No. 157: Lincoln National Life's Cost-of-Insurance Charges and the Settlement of an Indiana State Court Lawsuit

On June 2, 2015, a three-judge panel of the Indiana Court of Appeals handed down a unanimous ruling against Lincoln National Life Insurance Company (Fort Wayne, IN) in a class action lawsuit relating to cost-of-insurance (COI) charges. I learned of the case only recently, after the trial court approved the final settlement of the case.

COI Charges

The amount of protection in any given month of a universal life policy is the death benefit minus the account value. The COI charge in any given month is the COI rate per $1,000 per month multiplied by the amount of protection in thousands of dollars. The policy specifies a guaranteed maximum COI rate for each age of the insured, and the company is free to use COI rates below the maximum rates. The lawsuits involving COI charges allege that the companies increased COI charges in a manner that violated the provisions of the policies.

The Lincoln Policy

From 1986 to 2008, Lincoln sold a variable universal life policy called the "Ensemble II." Peter S. Bezich bought such a policy in 1996. With regard to the charges assessed against the policy each month, the policy says:

The monthly deduction for a policy month shall be equal to (1) plus (2), where: (1) is the cost of insurance ... [and] (2) is a monthly administrative charge. This charge is equal to $6.00 per month in each policy year.

The Bezich Lawsuit

In June 2009, Bezich filed a class action lawsuit in state court alleging that Lincoln had imposed COI charges in excess of those permitted in the policy. In July 2009, Lincoln removed the case to federal court. Bezich sought to move the case back to state court. In June 2010, after a long dispute, the federal court moved the case back to state court.

In July 2012, after extensive discovery, Bezich filed an amended complaint. He alleged three counts of breach of contract: that Lincoln had (1) included non-mortality factors in determining the COI rate, (2) loaded administrative fees and expenses into the COI rate, and (3) failed to reduce the COI rate in response to improving mortality rates.

In August 2012, Lincoln filed a motion to dismiss the complaint. The trial court denied the motion as to all three counts.

In September 2013, Bezich filed a motion to certify a national class of Ensemble II policyholders. In February 2014, the trial court held a one-day evidentiary hearing on the motion. In June 2014, the trial court denied class certification on Counts One and Two, and granted class certification on Count Three. (See Bezich v. Lincoln, Allen County Circuit Court, State of Indiana, Case No. 02C01-0906-PL-73.)

The Indiana Court of Appeals

Lincoln appealed the class certification on Count Three, and Bezich cross-appealed the denial of certification on Counts One and Two. On June 2, 2015, a three-judge appellate panel ruled that class certification was proper for all three of Bezich's claims. Thus the panel reversed the trial court ruling on Counts One and Two, and affirmed the trial court ruling on Count Three. The panel sent the case back to the trial court for further proceedings. In its discussion of Count Three, the panel said:

Finally, we cannot help but comment upon the absurdity of Lincoln's own interpretation of the COI rate provision, which is that the Ensemble II allows Lincoln to unilaterally increase rates on customers to reflect a change in mortality factors but offers no parallel commitment to decrease rates despite an overwhelming improvement in mortality. We have grave doubts that any policyholder of average intelligence would read the COI rate provision to confer on Lincoln that sort of "heads we win, tails you lose" power. [Italics in original.]

The panel's decision was written by Judge Margret G. Robb. Judges L. Mark Bailey and Elaine B. Brown concurred. (See Lincoln v. Bezich, Indiana Court of Appeals, Cause No. 02A04-1407-P-319.)

The Indiana Supreme Court

In July 2014, Lincoln petitioned to transfer the appeal to the Indiana Supreme Court. In September 2015, the Indiana Supreme Court granted the petition to transfer. By that time, however, the parties had essentially completed their settlement negotiations.

The Settlement

After lengthy and intensive negotiations, including the participation of a mediator, Bezich and Lincoln entered into a settlement agreement that resolved the claims of a class of more than 78,000 policyholders. Lincoln agreed to provide level term life insurance coverage to each member of the class without cost and without underwriting.

The amount of term coverage for in-force policies ranged from 14.5 percent of the face amount of the original policy for insureds up to attained age 40 down to 11.75 percent for insureds over 65. The amount of term coverage for terminated policies ranged from 11 percent for insureds up to age 40 down to 9 percent for insureds over 65. The period of term coverage for in-force policies and terminated policies ranged from six years for insureds up to age 40 down to two years for insureds over 65.

The actuarial estimate of the value of the settlement was not less than $171.8 million. The estimated aggregate face amount of term coverage was $2.25 billion, with face amounts ranging from about $1,000 to $3.75 million, and an average face amount of $28,660.

On October 25, 2015, in the trial court, Bezich filed an unopposed motion for class certification and for preliminary approval of the settlement. On November 15, the trial court granted preliminary approval and ordered the parties to disseminate the class notice.

On February 4, 2016, after the settlement hearing, and after the filing of a motion for final approval, the trial court issued an order granting final approval of the settlement. The order included a finding that the requested plaintiffs' attorney fees of $24 million plus expenses of about $419,000 were "fair and reasonable." The trial court entered final judgment and dismissed the case with prejudice (permanently).

General Observations

The Bezich class action lawsuit ended in a long, hard-fought partial victory for the policyholders. Although the lawsuit did not go to trial, I think Lincoln saw the handwriting on the wall and decided to settle the case after the Indiana Appellate Court panel's unanimous ruling on the class certification issue.

Nonetheless, it should be recognized that the case depended heavily on the wording of the policy's COI clause. Life insurance companies have learned the hard way that the wording of the clause is critical. Thus the companies have rewritten COI clauses in more recently issued policies to provide the companies with maximum flexibility on the imposition of COI charges, while at the same time trying to minimize the likelihood of a successful legal challenge.

Available Material

I am making available a complimentary 26-page PDF containing the Indiana Court of Appeals decision. Email jmbelth@gmail.com and ask for the June 2015 appellate decision in the case of Bezich v. Lincoln.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 156: Life Partners—Trustee Moran, Unsecured Creditors, and Class Action Plaintiffs File Joint Motion to Settle Bankruptcy Case

Life Partners Holdings Inc. (LPHI) and its subsidiaries Life Partners Inc. (LPI) and LPI Financial Services Inc. (LPIFS) participated for years in the secondary market for life insurance. On January 20, 2015, LPHI filed for protection under Chapter 11 of the federal bankruptcy law. On January 30, the U.S. Trustee appointed an Official Committee of Unsecured Creditors (committee) to represent investors in fractional interests in life settlements that LPI had sold. (See In re LPHI, U.S. Bankruptcy Court, Northern District of Texas, Case No. 15-40289.)

Other Developments Early in 2015

On March 13, the U.S. Trustee appointed H. Thomas Moran II as Chapter 11 Trustee. On March 19, the bankruptcy court judge approved Moran's appointment. On April 7, the judge allowed Moran to expand the bankruptcy filing to include LPI and LPIFS. On May 20, Moran filed a declaration containing a preliminary report of his investigation of the alleged fraudulent activities of the debtors (LPHI, LPI, and LPIFS) and their top officers that preceded the bankruptcy filing.

Recent Developments

On November 28, 2015, Moran and the committee filed a Plan of Reorganization. On January 19, 2016, they filed an Amended Plan of Reorganization. On March 24, they filed a Second Amended Plan of Reorganization.

The Joint Motion

On April 1, 2016, Moran, the committee, and the plaintiffs in a recently consolidated class action lawsuit filed a 44-page "Joint Motion to Compromise Class Action Controversies, to Approve Plan Support Agreement, and for Related Relief." The joint motion, which grew in part out of the previously mentioned Second Amended Plan of Reorganization, is a proposal to settle the bankruptcy case. (For the recent class action lawsuit, see Garner v. LPI, U.S. Bankruptcy Court, Northern District of Texas, Case No. 15-04061.)

The parties to the joint motion say "the proposed settlement is fair and equitable," is "in the best interests of the estates of the Debtors," resolves "pending disputes," and provides "meaningful compensation and recovery to approximately 22,000 investors ... who have been so grievously damaged by the Debtors' pre-petition activities." The parties to the joint motion also believe that the proposed settlement enables the unsecured creditors to "recover more than they are likely to recover under any realistic alternative scenario."

The joint motion describes the bankruptcy case, the class action lawsuits that were instituted before and after the bankruptcy filing, a recently consolidated class action lawsuit, and the "ownership issue." In the bankruptcy case, Moran had taken the position that LPI (and therefore Moran) owned the life insurance policies underlying the life settlements. In the consolidated class action lawsuit, however, the plaintiffs had taken the position that the class members owned the policies. The proposed settlement sidesteps and thereby resolves the ownership issue.

The joint motion also describes "complex and protracted discussions" that preceded the filing of the joint motion. Also, in a section entitled "The Proposed Settlement Is Truly the Product of Arm's-Length Bargaining and Not of Fraud or Collusion," the joint motion says:

It would be an understatement to suggest the Settlement Agreement was the product of anything other than hard fought and contentious negotiations. Through months of extensive good-faith and arm's-length bargaining, including two days of mediation with retired [federal] bankruptcy Judge Richard Schmidt, the Parties have reached a resolution they believe minimizes the potential damage and risk to all parties and maximizes value for the Settlement Class Members and the Debtors' estates and their creditors.

Attorneys' Fees

The joint motion describes the agreed-upon attorneys' fees (agreed fee) and calls the agreed fee "fair and reasonable." The parties say they negotiated the agreed fee "only after the parties reached agreement on the essential terms of the settlement." The agreed fee is $33 million, which will be paid over many years. The estimated present value of the agreed fee is about $5.2 million, depending on certain assumptions. Also, the agreed fee is 2.57 percent of the "common fund" of about $1.28 billion that was calculated in a lawsuit heard earlier by the Texas Supreme Court.

The Settlement Agreement

The 60-page settlement agreement itself is an appendix to the joint motion. It provides for the unsecured creditors to be divided into classes and subclasses that have differing options from which to choose. The settlement agreement discusses, among other things, the court approval process, a stipulation to class certification, equitable relief, and the release of claims.

The parties to the joint motion plan to file soon a motion seeking the bankruptcy court judge's preliminary approval of the settlement agreement. If the judge grants the motion, the parties would send the unsecured creditors a class notice of the proposed settlement.

An Alternative Settlement Proposal

To my knowledge, only one other proposal has been filed as an alternative to the settlement proposal in the joint motion. On April 5, 2016, Vida Capital (Austin, TX) filed an alternative plan. Vida, which was founded in 2009, describes itself as

an institutional asset manager focused exclusively on providing longevity-contingent investment solutions to institutions and individual investors. Vida specializes in the structuring, servicing, financing and management of life settlements, synthetic products, annuities, notes, and structured settlements.

In 2010, Vida acquired Magna Life Settlements, a life settlement provider. Magna, which has been in the life settlement business since 2004, is licensed in 37 states and the District of Columbia.

ASM Capital's Offer

ASM Capital (Woodbury, NY) is a firm that invests in obligations of companies in bankruptcy. As I reported in No. 138 (posted January 11, 2016), ASM sent a letter on December 22, 2015 to LPI fractional interest investors who have a "matured fund interest." That expression refers to a fractional interest in a policy on the life of an insured person who has died. ASM offered to pay 75 percent of the matured fund interest promptly in cash to each investor who would transfer to ASM the rights to the matured fund interest. Some LPI investors have accepted the offer. For example, a document filed with the bankruptcy court on April 7, 2016 lists 72 transfers of ownership to ASM.

General Observations

The settlement proposal presented in the joint motion is complex. I have attempted here to describe a few key elements of the proposal. It represents a difficult "compromise," a word that appears in the title of the joint motion, especially with regard to the important ownership issue relating to the fractional interests.

I think the parties to the joint motion have forged a satisfactory settlement. Further, I think the settlement would bring closure to the bankruptcy case in a relatively short time, thereby avoiding long delays and the huge expenses associated with dragged-out legal proceedings.

It remains to be seen how the bankruptcy court judge will rule on the upcoming motion for preliminary approval of the settlement. Also, it will be interesting to see whether the parties are able to provide, as part of the class notice, a reasonably brief and understandable explanation of the complex settlement proposal. Finally, it remains to be seen whether Vida's alternative proposal gains traction.

Available Material

I am making available a complimentary 44-page PDF containing the joint motion. Email jmbelth@gmail.com and ask for the April 2016 joint settlement motion in the Life Partners bankruptcy case.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 155: Genworth's Long-Term Care Insurance—Correction of an Error in the Preceding Post

On April 7, 2016, I posted No. 154 entitled "Genworth's Long-Term Care Insurance and the Company's Destacking Plan." When I sent the item to Genworth that day, President and Chief Executive Officer Thomas J. McInerney brought an error to my attention.

In the section entitled "The Reinsurance Repatriation," I mentioned Brookfield Life and Annuity Insurance Company (BLAIC), Genworth's primary Bermuda domiciled captive reinsurance subsidiary. I said that half the long-term care insurance business of Genworth Life Insurance Company (GLIC) has been ceded to BLAIC, and I said incorrectly that the reinsurance involves $1 billion of reserve liabilities. The correct figure is $10 billion.

I took the incorrect figure from Schedule S, Part 3, Section 1, on page 43.2 of GLIC's 2015 statutory financial statement. The correct figure is in Schedule S, Part 4, on page 45. Also, a discussion of the matter is in the "Notes to the Financial Statements" on pages 19.31 and 19.32. The discussion says that the $10 billion of reserve liabilities ceded to BLAIC relate to long-term care insurance, and that the $1 billion figure relates to fixed deferred annuities.

I regret the error. So that readers can see the statement pages to which I refer in this correction, I am making available a complimentary four-page PDF containing pages 19.31, 19.32, 43.2, and 45 of GLIC's 2015 statutory statement. Email jmbelth@gmail.com and ask for the four pages from GLIC's 2015 statutory statement.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 154: Genworth's Long-Term Care Insurance and the Company's Destacking Plan

In No. 144 (posted February 16, 2016), I discussed a news release issued by Genworth Financial, Inc. (NYSE:GNW) that mentioned a "strategic update." The release, filed as an exhibit to an 8-K (material event) report filed with the Securities and Exchange Commission (SEC) on February 4, said the company's planned actions are "aimed at separating and isolating its LTC [long-term care insurance] business."

The announcement triggered significant reductions in the financial strength ratings of Genworth's life insurance subsidiaries, mostly into the vulnerable (or below-investment-grade) range. The announcement also caused a sharp decline in the company's share prices. Here I discuss the "destacking" plan at the heart of the company's strategic update.

The Current Situation

Genworth's life insurance business consists of three operating subsidiaries: Genworth Life Insurance Company (GLIC), domiciled in Delaware; Genworth Life and Annuity Insurance Company (GLAIC), domiciled in Virginia; and Genworth Life Insurance Company of New York (GLICNY), domiciled in New York. The two subsidiaries most affected by the destacking plan are GLIC, primarily a long-term care insurance company; and GLAIC, primarily a life insurance and annuity company.

The long-term care insurance business of GLIC is financially troubled, while the life insurance and annuity business of GLAIC is financially sound. At present, Genworth, GLIC, and GLAIC are "stacked." That means Genworth is the parent of GLIC, and GLIC is the parent of GLAIC. Thus GLAIC is an asset of GLIC.

As of December 31, 2015, the statutory net worth of GLAIC is $1.7 billion, and the statutory net worth of GLIC is $2.7 billion. Because GLAIC represents more than 60 percent of GLIC's net worth ($1.7 divided by $2.7), GLAIC provides significant value and protection to GLIC and its long-term care insurance policyholders.

The Destacking Plan

Under the proposed "destacking" plan, GLAIC would be moved from GLIC to Genworth. In other words, GLIC and GLAIC would become sister subsidiaries of Genworth, and GLAIC, with its $1.7 billion of net worth, would no longer be an asset of GLIC. Under the proposed plan, Genworth would contribute $200 million to the net worth of GLIC. A major question is whether that amount is adequate compensation for GLIC and its long-term care insurance policyholders for the loss of GLAIC's $1.7 billion of net worth.

Genworth says the proposed destacking plan is subject to the approval of various state insurance regulators. An important question is whether the insurance commissioner in Delaware, where GLIC is domiciled, will approve the removal of a $1.7 billion asset from GLIC in exchange for a contribution of $200 million.

Genworth has not yet formally submitted the destacking plan to Delaware for approval. It remains to be seen whether the proposal will be available to the public when Genworth submits it, and whether the commissioner will conduct a public hearing on it.

The Note Indentures

Another dimension of the destacking plan relates to Genworth's eight issues of outstanding notes with principal amounts totaling $3.8 billion. The maturity dates of the notes range from 2018 to 2066. The note indentures provide that the "disposition" of a "significant subsidiary" might constitute an "event of default," thereby causing the notes to become due and payable immediately.

On March 4, Genworth asked the noteholders to consent to changes in the indentures to eliminate certain subsidiaries, including GLIC, from the definition of "significant subsidiary." To compensate noteholders for consenting to the changes in the indentures, Genworth offered consent fees ranging from $6.25 per $1,000 of principal amount for the short duration notes to $15 per $1,000 of principal amount for the long duration notes. The aggregate amount of the consent fees was $44 million, provided all the noteholders consented.

On March 22, Genworth announced it had received the required number of consents in order to effectuate the changes in the note indentures. The changes mean that the "disposition" of GLIC, through a sale or even an insolvency, would not be an "event of default" under the note indentures. The changes in the indentures remove a major potential obstacle to the implementation of the destacking plan.

The Reinsurance Repatriation

Brookfield Life and Annuity Insurance Company Limited (BLAIC) is Genworth's primary Bermuda domiciled captive reinsurance subsidiary. Half of GLIC's long-term care insurance business, involving about $1 billion of reserve liabilities, has been ceded to BLAIC. As part of the strategic update, and subject to regulatory approvals, Genworth plans to "repatriate" ("unwind") all the reinsurance its insurance subsidiaries have ceded to BLAIC. After the repatriation, which is expected to occur in 2016, Genworth plans to dissolve BLAIC.

Genworth's 2015 10-K report discloses that the company has been using various accounting practices that are permitted by Delaware and Vermont insurance regulators but that deviate from accounting practices permitted by the National Association of Insurance Commissioners. For more on such practices, see No. 153 (posted March 31, 2016).

General Observations

My initial reaction to the destacking plan was that Genworth might be considering the sale of GLIC. However, the questions that naturally follow such a reaction are "To whom?" and "At what price?" I think no reputable company would want to take over GLIC's large and troubled block of long-term care insurance policies at any price.

GLIC has been asking state insurance regulators to approve substantial premium increases on long-term care insurance policies. The company calls them "actuarially justified" premium increases, but the words "actuarially justified" are not necessary. I think GLIC or any other reputable company would refrain from seeking premium increases that are not actuarially justified.

The requests for premium increases create a dilemma for state insurance regulators. Disapproving the requests might force GLIC into insolvency. Approving the requests, on the other hand, increases the financial burdens faced by elderly long-term care insurance policyholders. Although policyholders may be offered the opportunity to avoid the premium increases by accepting reduced benefits, or to pay no further premiums by accepting even lower "paid-up" benefits, the financial burdens on those vulnerable policyholders remain.

I think the survival of GLIC is open to question. In the event of its insolvency, the changes in the note indentures protect Genworth's noteholders, Genworth's shareholders, and Genworth itself. However, the changes do not protect GLIC's long-term care insurance policyholders. Nor do they protect state guaranty associations or insurance companies that would be subjected to assessments. The Delaware commissioner and the other regulators who will be asked to approve the destacking plan are the only ones who can protect policyholders, state guaranty associations, and insurance companies that would be assessed.

Available Material

I am making available a complimentary 16-page PDF ("April 2016 Genworth package") consisting of selected pages from Genworth's filings with the SEC about the strategic update, the destacking plan, the consent solicitation, the results of the consent solicitation, and the repatriation of the Bermuda reinsurance. Also, the complimentary 31-page PDF ("February 2016 Genworth package") offered in No. 144 remains available. Email jmbelth@gmail.com and ask for the April 2016 Genworth package and/or the February 2016 Genworth package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 153: Vermont's Frightening Accounting Rules and the Secrecy Surrounding Them

Primerica Life Insurance Company is domiciled for regulatory purposes in Massachusetts and headquartered in Georgia. It is a wholly owned operating subsidiary of Primerica, Inc. (NYSE:PRI). The Primerica organization is the successor to the A. L. Williams organization (ALW). My first article about ALW was in the April 1981 issue of The Insurance Forum, and later I wrote 50 other articles in the Forum about ALW.

Recently I reviewed the two most recent 10-K annual reports filed by Primerica, Inc. with the Securities and Exchange Commission (SEC). The reports illustrate the contrast between the strong disclosure requirements imposed by federal securities regulators and the weak disclosure requirements imposed by state insurance regulators. Here I describe information from various reports about the accounting practices of one of Primerica Life's captive reinsurance companies.

Peach Re
Peach Re, Inc., which is wholly owned by Primerica Life, is a special purpose captive reinsurance company domiciled in Vermont. Thus Peach Re is regulated by the Vermont Department of Financial Regulation. Primerica, Inc. refers to it in 10-K reports as the "Vermont DOI," but I refer to it as the "Vermont DFR."

When Primerica Life formed Peach Re in 2012, the Vermont DFR issued a "licensing order" that explicitly permits Peach Re to treat a letter of credit (LOC) as an admitted asset. Thus Peach Re accepts reserve liabilities transferred to it from its parent, Primerica Life, and the Vermont DFR permits Peach Re to offset those liabilities in large part with an LOC that Peach Re treats as an admitted asset on its balance sheet.

It is important to understand that accounting rules adopted by the National Association of Insurance Commissioners (NAIC) prohibit companies from treating LOCs as admitted assets. The Vermont DFR, however, deviates from those accounting rules by permitting captive reinsurance companies domiciled in Vermont to treat LOCs as admitted assets. Primerica says in its 10-K reports that this accounting practice permitted by the Vermont DFR "was critical to the organization and operational plans of Peach Re."

Primerica says in its 10-K reports that Peach Re's statutory financial statements "are prepared in accordance with statutory accounting practices prescribed or permitted by the NAIC and the Vermont DOI." The word "and" implies that the practices are permitted by both the NAIC and Vermont. That implication is false because the NAIC prohibits treating LOCs as admitted assets. The problem could be avoided by saying the practices are permitted by the NAIC "or" the Vermont DFR.

Peach Re's LOC
The 10-K reports provide information about Peach Re's LOC. Effective March 31, 2012, Peach Re entered into an agreement with Deutsche Bank. The purpose of the agreement was to support reserve liabilities associated with level premium term life insurance policies that Primerica Life ceded to Peach Re through reinsurance. Primerica Life has issued many such term life policies, which are subject to enhanced reserve liability requirements imposed by state insurance regulators.

Under the agreement, Deutsche issued an LOC in the initial amount of $450 million with a term of about 14 years. The LOC amount may be increased to a maximum of about $507 million. The LOC is for the benefit of Primerica Life. If Primerica Life should draw from the LOC, Peach Re would be obligated, with limitations, to reimburse Deutsche, with interest. Peach Re collateralized its obligations to Deutsche by granting Deutsche a security interest in all of Peach Re's assets, with exceptions.

Peach Re's LOC and Primerica's Risk-Based Capital
An insurance company's risk-based capital (RBC) ratio is total adjusted capital divided by company action level RBC, with the quotient expressed as a percentage. At the end of 2015, Primerica Life's total adjusted capital was $576.8 million, company action level RBC was $127.3 million, and the RBC ratio was 453 percent ($576.8 divided by $127.3).

Because Peach Re is a wholly owned subsidiary of Primerica Life, an admitted asset of Peach Re is reflected directly in the admitted assets and total adjusted capital of Primerica Life. The LOC amount at the end of 2015 was $455.7 million. Therefore, if Peach Re was not permitted to treat the LOC as an admitted asset, the total adjusted capital of Primerica Life would have been $121.1 million ($576.8 minus $455.7), and the RBC ratio would have been 95 percent ($121.1 divided by $127.3), or 358 percentage points below the RBC ratio including the LOC amount (453 minus 95).

The impact of the LOC on Primerica Life's RBC data was more severe in 2014, when the LOC amount was $507 million. Primerica Life's total adjusted capital was $515.4 million, company action level RBC was $127.6 million, and the RBC ratio was 404 percent ($515.4 divided by $127.6). Without the $507 million LOC amount, Primerica Life's total adjusted capital would have been only $8.4 million ($515.4 minus $507). Total adjusted capital of $8.4 million would have been far below all the RBC levels, including mandatory control level RBC.

Peach Re's LOC and Primerica's Financial Strength Ratings
Primerica Life has high financial strength ratings: A+ (superior) from A. M. Best, A2 (upper medium grade) from Moody's Investors Service, and AA– (very strong) from Standard & Poor's. All three ratings have a stable outlook. It is not clear to what extent the ratings take into account the questionable nature of the LOC as an admitted asset.

Regulatory Triggers
The 10-K reports mention "minimum statutory capital and surplus" that might "trigger a regulatory action event" at Primerica Life. For example, the 2014 10-K report mentions a trigger of $79.3 million. The 2015 10-K report alludes to the subject, but does not mention a number.

In an effort to understand precisely what "regulatory action event" is referred to in the 10-K reports, I calculated the RBC levels for 2014 from data shown in Primerica Life's statutory statement. For example, regulatory action level RBC was $95.7 million, and authorized control level RBC was $63.8 million. Thus the trigger of $79.3 million mentioned in the 2014 10-K report was about halfway between regulatory action level RBC and authorized control level RBC. When this blog item is posted, I will ask Primerica, Inc. how it calculates the triggers.

Consequences of the Triggers
In its 10-K reports, Primerica, Inc. mentions the significance of the regulatory triggers discussed above. Here are comments in the 2014 10-K report and the less informative comments in the 2015 10-K report:

• [2014 10-K] As of December 31, 2014, if Peach Re had not been permitted to include the letter of credit as an admitted asset, Primerica Life would have been below the minimum statutory capital and surplus level of approximately $79.3 million that triggers a regulatory action event. However, if Peach Re had not been permitted to include the letter of credit as an admitted asset in its statutory capital and surplus, Primerica Life would not have paid the ordinary dividends to the Parent Company that were paid in 2014.
• [2015 10-K] As of December 31, 2015, even if Peach Re had not been permitted to include the letter of credit as an admitted asset, Primerica Life would not have been below the minimum statutory capital and surplus level that triggers a regulatory action event. [Blogger's note: This assertion is questionable. As I mentioned earlier, Primerica Life's RBC ratio would have been 95 percent. That figure is between company action level RBC and regulatory action level RBC. The situation would have required the company to file an RBC report with its domiciliary regulator, and possibly take further action to deal with the low RBC ratio.]

The Capital Maintenance Agreement
The 10-K reports mention a "capital maintenance agreement" with Peach Re. It requires Primerica, Inc. to make capital contributions to Peach Re to assure that Peach Re's regulatory account as defined in the reinsurance with Primerica Life will not be less than $20 million. The regulatory account will only be used to satisfy obligations under the reinsurance with Primerica Life after all other assets have been used, including the LOC issued by Deutsche.

My Public Records Request to Vermont
On March 21, 2016, I sent a public records request to Commissioner Susan L. Donegan of the Vermont DFR. I quoted from the 2015 10-K report of Primerica, Inc. and requested copies of four items: the licensing order, the LOC, the capital maintenance agreement, and the 2015 statutory financial statement of Peach Re. I asked, if the request is denied in whole or in part, that DFR cite the statutes or regulations on which the denial is based. On March 22, a DFR staff person said:

By statute the information you have requested is confidential, however, we would be happy to pass along your request to the appropriate management company, who would be more likely to answer your questions. I won't take further action unless you authorize.

I responded by repeating my request for the relevant statutes or regulations. I also said I would prefer to contact the appropriate person at the management company directly, and requested contact information for that person. On March 24, David F. Provost, DFR's deputy commissioner for captive insurance, said:

The information you requested in your letter of March 21, 2016 contains information proprietary to the operations of Primerica and is held confidential pursuant to 8 V.S.A. §§ 6002 and 6007 and is exempt from public records request pursuant to 1 V.S.A. §317(c). Pursuant to 1 V.S.A. §318(a)(2), you have a right to appeal any determination regarding exemptions under 1 V.S.A. §317(c) to Commissioner Donegan.

Deputy Commissioner Provost also gave me contact information for the appropriate person at the management company: Edward F. Precourt, senior vice president of Marsh Management Services, Inc. in Burlington. I wrote to him but have not yet received a reply.

My Public Records Request to Massachusetts
On March 21, 2016, I sent a public records request to the Massachusetts Division of Insurance (MDOI), which is Primerica Life's domiciliary regulator. I mentioned the comment in the 2015 10-K report of Primerica Life's parent that Peach Re's statement is filed with Primerica Life's statement. On March 29, I received from the MDOI an 84-page PDF containing Peach Re's 2015 statutory financial statement. Some information as of December 31, 2015 is shown here. Dollar figures are to the nearest tenth of a million, except where billions are indicated.

The balance sheet shows that total net admitted assets were $582.6, of which the LOC amount was $455.7. Most of the remainder was $44.4 of bonds and $51.2 of funds held by or deposited with reinsured companies. Total liabilities were $506.7, of which $498.9 was aggregate reserve for life contracts. Surplus was $75.9.

The summary of operations shows total income was $107.3, of which $104.7 was premiums and annuity considerations for life and accident and health contracts. Total expenses were $50.9, of which $32.0 were death benefits. Net income was $55.6. Dividends to stockholders were minus $60.4. Surplus adjustment for letter of credit was minus $51.3.

The notes to the financial statements include a discussion of the LOC. Among other comments, the notes say:

The LOC is not included as a risk-based asset in our risk-based capital calculation. As of December 31, 2015, had we not been permitted to include the LOC as an admitted asset, our NAIC risk-based capital would have been below the NAIC mandatory control level.

The notes also indicate that the surplus on the Vermont basis was $75.9, and on the NAIC basis was minus $379.8 ($75.9 minus $455.7). In 2015 Peach Re paid a dividend of $60.4 to Primerica Life with the approval of the Vermont DFR.

The Atlanta office of KPMG LLP conducts the annual audit. Daniel B. Settle, FSA, MAAA, executive vice president and chief actuary of Primerica Life and Peach Re, provides the actuarial opinion.

From the statement I derived RBC data for the end of 2015. Total adjusted capital was $76.1, company action level RBC was $10.5, and the RBC ratio was 725 percent ($76.1 divided by $10.5). The exhibit of reinsurance assumed shows that Peach Re assumed $498.9 of reserve liabilities from Primerica Life on policies whose total amount in force was $11.8 billion.

General Observations
No justification exists for the secrecy surrounding admitted assets that captive reinsurance companies carry on their statutory balance sheets. I refer to LOCs, parental guarantees, contingent notes, variable funding notes, credit linked notes, note guarantees, and other questionable financial instruments. Nor is there justification for the secrecy surrounding licensing orders, capital maintenance agreements, statutory financial statements of captive reinsurance companies, valuation actuary reports, and independent auditor reports. The response by the MDOI to my request for Peach Re's 2015 statutory financial statement clearly demonstrates the lack of justification for secrecy surrounding such statements.

The fact that statutes and regulations shroud such documents in secrecy does not justify the secrecy. Statutes are drafted by those who want documents kept secret, and friendly state legislators enact the statutes without public input. Regulations are drafted by those who want documents kept secret, and friendly state insurance regulators adopt the regulations without public input. In short, at no time during the process of enacting the statutes and adopting the regulations are those desiring secrecy required to provide the public with justification for the secrecy.

I challenge those who favor secrecy in this area to explain why they favor secrecy. I plan to report on the responses to this challenge.

Available Material
I am making available a complimentary 19-page PDF containing selected excerpts from the 2014 and 2015 10-K reports filed with the SEC by Primerica, Inc., RBC data derived from the 2015 statutory financial statement filed with state insurance regulators by Primerica Life, and selected pages from the 2015 statutory financial statement filed with the MDOI by Peach Re. Email jmbelth@gmail.com and ask for the March 30, 2016 excerpts from Primerica filings.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 152: Captive Reinsurers—A Brief Released by the Office of Financial Research in the U.S. Department of the Treasury

In No. 135 (posted December 28, 2015), I discussed the first Financial Stability Report issued by the Office of Financial Research (OFR), an independent bureau within the U.S. Department of the Treasury. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 established the OFR, which issues periodic reports. The OFR also issues "briefs" on various topics.

Brief No. 16-02
On March 17, 2016, the OFR issued Brief No. 16-02 entitled "Mind the Gaps: What Do New Disclosures Tell Us About Life Insurers' Use of Off-Balance-Sheet Captives?" The authors of the brief are four members of the OFR staff: Jill Cetina, Arthur Fliegelman, Jonathan Glicoes, and Ruth Leung. Here is the abstract of the ten-page brief:

Some U.S. life insurance companies use wholly owned captive reinsurers to transfer risk and reduce regulatory requirements. Since 2002, such transfers have increased rapidly, and they now exceed $200 billion in reserve credit. This brief discusses recent policy measures and the data that insurers began reporting in 2015 about their captive transactions. Publicly available data are insufficient to analyze fully the risks from captives and the impact on insurers' financial condition. Regulators have revised reporting standards to improve the public data, but gaps remain. Because life insurers are a material part of the financial system, these gaps may mask financial stability vulnerabilities.

Background
The authors of the brief explain that the ceding of reserve liabilities to captive reinsurers to reduce the liabilities of the parent ceding companies began about 15 years ago, after state insurance regulators had increased reserve requirements for term life policies and for universal life policies with secondary guarantees (ULSG). The problem is that the captive reinsurers are permitted by some state insurance regulators to treat as admitted assets what the authors of the brief refer to as "nontraditional" items such as letters of credit and parental guarantees, despite the fact that accounting rules adopted by the National Association of Insurance Commissioners do not permit such items to be treated as admitted assets.

Some of the Data
The brief contains a considerable amount of information based on year-end 2014 data. (Year-end 2015 data were not available when the brief was being prepared.) The 2014 data show that the use of captives by U.S. life insurers totaled $213.4 billion in reserve credit. The authors of the brief point out that, because of exemptions, ceding insurers disclosed the quality of the assets for only 55 percent of the assets of term life and ULSG captives. The authors of the brief also point out that, for the 2014 data, there were no requirements for disclosure of the impact of the use of captives on the risk-based capital ratios of the ceding insurers.

General Observations
This is not the first time OFR has expressed concern about captive reinsurers. Earlier expressions of concern were in OFR's 2014 Annual Report and 2015 Financial Stability Report. I think the recent OFR brief should be studied carefully by persons interested in the welfare of life insurance companies and policyholders.

Perhaps the most detailed official expression of concern about captive reinsurers was a 24-page report entitled "Shining a Light on Shadow Insurance." The report was issued in June 2013 by the New York Department of Financial Services (NYDFS) during the tenure of Benjamin M. Lawsky, the former NYDFS superintendent.

Today, almost three years after issuance of the NYDFS report, we still have very little disclosure of the details of captive reinsurance transactions. In my view, the central problem is the secrecy surrounding what the authors of the OFR brief refer to as "nontraditional" admitted assets carried on the balance sheets of captive reinsurers. I think of those assets as "toxic," and I have referred to their use as a "shell game" that would collapse if the details of those assets were clearly disclosed.

Available Material
I am making available two complimentary PDFs. One is the recent ten-page OFR brief. The other is the 24-page NYDFS report released in 2013. Email jmbelth@gmail.com and ask for the March 2016 OFR brief and/or the June 2013 NYDFS report on shadow insurance.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 151: Life Partners—Trustee Moran Files 17 Adversary Proceedings in the Bankruptcy Case

H. Thomas Moran II is the chapter 11 trustee in the Life Partners Holdings Inc. (LPHI) bankruptcy case. On March 5, 2016, as I reported in No. 150 (posted March 16), Moran filed an extensive report describing the results of his investigation of the allegedly fraudulent business conduct that preceded the January 2015 bankruptcy filing. (See In re LPHI, U.S. Bankruptcy Court, Northern District of Texas, Case No. 15-40289.)

Adversary Proceedings
During the period from March 11 to March 13, a week after filing his extensive report, Moran filed 17 adversary proceedings. As I explained in Nos. 117 and 126 (posted September 21 and November 12, 2015), an "adversary proceeding" is a lawsuit filed within a bankruptcy case and assigned its own case number. In the above 2015 posts, I mentioned a pair of adversary proceedings that Moran had filed earlier: one against Brian D. Pardo, former chief executive officer and controlling shareholder of LPHI, and one against former licensees.

The 17 new adversary proceedings include several complaints against former licensees, a complaint against the former outside directors of LPHI, a complaint against former LPHI life expectancy estimator Dr. Donald T. Cassidy, a complaint against former shareholders who received dividends from LPHI, a complaint against former LPHI employees, several complaints against transferees who received funds from LPHI, and several complaints against local and national charities that received donations from Pardo. Here is a list, in numerical order, showing case numbers, abbreviated case names, and types of defendants:

16-04022: Moran v. A. Chris Ostler (Licensees)
16-04024: Moran v. Happy Endings Dog Rescue (Charity)
16-04025: Moran v. Jonathan Brooks (Licensee)
16-04026: Moran v. Argentus Securities LLC (Licensees)
16-04027: Moran v. ESP Communications Inc. (Transferee)
16-04028: Moran v. American Heart Association (Charities)
16-04029: Moran v. Funds for Life Ministries (Charities)
16-04030: Moran v. Andrea Atwell (Employees)
16-04031: Moran v. Blanc & Otus (Transferees)
16-04032: Moran v. Averitt & Associates (Transferees)
16-04033: Moran v. Donald T. Cassidy (Life Expectancy Estimator)
16-04034: Moran v. Robin Rock Ltd. (Transferees)
16-04035: Moran v. 72 Vest Level Three LLC (Licensees)
16-04036: Moran v. James Alexander (Shareholders)
16-04037: Moran v. Garnet F. Coleman (Transferees)
16-04038: Moran v. A Roger O. Whitley Group Inc. (Licensees)
16-04039: Moran v. Tad Ballantyne (Outside Directors)

Complaint against Ballantyne
As an example of the 17 complaints, I selected the complaint against the outside members of LPHI's board of directors: Tad M. Ballantyne (Racine, WI), Fred Dewald (Woodway, TX), and Harold E. Rafuse (Crawford, TX). The "Factual Background" section describes the procedural history of the bankruptcy case, the overall scheme to defraud, and LPHI's insolvency. That section also includes a 23-page, 19-part description of the involvement of the three outside directors.

The complaint contains 12 counts: one count of breaches of fiduciary duty, three counts of violations of securities laws, two counts of actual fraudulent transfers, two counts of constructive fraudulent transfers, one count of preferences, one count of unjust enrichment and constructive trust, one count of disallowance of defendants' claims, and one count of equitable subordination. The concluding section of the complaint reads:

WHEREFORE, the Plaintiffs request that the Outside Directors each be ordered to return all funds received from Life Partners to the Debtor's Estate as a result of the conduct described herein, and that judgment be entered against them and in favor of Plaintiffs for the total amount transferred to Defendants. Plaintiffs request actual and consequential damages as determined at a trial on the merits, as well as exemplary damages where warranted. In the case that the funds were spent to acquire any real or personal property, Plaintiffs request that a constructive trust be imposed upon the property, and an order that such property must immediately be turned over to Plaintiffs. Plaintiffs ask for pre-judgment and post-judgment interest at the highest rates allowed by law. Further, Plaintiffs request recovery of their attorneys' fees and costs, and that they be granted any other relief, both special and general, to which they may be justly entitled.

General Observations
Through these adversary proceedings, Moran is attempting to claw back as much money as possible for the benefit of those victimized by allegedly fraudulent business conduct over the years, especially for the benefit of investors in fractional interests in life settlements marketed by LPHI. He has cast a wide net; however, to what extent he will succeed in the effort remains to be seen. I plan to continue watching the progress of the case and reporting significant developments.

Available Material
I am making available as a complimentary 46-page PDF the complaint against the three former outside members of LPHI's board of directors. Email jmbelth@gmail.com and ask for the March 2016 Moran complaint against Ballantyne.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com