circuit, Case No. 12-3264.)

In March 2013, LaPlant filed a motion in the federal district court to expand the state class to a national class. Northwestern opposed the motion and filed a motion to decertify the Wisconsin class. The court has not acted on those motions.

In May 2014, the parties, with the help of a different mediator, undertook a second effort to resolve the dispute by reaching an agreement. This time the effort succeeded. On September 9, 2014, the parties entered into a memorandum of understanding to resolve all the claims of the national class, including the claims in the related cases. They selected a settlement administrator, a notice provider, and an escrow agent. Later they entered into the recently announced settlement.

The Proposed Settlement
Plaintiff experts estimate that the losses suffered by the annuitants are from $100 million to $278 million. Northwestern disputes that there are any damages.

The gross amount of the settlement is $84 million. That will be reduced by plaintiff attorneys' fees in the LaPlant case and the related cases (not to exceed 35 percent of the gross amount of the settlement), plaintiff attorneys' expenses, cost of notice to class members, cost of claims administration, and payments to class representatives in the various cases. I think the net amount of the settlement will be around $50 million.

The recent motion asks the federal district court to approve the settlement on a preliminary basis to allow notices to be sent to the annuitants, and to certify the national class solely for purposes of the settlement. The notices will explain the case. The annuitants will be given the opportunity to opt out of the settlement, register objections, and be heard at the final fairness hearing. According to the proposed schedule, final court approval is at least five months away.

General Observations
LaPlant and the plaintiffs in the related cases did not commence legal action when they were receiving larger dividends than they would have received without the 1985 change. In other words, they took action only when they began receiving smaller dividends as a result of the change. That may be a partial explanation for Northwestern's long and bitter opposition to the lawsuit. For example, the company's recent letter to employees announcing the settlement includes this sentence:
According to Rodd Schneider, vice president–litigation counsel in the Law department, the lawsuit was a case of a small group of customers seeking more than its fair share of dividends, which would have come at the expense of all our other policyowners.
On the other hand, it is also true that Northwestern made the change unilaterally and sought to conceal it. That was out of character for the company. In previous situations, the company announced policy or contract changes and offered policyholders the opportunity to accept or reject the changes. For example, in the 1970s the company announced a policy loan interest rate amendment program. The company had begun issuing policies with a variable policy loan interest rate subject to a maximum of 8 percent. In the amendment program, the company offered policyholders with a 5 percent or 6 percent fixed policy loan interest rate the opportunity to change to the variable policy loan interest rate subject to the 8 percent maximum. In exchange for agreeing to the amendment, policyholders became entitled to enhanced dividends.

In my opinion, the lawsuits were justified. I also believe that Judge Flynn got it right. Whether the settlement will receive final approval remains to be seen.

Available Material
For those keenly interested in the case, I offer a complimentary 86-page PDF consisting of five documents: the 3-page motion, the 24-page memorandum in support of the motion, the 4-page declaration in support of the motion, the 3-page plan of allocation, and the 52-page settlement agreement. Send an e-mail to jmbelth@gmail.com and ask for the settlement package in the LaPlant case.

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Tuesday, March 17, 2015

No. 90: Life Partners—The U.S. Trustee Appoints Thomas Moran the Chapter 11 Trustee

On March 13, 2015, the U.S. Trustee appointed H. Thomas Moran II the Chapter 11 Trustee in the Life Partners Holdings, Inc. (LPHI) bankruptcy case. The appointment of Moran is not a surprise; as mentioned below, the Securities and Exchange Commission (SEC), even before LPHI's bankruptcy filing, recommended that the district court appoint Moran the receiver. He is chief executive officer of Asset Servicing Group LLC, 521 West Wilshire Boulevard, Suite 200, Oklahoma City, OK 73116, telephone (405) 753-9100. Biographical information about him and his associates is on the company's website (www.asgllc.us).

Background
LPHI is the parent of Life Partners, Inc. (LPI), an intermediary in the secondary market for life insurance. In January 2012, the SEC filed a civil lawsuit against LPHI and its top officers alleging violations of federal securities laws. The case was assigned to U.S. Senior District Court Judge James R. Nowlin. After the trial in January 2014, the jury found in favor of the defendants on some allegations and against the defendants on some allegations.

On December 2, 2014, Judge Nowlin handed down an Order. On January 16, 2015, he handed down a Final Judgment confirming the terms of his December 2 Order. He imposed civil penalties on LPHI of more than twice the company's total assets. Also, he imposed large civil penalties on two LPHI officers: Brian D. Pardo, chairman and chief executive officer; and R. Scott Peden, general counsel.

Other Recent Developments
On January 5, 2015, the SEC filed a motion for the appointment of a receiver to "protect investors and LPHI's creditors," "ensure that its current officers...are unable to continue to waste assets," and "ensure that LPHI is operated in compliance with the federal securities laws." The SEC recommended that Moran be appointed the receiver. (See SEC v. LPHI, U.S. District Court, Western District of Texas, No. 1:12-cv-33.)

On January 20, LPHI filed for protection under Chapter 11 of the federal bankruptcy law. The case was assigned to U.S. Bankruptcy Court Judge Russell F. Nelms. On March 10, Judge Nelms ordered the U.S. Trustee to appoint a Chapter 11 Trustee for LPHI. (See In re LPHI, U.S. Bankruptcy Court, Northern District of Texas, No. 15-40289.)

General Observations
It will be interesting to see Moran's progress reports. In light of the comments by Judge Nelms in the March 9 hearing that preceded his March 10 Order (I offered the hearing transcript in No. 89), I think he and Moran will do everything possible to protect those with fractional interests in LPI's life settlements.

I offer a complimentary 14-page PDF consisting of the 2-page March 13 notice of Moran's appointment and the 12-page January 5 SEC motion for appointment of a receiver in the district court case. Send an e-mail to jmbelth@gmail.com and ask for the SEC-LPHI March 17 package.

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Friday, March 13, 2015

No. 89: Life Partners—The Bankruptcy Court Judge Comes Down Hard on the Company's Former Management

In No. 88 posted March 12, I reported that, on March 10, U.S. Bankruptcy Court Judge Russell F. Nelms granted the motion of the Securities and Exchange Commission (SEC) and ordered the U.S. Trustee to appoint a Chapter 11 Trustee for Life Partners Holdings, Inc. (LPHI). I also said I had not seen Judge Nelms' findings of fact and conclusions of law referred to in his Order. I now have the 32-page transcript of the 48-minute March 9 hearing at which Judge Nelms placed his findings of fact and conclusions of law on the record.

The Hearing
In attendance at the hearing, in person or by telephone, were attorneys representing the SEC, LPHI, certain LPHI shareholders, the U.S. Trustee, an ad hoc committee of investors in fractional interests, Advance Trust & Life Escrow Services, the Official Committee of Unsecured Creditors, and plaintiffs in the Arnold case. Also in attendance were an investor in fractional interests, two monitors, and the reporter.

Judge Nelms explained five principles that guided him in his ruling. He discussed the judgment handed down by Senior U.S. District Court Judge James R. Nowlin in the SEC lawsuit against LPHI, Brian D. Pardo, and R. Scott Peden, the jury findings in the case, and a series of issues in the case. Among those issues are the continued use (until February 2015) of life expectancy estimates by Dr. Cassidy, the ministerial fees imposed in 2014, the continued payment of dividends to LPHI shareholders in recent years (even in September 2014), the level of Pardo's compensation in recent years, the continued subservience of the LPHI board of directors to Pardo, and the most recent 8-K (material event) report and the accompanying letter and press release that created "panic" among investors in fractional interests. In summary, Judge Nelms said:
Finally, cause exists and the best interests of all parties would be served by appointing a trustee because someone needs to come into this case and calm the waters. In the last three months, a $40 million judgment has been entered against the Debtor, the Debtor has filed bankruptcy, Pardo and Peden have resigned, and the Debtor told creditors that a trustee would likely pool their interests. Naturally, investors and shareholders are concerned. Premiums are at risk. Someone needs to come into this case and assure everyone that they have a voice and that voice will be heard. And that message needs to come from someone who does not sound like they are contradicting themselves.
Finally, someone needs to come into this case and remind every party in interest of the role that this Court plays in this process. Nothing outside of the ordinary course of business is going to happen to this Debtor without this Court saying so. And this Court will not say so without according to all parties their rights under the law, including their rights of due process.
So, for these reasons, I will grant the SEC's motion to appoint a trustee.
General Observations
I came away from reading the transcript with the belief that Judge Nelms has provided a strong statement of the need for a Chapter 11 Trustee in the LPHI case. I also believe that the best way for readers to understand the matter is to read the transcript for themselves.

Therefore I am offering a complimentary 32-page PDF containing the transcript of the hearing. Send an e-mail to jmbelth@gmail.com and ask for the transcript of the Nelms March 9 hearing in the LPHI case.

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