No. 189: Life Settlement Promotion Based on a Lawsuit That Went Nowhere

On November 10, 2016, I received an email from a marketing organization on the subject of "Fiduciary notice for life agents." Here is the full text of the email:

Recently, a family filed a class action lawsuit in a California U.S. District Court against their life insurance provider. They sought punitive damages, treble damages, restitution and an injunction because their agent failed to inform them of their options on the life settlement market.

This is not a fluke occurrence.

Uphold your fiduciary responsibility, save yourself from litigation and help seniors save the 100B worth of lapsed policies that could be used, for example, to fund long-term care.

Simply read a new white paper that provides a simple overview of life settlements in a fiduciary context, plus life and annuity options to help you uphold your responsibility and make additional sales. [Emphasis in original.]

The email identified the lawsuit as Grill v. Lincoln National Life. I had looked at the case in February 2016, but did not report on it at the time because it had gone nowhere. Now that the case is being used to support the argument that a life insurance agent has a "fiduciary responsibility" to mention life settlements as "options," I felt it would be appropriate to report on the case.

The Grill Lawsuit
On January 9, 2014, three members of the Grill family filed a class action lawsuit against Lincoln National Life Insurance Company. The case was assigned to U.S. District Judge Jesus G. Bernal. President Obama nominated him in April 2012, and the Senate confirmed him in December 2012. His career is an immigrant success story. Born in Mexico, he received his undergraduate degree cum laude from Yale University and his law degree from the Stanford Law School. (See Grill v. Lincoln National, U.S. District Court, Central District of California, Case No. 5:14-cv-51.)

The plaintiffs filed four complaints. The discussion here is based on the fourth (third amended) complaint, which was filed September 29, 2014.

In 2004 the plaintiffs purchased a second-to-die policy with a death benefit of $7.2 million. The insureds were aged 68 and 65. The third plaintiff was trustee of the trust that was owner and beneficiary of the policy. The policy type is not stated, but it was probably universal life because the complaint said the "premium payments were designed to generate investment returns that would cover the cost of insurance." Although the complaint did not say so, the policy probably was being paid for with minimum premiums so as to generate no account value.

By 2008 the investment returns became insufficient to cover the cost of insurance. The plaintiffs consulted their agent, who allegedly said "they had two options: (1) pay new premiums into the Policy to extend it, or (2) surrender the Policy, in whole or in part, to reduce the cost of insurance." The plaintiffs surrendered part of the policy, decreasing the death benefit to $5.4 million. By 2009 the investment returns again became insufficient, and the plaintiffs again surrendered part of the policy to reduce the death benefit to $2 million. The plaintiffs alleged that they had twice surrendered parts of the policy "for no consideration" and that their agent did not tell them about life settlements. Further, they alleged:

Defendant's failure to inform and/or concealment of the option of a life settlement is part of a common and systematic practice by Defendant to hide this option from its insureds. The reason for this failure to inform and/or concealment is clear: Defendant stands to profit significantly if Plaintiffs and similarly situated Class members pay new premiums into their policies or surrender their policies for little or no value. Conversely, if Plaintiffs and similarly situated Class members sell their policies in a life settlement, Defendant would have to pay the death benefit without receiving higher premiums and/or without a surrender.

The complaints survived Lincoln's motions to dismiss. On October 6, 2014, one of the insureds died. On May 29, 2015, Judge Bernal ordered the plaintiffs to file a motion for class certification by June 15. On that date the plaintiffs instead filed a notice of settlement. On August 24 the parties filed a joint stipulation to dismiss the case based on the fact that one of the lead plaintiffs had died and the survivors had not substituted another lead plaintiff. On August 25 Judge Bernal granted the stipulation to dismiss with prejudice (permanently) all claims asserted by the plaintiffs.

The Final Stipulation
On September 21, 2015, the parties filed a joint stipulation of dismissal. Here is the full text of the stipulation:

WHEREAS, Plaintiffs' investigation and analysis to date did not support the allegation that Defendant had a common and systematic practice of concealing life settlement options from its insureds;

WHEREAS, the parties have elected to settle each and every claim asserted in the above-captioned matter with no admission of wrongdoing, impropriety or liability on the part of any party;

NOW, THEREFORE, IT IS HEREBY STIPULATED AND AGREED by and between the parties through their respective counsel of record pursuant to that settlement agreement, and pursuant to Rule 41(a)(1) of the Federal Rules of Civil Procedure, the individual claims of the named plaintiffs in the above-entitled action be dismissed with prejudice, and the claims of the putative class be dismissed without prejudice, with each party to bear its own costs.

General Observation No. 1
Citing a case that went nowhere to support the notion that the agent has a fiduciary obligation to disclose life settlement "options" is not the only phony tactic used by life settlement promoters. The requirement of insurable interest has caused a huge amount of litigation in the secondary market for life insurance. In the June 2009 issue of The Insurance Forum, in a discussion of an agent's lawsuit against Phoenix Life Insurance Company, I said the plaintiff had cited a 2007 article in a prestigious law journal condemning the insurable interest doctrine. The author argued that "the doctrine creates perverse incentives that encourage the very practices the doctrine seeks to deter," that "the doctrine also invites unfairness and inefficiency in the insurance market," and that the doctrine should be abolished. The article was written by a law student on the editorial staff of the law journal. In a note the author acknowledged the help of a fellow student on the editorial staff of the law journal, and the help of a member of the faculty of the law school.

I was certain that the article had been planted by promoters of the secondary market for life insurance. I wrote to the author and his fellow student, both of whom by then were associated with major law firms. I also wrote to the faculty member. I asked who had suggested the idea for the article. I also asked whether anyone at the law school had received compensation. In the December 2013 issue of the Forum, in an article entitled "Why the Secondary Market for Life Insurance Will Never Win Full Public Acceptance," I said I had received no reply.

General Observation No. 2
The plaintiffs in the Grill case, in their reasoning about why Lincoln allegedly concealed the life settlement option, are incorrect. As a general rule, life insurance companies want their policies to remain in force. That is why companies often reward agents for strong persistency. Exceptions to the general rule are so-called "lapse-supported" policies that are priced so as to depend on high lapse rates for profitability. The policy in this case does not fit into the "lapse-supported" category. Furthermore, in their reasoning, the plaintiffs neglected to point out that the speculator in human life who would have acquired the policy in the secondary market would have had to continue paying premiums to keep the policy in force until the death of the second insured, and that the need to pay those premiums would have been a factor in determining the price paid in a life settlement.

General Observation No. 3
A matter somewhat related to the second observation above is the question of how much a company would pay on surrender of a policy whose insured is in poor health. At least two observers—an actuary and I—have suggested the idea of "health-related" or "health-adjusted" cash values. If an insured is in poor health, it would seem reasonable for a company to pay an enhanced cash value upon surrender of the policy. In the March 1999 issue of the Forum, which was a special 12-page issue, I mentioned health-related cash values as one of eleven suggested methods of dealing with "The Growth of the Frightening Secondary Market for Life Insurance Policies." The February 2001 issue of the Forum included an article by Albert E. Easton, FSA, MAAA. He had written a technical article on the subject in an actuarial journal, and I had invited him to write a nontechnical article for the Forum.

Available Material
I am offering a complimentary 21-page PDF containing the four Forum articles mentioned in the general observations above. Email jmbelth@gmail.com and ask for the November 2016 package of Forum articles about the secondary market for life insurance.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 188: The U.S. Department of Labor Wins One of the Lawsuits Challenging Its New Fiduciary Rule

On April 8, 2016, the U.S. Department of Labor (DOL) promulgated its long-awaited "fiduciary rule" addressing conflicts of interest in the marketing of commission-driven retirement advice given to consumers. In the months that followed, the industry's opposition to the rule took the form of several lawsuits seeking to prevent or at least delay implementation of the rule. The rule is to go into effect on April 10, 2017, with full implementation of certain aspects of the rule on January 1, 2018.

The NAFA Lawsuit
On June 2, 2016, the National Association for Fixed Annuities (NAFA) filed a complaint seeking to delay implementation of the new DOL rule, a motion for a preliminary injunction, and a memorandum in support of the motion. The defendants are the DOL and Secretary of Labor Thomas E. Perez. The case was assigned to U.S. District Judge Randolph D. Moss. President Obama nominated him in April 2014, and the Senate confirmed him in November 2014. (See NAFA v. DOL and Perez, U.S. District Court, District of Columbia, Case No. 1:16-cv-1035.)

On June 7 Judge Moss said NAFA's motion will be treated as a motion for a preliminary injunction and for summary judgment. On July 8 the defendants filed an opposition to NAFA's motion and a cross-motion for summary judgment. On August 30 Judge Moss held a hearing on NAFA's motion and the defendants' cross-motion.

The Opinion
On November 4 Judge Moss issued a 92-page opinion and a one-page order. They constitute a win for the defendants. Here, without citations, are the first and last paragraphs of the five-page introductory section of the opinion:

• Plaintiff the National Association for Fixed Annuities ("NAFA") brings this action under the Administrative Procedure Act and the Regulatory Flexibility Act, challenging three final rules promulgated by the Department of Labor on April 8, 2016. Taken together, the three rules substantially modify the regulation of conflicts of interest in the market for retirement investment advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. NAFA focuses its challenge on how the new rules will affect the market for the fixed annuities its members sell.
• Based on these arguments, and its further contention that the new rules will have catastrophic consequences for the fixed indexed annuities industry, NAFA seeks both a preliminary injunction and summary judgment. The Department opposes both motions and has cross-moved for summary judgment. For the reasons explained below, the Court will deny NAFA's motions for a preliminary injunction and summary judgment and will grant the Department's cross-motion for summary judgment.

The Outline
Below is an outline of the opinion. In parentheses is the page number on which the discussion of each item begins. "ERISA" is "Employee Retirement Income Security Act of 1974," "PTE" is "Prohibited Transaction Exemption," and "BIC" is "Best Interest Contract."

Memorandum Opinion (1)
I.	Background (5)
	A.	Annuities (5)
	B.	Statutory and Regulatory Background (7)
		1.	ERISA (7)
			a.	Title I of ERISA (8)
			b.	Title II of ERISA (10)
		2.	The 1975 Definition of "Fiduciary" and PTE 84-24 (11)
		3.	The Current Rulemaking (14)
			a.	The 2010 Proposed Rule (14)
			b.	The 2015 Proposed Rules (15)
			c.	The Final Rule (21)
	C.	Procedural Background (27)
II.	Analysis (29)
	A.	Revised Definition of "Rendering Investment Advice" (30)
		1.	Chevron Step One (30)
		2.	Chevron Step Two (40)
	B.	Imposition of Fiduciary Duties as Condition of PTE 84-24 and the BIC Exemption (45)
	C.	Written Contract Requirement of the BIC Exemption (55)
	D.	Reasonable Compensation Requirement and Due Process (61)
	E.	Placement of Fixed Indexed Annuities in the BIC Exemption (71)
		1.	Treatment of Fixed Income [sic] Annuities as "Securities" (72)
		2.	Notice and Opportunity to Comment (73)
		3.	Reasoned Explanation (76)
		4.	Workability and Rationality (79)
		5.	Cost/Benefit Analysis (85)
	F.	Regulatory Flexibility Act (88)
Conclusion (92)

The Parties' Statements
After Judge Moss's ruling, Secretary Perez issued a brief statement. NAFA sent its members a relatively lengthy statement entitled "NAFA to Appeal Court Decision on DOL Fiduciary Rule" and subtitled "NAFA Will Seek Expedited Review." Here are the statements:

Perez: The conflicts of interest rule was developed after substantial input from a variety of stakeholders, including the industry, and it will make sure that retirement savers receive advice that puts their interests first. I'm pleased that the court recognized the comprehensive and thoughtful process we used in crafting this rule—this ruling is a win for working Americans who simply want a secure retirement.

NAFA: The National Association for Fixed Annuities ("NAFA") announced today, following a federal district court decision upholding the Department of Labor's fiduciary rule, that it will appeal to the D.C. Circuit Court of Appeals. "We are obviously disappointed by the court's decision, but we have always assumed this case would get decided by a higher court and we are pleased the issues will get de novo review by the Circuit Court," said Chip Anderson, Executive Director of NAFA. De novo review means the appellate court will consider the case without being bound or influenced by the lower court's decision. NAFA filed its lawsuit last June seeking a preliminary injunction to stay implementation of the rule, which is scheduled to go into effect in April 2017. Judge Randall [sic] Moss denied the preliminary injunction and at the same time ruled in favor of the DOL on the merits upholding the rule. NAFA's lawsuit, one of four lawsuits against the rule, challenges the DOL's authority to issue the rule, asserts the rule creates an impermissible private right of action, contends the rule contains unconstitutionally vague requirements that compensation be reasonable, and alleges the manner of adoption of the rule by DOL was arbitrary and capricious. Anderson stressed that NAFA would move quickly to get the case up to the appellate court and would continue to seek a preliminary injunction. Anderson said NAFA remains optimistic that the courts will ultimately find the rule to be an overreach by the Department of Labor that is inconsistent with existing tax and financial services laws. "NAFA believes the fiduciary rule will disrupt the distribution and availability of fixed annuities and have a particularly adverse impact on the low and middle income consumers who have come to rely on these valuable retirement savings products," said Anderson. Fixed annuities provide consumers with a guaranty of principal and minimum accumulation and provide a guaranteed lifetime income stream consumers cannot outlive. NAFA consists of insurance companies, agencies, and agents and affiliated persons who provide fixed annuities.

Other Lawsuits
As mentioned in NAFA's statement, several lawsuits have been filed seeking to delay implementation of the DOL rule. Some of the lawsuits have been consolidated. It is beyond the scope of this post to discuss the status of the other cases. However, to appreciate the significance of the DOL rule, it is instructive to identify some (but by no means all) of the parties involved as plaintiffs, as filers of amicus curiae (friend of the court) briefs, and as participants in other capacities, on both sides of the cases.

Some of those opposing the DOL, in addition to NAFA, are American Council of Life Insurers, American Equity Investment Life Insurance Company, Chamber of Commerce of the U.S., Life Insurance Company of the Southwest, Midland National Life Insurance Company, National Association of Insurance and Financial Advisors, North American Company for Life and Health Insurance, and Thrivent Financial for Lutherans. Some of those supporting the DOL are AARP, Americans for Financial Reform, Better Markets, Inc., Consumer Federation of America, and Public Citizen, Inc.

General Observations
Judge Moss's opinion is an extraordinary document. The five-page introductory section is an excellent summary of the DOL rule and the arguments for and against its implementation.

The terminology is interesting. In the first paragraph of the introductory section of the opinion, the expression "fixed annuities" appears. In the fifth paragraph, the expression "fixed index annuities" appears. Including NAFA's name, the statement to its members contains four references to "fixed annuities" and no mention of "fixed index annuities." It is my understanding that "fixed annuities" have no special upside potential based on a stock index, and that they are deemed to be insurance products. "Index annuities," on the other hand, have some upside potential based on a stock index, and therefore should be deemed securities. However, those arguing against their being deemed securities changed the name in a confusing and even contradictory manner to "fixed index annuities" in an effort to strengthen their argument.

Although many readers have asked me to write in detail about index annuities or fixed index annuities, I have not done so. The reason is that I do not understand the instruments well enough to feel comfortable writing about them. Some promoters have said I am too stupid to know a good thing when I see it, but I think the instruments are being sold by agents who do not understand them to buyers who do not understand them.

I have long believed that those selling insurance instruments, whether or not the instruments are deemed securities, should be required to operate under the fiduciary standard of care rather than the much weaker suitability standard of care. I think the new DOL rule, provided it survives the efforts of the industry to delay its implementation, will be an important step in that direction. In the long run, I think such a result would benefit not only insurance consumers but also the insurance industry.

Blogger's Note
In view of the results of the November 8 election, it is likely that the Trump-appointed Secretary of Labor—whoever he or she may be—will withdraw the DOL rule in view of the campaign promises that have been made to cut back on government regulations. Thus the efforts of all the parties—including the industry and the Department of Labor—in developing the rule and preparing for its implementation, as well as all the efforts of the parties and the courts in fighting over the rule, are likely to have been wasted.

More importantly, withdrawal of the rule will have a severe, adverse effect on retirement savers and other consumers. They will continue to be victimized by purchasing so-called fixed index annuities that benefit primarily commission-driven agents and others who sell them.

Available Material
I am offering a complimentary 92-page PDF containing the opinion Judge Moss issued on November 4, 2016. Email jmbelth@gmail.com and ask for the Moss ruling in the NAFA/DOL case.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 187: Genworth Financial, Long-Term Care Insurance, and Clarification of a Comment in No. 185

The purpose of this post is to clarify a comment I made in No. 185, in which I discussed, among other things, regulatory supervision. I discussed the October 23 surprise announcement by Genworth Financial, Inc. that it had entered into a definitive merger agreement. If the agreement is consummated, Genworth would be an indirect, wholly owned subsidiary of China Oceanwide Holdings Group Co., Ltd., a privately held international financial holding company group headquartered in Beijing.

I said Genworth has long been in the long-term care (LTC) insurance business, it is one of the few major companies still in the business, its subsidiaries have suffered significant declines in their financial strength ratings, primarily as a result of their LTC insurance business, and the company is trying to reorganize in order to "isolate" its LTC insurance business. I also said that, because of Genworth's financial problems and its effort to reorganize, one or more of its subsidiaries may be operating under a supervision order, but that I was not aware of the existence of such an order.

When No. 185 was posted on Friday morning, November 4, I forwarded it as a courtesy to a Genworth spokeswoman. She promptly said Genworth is not operating under a supervision order. She also said she is happy to fact check anything I am uncertain about before posting an item on my blog. I explained that I made a decision not to ask Genworth about supervision because I felt that the very act of asking such a question would be unfair. On Monday afternoon, November 7, she said:

Our corporate counsel wanted to make sure you understood the implications of your suggestion that one or more of Genworth's companies are operating under a supervision order. He told me there is virtually no circumstance under which a publicly traded company could keep from disclosing such an order and by suggesting that one or more of our companies are operating under a supervision order that has not been disclosed in our SEC [Securities and Exchange Commission] report is, in essence, suggesting that we are committing securities fraud. Although we know this was not your intent, the statement does establish a cloud of uncertainty that is unwarranted. We respectfully ask that you correct the statement and let your readers know definitively that Genworth is not operating under a supervision order.

The 1999 Incident
In No. 185 I also discussed the 1999 case of General American Life Insurance Company. Also involved in the case were ARM Financial, Inc., which is a publicly traded company, and Integrity Life Insurance Company, an ARM subsidiary that is domiciled in Ohio. I said ARM had disclosed in a public filing with the SEC that Integrity Life was operating under a confidential supervision order issued by the Ohio Department of Insurance. Thus ARM's attorney and Genworth's attorney apparently agree that a public company must disclose in its SEC filings the existence of a supervision order.

Blogger's Note
I finished writing this item on November 8 and planned to schedule it on November 9 for posting early in the morning on November 10. I sent an email on the morning of November 9 to Genworth's spokeswoman asking for a brief company statement about the impact of the election results on the pending merger agreement with China Oceanwide. She responded that afternoon as follows:

We will have no comment on the impact of the election results on the China Oceanwide transaction. Thank you.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 186: Chernow's Superb Biography of Alexander Hamilton—An Election Day Special

Ron Chernow's Alexander Hamilton, a superb biography of our first Secretary of the Treasury, inspired the smash Broadway hit, Hamilton: An American Musical. The 818-page book, published in 2004, provides fascinating details about many of the founders of our great nation. For example, the book delves into Hamilton's abolitionist views as well as the views of other founders on the subject of slavery.

Chernow describes Hamilton's birthplace on the Caribbean island of Nevis, and his early life on other islands there. His apparent illegitimate birth plagued his entire life. When he immigrated (yes, he was an immigrant) to New York City as a young man, he became a prodigious student, reader, and writer, and he built an amazing life as an attorney and political leader.

George Washington was Hamilton's greatest supporter. Hamilton was Washington's top assistant during most of the Revolutionary War. Toward the end of the war Hamilton achieved the military rank of general and became a battlefield hero. He later ran the Treasury Department, which was the dominant cabinet department during Washington's administration. The Treasury Department dwarfed the State Department, which at the time was headed by Thomas Jefferson.

Chernow examines in detail Aaron Burr's career, which in many ways was parallel to Hamilton's career. Burr was Jefferson's vice president at the time of the fateful duel that ended Hamilton's life. The duelists and their seconds crossed the Hudson River in separate boats to meet at Weehawken, New Jersey, because dueling was illegal in New York State at the time. As is common in such incidents, there are conflicting views about precisely what happened. Chernow believes that Hamilton purposely fired the first shot into the trees high above Burr.

Chernow devotes considerable space to Hamilton's beloved wife Eliza, who survived him by about half a century. They had eight children. One thing I never knew before was that Philip, their eldest and a handsome young man in the prime of his life, died in a duel about two years before Hamilton's death. Hamilton never fully recovered from the shock of that loss. They named their youngest child Philip (nicknamed Little Phil), who was born after his eldest brother's death.

Chernow provides detail about Hamilton's philandering, especially an affair that resulted in his paying blackmail in what turned out to be an unsuccessful attempt to keep the matter secret. Apparently the affair was a major obstacle that prevented Hamilton from occupying a prominent position in the government after he left Washington's cabinet.

Throughout the book are descriptions of the prickly (to put it mildly) relationship between Hamilton and Jefferson. Hamilton was an admirer of Great Britain and its form of government. Jefferson had spent a substantial amount of time in France and was an admirer of the French, even after the nasty developments that occurred during the French revolution.

Chernow describes in detail Hamilton's strained relationships with other founding fathers, including not only Jefferson, but also John Adams, James Madison, James Monroe, and others. Hamilton's friendship with Madison, for example, was on and off. In the early days of their close relationship, they worked together on The Federalist Papers, although Hamilton wrote most of the pieces in that famous series. Hamilton and Madison later had a falling out.

Chernow describes how Hamilton became the leader of the Federalists in the original two-party system and served as a member of the Constitutional Convention. Hamilton laid the groundwork for what became the New York Stock Exchange, and he developed our tax system. He created our first central bank, the Coast Guard, and the Customs Service. Early in 1795, at age 40, he resigned as Secretary of the Treasury. Here are two sentences (buried on page 481) that summarize Chernow's views on Hamilton's contributions to his adopted country:

Hamilton's achievements were never matched because he was present at the government's inception, when he could draw freely on a blank slate. If Washington was the father of the country and Madison the father of the Constitution, then Alexander Hamilton was surely the father of the American government.

General Observations
Chernow's book is so well written that it is a delight to read. I strongly recommend it to anyone interested in learning about the beginnings of the United States. Readers will recognize the relevance of many parts of the book to happenings in our country today, even including the presidential election campaign of 2016.

This is the first Chernow book I have read. It is so superb that I am determined to read his two other major books—about John D. Rockefeller (Titan) and about John Pierpont "J.P." Morgan (The House of Morgan).

An Interesting Coincidence
When I acquired Chernow's book about Hamilton, I was startled by the back cover of the dust jacket. Two of the three testimonials were written by two of my favorite authors—Robert Caro and David McCullough. I have read all their books. Caro has written about Robert Moses (The Power Broker) and about Lyndon Johnson. The biography of Johnson now consists of four major volumes; Caro's faithful readers anxiously await the fifth and presumably final volume. McCullough has written about Harry Truman, John Adams, the early life of Theodore Roosevelt, the Wright Brothers, the Johnstown Flood, the building of the Brooklyn Bridge, and the building of the Panama Canal, among other persons and events.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 185: Long-Term Care Insurance—Regulatory Supervision, Rehabilitation, and Liquidation of Financially Troubled Companies

For 25 years I have been saying that the problem of financing long-term care (LTC) cannot be solved through private insurance because the LTC exposure violates important principles necessary for the proper functioning of private insurance. Thus I am not surprised that most companies in the LTC insurance business have left the business, and that some of the few remaining are in fragile financial condition. Here I discuss and provide examples of three processes that state insurance regulators use to deal with financially troubled insurance companies.

Supervision
Supervision is a process that state insurance regulators use to deal with financially troubled companies. Regulators normally have the authority to place a company under supervision without obtaining court approval. In some instances, the regulator issues a supervision order openly, by making public the existence of the order and the order itself. In other instances, the regulator makes public the existence of the order but keeps the order itself confidential. In still other instances, the regulator keeps the existence of the order and the order itself confidential.

Rehabilitation and Liquidation
Rehabilitation and liquidation are two other processes that state insurance regulators use to deal with financially troubled companies. In contrast to supervision, court approval is required for rehabilitation or liquidation. The regulator files a petition in state court. If the court approves the petition, the court would appoint the regulator as rehabilitator or liquidator, and full details would be available to the public. The objective of a rehabilitation is to preserve the company so as to allow it to emerge from rehabilitation. To accomplish that objective, the rehabilitator may take such actions as modifying the company's operations, selling the company in whole or in part, merging the company into another company, or changing provisions of the company's existing policies.

Liquidation is a last resort when the regulator and the court agree that rehabilitation is futile. State guaranty associations become involved, and drastic actions may have to be taken. For example, the company may have to be wound down, and policyholders may suffer significant losses.

General American, ARM Financial, and Integrity Life
The 1999 case of Missouri-domiciled General American Life Insurance Company illustrates the use of supervision, although the incident did not involve LTC insurance. At the company's request, the Missouri department of insurance placed the company under supervision to stop a devastating run. The existence of the order became known to the public, but the department kept the order itself confidential.

My first article about supervision, which discussed the General American case, was in the October 1999 issue of The Insurance Forum. While working on the article, I learned that ARM Financial Group, Inc. and a subsidiary, Ohio-domiciled Integrity Life Insurance Company, had extensive dealings with General American. The Ohio department of insurance placed Integrity Life under a confidential supervision order, but word of the existence of the order leaked out. Pursuant to the Ohio public records law, I asked the Ohio department for a copy of the order. The department denied the request, saying the order was confidential. However, ARM Financial, a shareholder-owned company, included the order in a public filing with the Securities and Exchange Commission. I showed the order in the article about the General American case.

Ability Insurance Company
A few companies that abandoned the LTC insurance business transferred their existing policies to Nebraska-domiciled Ability Insurance Company, which is running off the policies. In December 2012 the Nebraska department of insurance placed Ability under a supervision order. The existence of the order was publicly known, and the order itself was available to the public. Here is the third of the department's seven findings of fact in the supervision order:

Based upon examination of financial statements filed by [Ability], including those filed with the Department dated September 30, 2011 and September 30, 2012, the Director has reasonable cause to believe that [Ability] is in such a condition as to render the continuance of its business hazardous to its policyholders and the general public as defined in the Nebraska Insurance Regulations, specifically, 210 Neb. Admin. Code 55 §§ 004.05 and 004.06.

In January 2013 the Nebraska department approved the acquisition of Ability by Advantage Capital Holdings, LLC, an investment company based in Wilmington, Delaware. In July 2014 the department issued an order removing Ability from under supervision. I wrote about the Ability case in the May 2013 issue of the Forum.

IWO and ELNY
Two examples of liquidation, neither of which involved LTC insurance, are the International Workers Order (IWO) and Executive Life Insurance Company of New York (ELNY). IWO was liquidated during the "Red Scare" in the 1950s. ELNY was placed in rehabilitation in 1991 and remained there for 21 years until it was liquidated in 2012. I wrote about the IWO and ELNY liquidations in the August 2012 issue of the Forum.

Penn Treaty
In 2009 the Pennsylvania insurance department petitioned the court to place Pennsylvania-domiciled Penn Treaty Network America Insurance Company, an LTC insurance company, in rehabilitation. Six months later the department petitioned the court to convert the rehabilitation to a liquidation. In 2012, after lengthy proceedings including a 30-day bench trial, the judge, in a 162-page opinion and order, denied the liquidation petition and ordered the department to develop a rehabilitation plan. Later the department and the court revised the rehabilitation plan. In July 2016 the department again petitioned the court to liquidate the company. In October 2016 the judge scheduled a November 9 hearing on the liquidation petition. If the judge approves the petition, the case might have a profound impact on the U.S. system of state guaranty associations. That subject, however, is beyond the scope of this discussion. I wrote about the Penn Treaty case in the August 2012 issue of the Forum, and I plan to write again irrespective of what happens during and after the hearing.

CNO Financial Group
In 2008 CNO Financial Group, Inc. (then Conseco, Inc.) separated itself from Pennsylvania-domiciled Conseco Senior Health Insurance Company (CSHI), a financially troubled LTC insurance subsidiary. With the approval of the Pennsylvania insurance department, Conseco transferred CSHI to an independent trust and renamed the company Senior Health Insurance Company of Pennsylvania (SHIP). I have written about the separation, most recently in No. 182 (October 7, 2016).

In that post I also wrote about a CNO effort to separate itself from a total of about 10,000 LTC insurance policies written by two other CNO subsidiaries, which are domiciled in Indiana and New York. That effort was through reinsurance with Cayman Islands-based Beechwood Re. The Indiana and New York departments required the CNO companies to recapture the reinsurance. Also, CNO filed a lawsuit against three individuals who allegedly misled CNO by failing to disclose Beechwood's close ties to Platinum Partners, a troubled hedge fund. Although CNO's problems with Beechwood and Platinum are significant, I think the problems do not warrant supervision of the CNO companies.

SHIP
SHIP, the former Conseco subsidiary, is in fragile financial condition. It has suffered operating losses, its total adjusted capital at the end of 2015 was below company action level risk-based capital, and it too is entangled with Beechwood and Platinum. Because of its financial condition, SHIP may be operating under a supervision order, but I am not aware of the existence of such an order. I have written about SHIP, most recently in No. 183 (October 19, 2016).

Genworth
Genworth Financial, Inc. has long been in the LTC insurance business, and is one of the few major companies that are still in the business. Genworth has suffered significant declines in its financial strength ratings, primarily as the result of its LTC insurance business. Genworth's subsidiaries, other than those in the mortgage insurance business, are domiciled in Delaware, New York, and Virginia. Genworth is trying to reorganize in order to "isolate" its LTC insurance business. I have written about that effort, most recently in Nos. 154 and 155 (April 7 and 13, 2016). Because of its financial problems and its effort to reorganize, one or more of Genworth's companies may be operating under a supervision order, but I am not aware of the existence of such an order.

On October 23, 2016, Genworth surprised insurance observers by announcing its entry into a definitive merger agreement. If the agreement is consummated, Genworth would be an indirect, wholly owned subsidiary of China Oceanwide Holdings Group Co., Ltd., a privately held international financial holding company group headquartered in Beijing. The agreement provides for Genworth's headquarters to remain in Virginia under the current senior management. The agreement is subject to the approval of Genworth's shareholders, state insurance regulators, federal agencies in the U.S., and governmental authorities in Australia, Canada, China, and Mexico. Genworth hopes to close on the agreement by the middle of 2017.

The agreement consists of 129 single-spaced pages and additional exhibits and schedules that Genworth will make available upon request. An overview of the agreement is in a five-page, single-spaced, October 23 joint press release from China Oceanwide and Genworth. Here are the first two paragraphs of the press release:

China Oceanwide Holdings Group Co., Ltd. ("China Oceanwide") and Genworth Financial, Inc. (NYSE:GNW) ("Genworth") today announced that they have entered into a definitive agreement under which China Oceanwide has agreed to acquire all of the outstanding shares of Genworth for a total transaction value of approximately $2.7 billion, or $5.43 per share in cash. The acquisition will be completed through Asia Pacific Global Capital Co. Ltd., one of China Oceanwide's investment platforms. The transaction is subject to approval by Genworth's stockholders as well as other closing conditions, including the receipt of required regulatory approvals.

As part of the transaction, China Oceanwide has additionally committed to contribute to Genworth $600 million of cash to address the debt maturing in 2018, on or before its maturity, as well as $525 million of cash to the U.S. life insurance businesses. This contribution is in addition to $175 million of cash previously committed by Genworth Holdings, Inc. to the U.S. life insurance businesses. Separately, Genworth also announced today preliminary charges unrelated to this transaction of $535 to $625 million after-tax associated with long term care insurance (LTC) claim reserves and taxes. Those items are detailed in a separate press release. The China Oceanwide transaction is expected to mitigate the negative impact of these charges on Genworth's financial flexibility and facilitate its ability to complete its previously announced U.S. life insurance restructuring plan. Genworth believes this transaction is the best strategic alternative to maximize stockholder value.

The "separate press release" referred to in the second paragraph quoted above is a three-page, single-spaced, October 23 press release from Genworth. It is entitled "Genworth Financial Announces Preliminary Charges For The Third Quarter."

General Observations
Unlike in the case of a rehabilitation or a liquidation, state insurance regulators normally have the authority to place an insurance company under supervision without court approval. The supervision may be carried out in secret, or it may be carried out publicly. Where secrecy is used, the reason is to avoid exacerbating the company's fragile financial condition. Nonetheless I question the wisdom of secret supervision because I think policyholders, shareholders, creditors, employees, agents, and other interested parties are entitled to the truth about the company's financial problems.

It is my understanding that similar secret proceedings are used in the banking business, arguably to prevent runs. Here again, however, I think a bank's customers, shareholders, creditors, employees, and other interested parties are entitled to the truth about the bank's financial problems.

Available Material
I am offering a complimentary 22-page PDF. It consists of articles from the October 1999, August 2012, and May 2013 issues of The Insurance Forum (a total of 14 pages), the five-page October 23 joint press release from China Oceanwide and Genworth, and the three-page October 23 press release from Genworth. Email jmbelth@gmail.com and ask for the November 2016 package about LTC insurance and supervision.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 184: The SEC's Fraud Charges Against Torchia—An Update

On November 10, 2015, the Securities and Exchange Commission (SEC) filed a 39-page, eight-count civil complaint against James A. Torchia, who is a Georgia resident, and five entities he controlled. The SEC alleged securities fraud, including operation of a Ponzi scheme. The two aspects of the case are the marketing of unregistered promissory notes arising from subprime automobile loans, and the marketing of unregistered interests in viatical and life settlements. In No. 128 (November 19, 2015), I reported on the case and offered readers a complimentary PDF containing the SEC complaint. (See SEC v. Torchia, U.S. District Court, Northern District of Georgia, Case No. 1:15-cv-3904.)

An Unsolicited Email
On October 3, 2016, I received out of the blue an email message from "Jim Torchia." The text of the email consisted of two sentences:

Read your article about the charges against me. You may want to get the real truth behind this action by the sec [sic].

I follow the practice of refraining from contact with litigants. Therefore I reported the email to Torchia's attorney and the SEC's lead attorney, and invited them to provide any information they might wish to share. I received no reply. However, I decided to prepare this update.

Early Developments
The case was assigned to U.S. District Judge William S. Duffey, Jr. President George W. Bush nominated him in November 2003, and the Senate confirmed him in June 2004.

When the SEC filed its complaint, it also filed an emergency motion for a temporary restraining order, an asset freeze, and the appointment of a receiver. On November 19 Judge Duffey ordered the SEC to file a motion for a preliminary injunction, and he ordered the parties to engage in expedited discovery. On December 1 the SEC filed a motion for a preliminary injunction, and the defendants filed a motion to dismiss the complaint. On December 15 the SEC opposed the motion to dismiss the complaint, and the defendants opposed the motion for a preliminary injunction. On December 18 the SEC responded to the defendants' opposition to the motion for a preliminary injunction. On January 7 and 8, 2016, Judge Duffey held a preliminary injunction hearing. On January 19 the parties filed a joint report and discovery plan.

Judge Duffey's Order
On April 25 Judge Duffey issued an 87-page opinion and order. He outlined the background of the case and his findings of fact. He described the defendants' businesses, the procedural history of the case, and the testimony at the preliminary injunction hearing. He denied the defendants' motion to dismiss the complaint. He granted the SEC's motion for a preliminary injunction, a freeze on the defendants' assets, and the appointment of a receiver. He appointed Al B. Hill of the Atlanta law firm of Taylor English Duma LLP as receiver.

Judge Duffey also ordered financial institutions and others to file statements describing assets they hold in the name of or for the benefit of the defendants. In response to that component of the order, many life insurance companies filed statements. Among them are Allstate Life, American General, American National, Athene Annuity & Life, Bankers Life & Casualty, Conseco Life, John Hancock, Liberty National, Lincoln National, Manufacturers Life, Massachusetts Mutual, Nationwide Life, Pacific Life, Primerica Life, Protective Life, ReliaStar Life, Transamerica, United of Omaha, USAA Life, and Voya Financial.

Some Other Developments
On May 9, 2016, the defendants filed an answer to the SEC complaint. Later in May the receiver filed several emergency motions relating to the handling of certain assets of the defendants, and Judge Duffey generally granted the motions. On July 15, the parties filed another joint preliminary report and discovery plan. On July 27, the receiver filed a status report. At this writing discovery is continuing, including a deposition by Torchia. A trial date has not been announced, but discovery is to be completed by December 30, 2016, with no further extensions.

General Observations
The details of the case, as described in Judge Duffey's April 25 order, are troubling. The allegations against the defendants and the judge's findings are very serious. Whether the case goes to trial remains to be seen. I plan to report further on the case.

Available Material
I am offering a complimentary 87-page PDF containing Judge Duffey's April 25 order. E-mail jmbelth@gmail.com and ask for Judge Duffey's order in the case of SEC v. Torchia.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 183: The Surplus Note at Senior Health Insurance Company of Pennsylvania—Further Information and a Correction

Senior Health Insurance Company of Pennsylvania (SHIP) is a long-term care insurance company in runoff. On February 19, 2015, SHIP issued a $50 million five-year surplus note to Beechwood Re, a Cayman Islands-based reinsurance company. The interest rate is 6 percent. SHIP used the $50 million as an urgently needed surplus infusion. The infusion was shown in SHIP's December 31, 2014 financial statement, which was filed with the Pennsylvania insurance department on March 1, 2015. I wrote about the SHIP/Beechwood surplus note in Nos. 123 (10/27/15), 125 (11/6/15), 174 (8/11/16), 180 (9/19/16), and 182 (10/7/16). Here I provide further information and correct a statement I made in No. 182.

The Bizarre Nature of a Surplus Note
A surplus note is a bizarre financial instrument. The money received by the company issuing the note increases the company's surplus. That happens because state surplus note laws say the company issuing the note does not have to establish a liability. A surplus note is subordinate to all the company's obligations. A surplus note can be issued only with the prior approval of the insurance commissioner in the issuing company's state of domicile. Interest and principal payments on a surplus note can be made only with the prior approval of the commissioner.

The Unpaid Interest
In No. 182, I said SHIP missed three $1.5 million semiannual interest payments on the surplus note (in August 2015, February 2016, and August 2016) for a total of $4.5 million. A SHIP spokesman confirmed that the company has not made interest payments. I asked him whether SHIP asked the Pennsylvania commissioner for permission to pay interest and was denied permission, or whether SHIP did not ask for permission. He said SHIP did not ask for permission to pay interest.

In No. 182, I also said the failure to pay interest means the surplus note is in default. One of my readers said the failure to pay interest on a surplus note is not a default. His comment prompted me to look closely at the wording of SHIP's surplus note. I asked SHIP for a copy of the surplus note, but the spokesman said SHIP would not provide it.

Therefore I reviewed the offering circulars for surplus notes issued by several large mutual life insurance companies in the 1990s. Through the review, I learned that my reference to default was incorrect, and that my reader was correct. Here is some language in one of the circulars:

• Each payment of interest on and the payment of principal of the Notes may be made only out of [the Company's] surplus and with the prior approval of the Insurance Commissioner of [the Company's state of domicile] if, in the judgment of the Commissioner, the financial condition of [the Company] warrants the making of such payments.
• The Notes will constitute debt obligations of the type generally referred to as "surplus notes." The net proceeds of the issuance of the Notes will be recorded by [the Company] as additional admitted assets. For statutory accounting purposes, however, the Notes are not part of the legal liabilities of [the Company]. Accordingly, [the Company's] surplus will be increased by the net proceeds from the sale of the Notes.
• Any such payment [of interest or principal] will reduce [the Company's] surplus.
• If the Commissioner does not approve a payment of interest on or principal of the Notes, the applicable interest payment date or the maturity date, as the case may be, will be extended until such time, if any, as such approval is obtained. Interest will continue to accrue on any unpaid principal amount of the Notes (but not on unpaid interest the payment of which has not been approved) during the period of such extension.
• The Notes will be expressly subordinate in right of payment to all existing and future Senior Indebtedness and Policy Claims of [the Company], including all future indebtedness issued, incurred or guaranteed by [the Company], other than any future surplus notes or similar obligations of [the Company].
• To the extent authorized by [the Company's] Board of Directors, [the Company] may continue to declare policyholder dividends and to make dividend payments on its participating policies regardless of the effect any such declaration or payment may have on the Commissioner's decision regarding the payment of interest on or principal of the Notes. [Note: I believe that SHIP does not offer participating policies, but I included this point to help readers gain a further understanding of surplus notes.]

In short, if interest or principal payments are not made, the due dates of the payments would be extended indefinitely. Thus the party that purchases a surplus note would have no recourse if the company that issued the surplus note misses interest or principal payments.

The Invention of Surplus Notes
Surplus notes were invented more than a century ago as a vehicle through which a mutual insurance company in financial trouble can obtain a surplus infusion. A mutual company has no shareholders who can provide a surplus infusion. Also, a company cannot obtain a surplus infusion by borrowing the money through an ordinary loan, because the asset (cash) received would be offset by a liability and there would be no increase in surplus. The early state surplus note laws allowed only mutual companies to issue surplus notes, but the laws were later amended to allow stock companies to issue them.

The Income Tax Issue
A question arose concerning federal income taxation of the interest an insurance company pays on a surplus note. Insurance companies argued that the interest is deductible because it is interest on debt. The Internal Revenue Service (IRS) argued that the interest is not deductible because it is in the nature of a dividend on stock. The insurance companies won the argument, but it made little difference at the time because surplus notes were issued only in small amounts by companies in financial trouble.

The Revolution of 1993
Then came the revolution of 1993, which I discussed in the February 1994 issue of The Insurance Forum. Prudential Insurance Company of America, a mutual company at the time, was not in financial trouble. Yet the company issued $300 million of surplus notes in a private offering. The company used the net proceeds to prefund a voluntary employee benefit association (VEBA) providing certain post-retirement benefits for certain employees. The company used surplus notes solely for one reason: the interest was deductible. Goldman, Sachs & Co., Prudential's adviser on the surplus note offering, put it succinctly: 62 percent of the contribution to the VEBA came from Prudential and the other 38 percent came from the IRS. The transaction also could be viewed as increasing our annual deficit, increasing our national debt, and burdening other taxpayers.

At the end of 1981, small life insurance companies in financial trouble had about $400 million of surplus notes outstanding. Prudential's 1993 action touched off an avalanche of surplus note offerings by major insurance companies that were not in financial trouble. By the end of 2012 (based on the final tabulation I published in the August 2013 issue of the Forum), life insurance companies had $28 billion of surplus notes outstanding, and property insurance companies had $14 billion outstanding.

For many years the only holdouts among major life insurance companies were Northwestern Mutual Life Insurance Company and Teachers Insurance and Annuity Association of America. When they succumbed to the temptation to issue surplus notes, I wrote about their actions in the August 2010 issue of the Forum.

The surplus note activity that began in 1993 stemmed from the deductibility of the interest paid on surplus notes. I think the IRS was correct. A surplus note is not a "debt obligation" (despite what offering circulars say), and the interest paid on a surplus note is not interest on debt. I think the interest is in the nature of a shareholder dividend, which is not deductible.

An Interesting Coincidence
In SHIP's annual statement for the year ended December 31, 2015, Schedule BA - Part 2 shows "other long-term invested assets acquired." The schedule says SHIP, on February 19, 2015, acquired an "other long-term invested asset" from "Beechwood Re Investments" for $50,168,039. SHIP made the acquisition on the very day SHIP issued the surplus note to Beechwood Re, and the cost of the acquisition was almost identical to the amount of the surplus note. In other words, on that day SHIP received a $50 million surplus infusion from Beechwood pursuant to the surplus note, and SHIP handed over about $50 million to Beechwood.

General Observations
In No. 182, I expressed the belief that the SHIP/Beechwood surplus note was not an arm's-length transaction, because an interest rate of 6 percent did not compensate Beechwood for the risk involved in lending money to SHIP, a company which was at the time and still is in fragile financial condition. I also expressed the belief that the $50 million surplus infusion was a gift from Beechwood in exchange for SHIP's investing money with Beechwood. The schedule in SHIP's 2015 statement supports my beliefs.

The "other long-term investments" schedule in SHIP's 2015 statement shows some SHIP investments in Platinum Partners, a hedge fund, near the end of 2015. The SHIP spokesman said SHIP was deceived, because in early 2015 Beechwood did not tell SHIP about Beechwood's close ties to Platinum, and because Beechwood transferred the invested funds to Platinum without SHIP's knowledge or consent. Those SHIP allegations resemble the allegations in CNO Financial Group's lawsuit against Platinum/Beechwood officials. I discussed the lawsuit in No. 182.

Available Material
I am offering a 15-page complimentary PDF consisting of excerpts from the February 1994, August 2010, and August 2013 issues of The Insurance Forum. Email jmbelth@gmail.com and ask for the October 2016 surplus note package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 182: Long-Term Care Insurance Liabilities Return to the Forefront at CNO Financial (Formerly Conseco)

On September 29, 2016, two developments brought long-term care insurance reserve liabilities back to the forefront at CNO Financial Group, Inc. (CNO), which formerly was Conseco, Inc. First, CNO filed an 8-K (significant event) report with the Securities and Exchange Commission. Second, two CNO subsidiaries, New York-domiciled Bankers Conseco Life Insurance Company and Indiana-domiciled Washington National Insurance Company, filed a federal court lawsuit (referred to here as "CNO's complaint") against three individuals associated with Beechwood Re, a Cayman Islands-based reinsurance company, and Platinum Partners, a New York-based hedge fund. On the same day, Reuters posted an article by reporter Lawrence Delevingne about CNO's 8-K report and CNO's complaint.

Background

In No. 180 (posted September 19, 2016), I described how CNO (then Conseco) separated itself in 2008 from a financially troubled long-term care insurance subsidiary that was in runoff. With the approval of the Pennsylvania insurance commissioner, CNO transferred the subsidiary, Pennsylvania-domiciled Conseco Senior Health Insurance Company, to an independent trust and renamed it Senior Health Insurance Company of Pennsylvania (SHIP).

In the same post I explained how SHIP enhanced its surplus by borrowing money, through a surplus note, from Beechwood, which has close ties to Platinum. I indicated that SHIP invested a significant amount of assets in Platinum offerings, but was trying to divest itself of those investments. I also described SHIP's fragile financial condition, with total adjusted capital at the end of 2015 (including the surplus infusion from Beechwood) below company action level risk-based capital.

CNO's 8-K Report

Bankers Conseco Life and Washington National transferred their long-term care insurance reserve liabilities to Beechwood through reinsurance agreements that required Beechwood to maintain quality assets in trust to meet its obligations under those agreements. CNO's 8-K report explains how CNO and its regulators, through examinations, learned that Beechwood and Platinum were tied closely together, that Beechwood had invested its reinsurance trust assets in Platinum's offerings, that those offerings were not in compliance with state laws and regulations governing reinsurance trust assets, and that the transfers of liabilities from the CNO subsidiaries to Beechwood therefore were not valid.

The text of CNO's 8-K report describes the problems. The report also contains three exhibits: a regulatory demand letter from the New York Department of Financial Services to Bankers Conseco Life, a regulatory demand letter from the Indiana Department of Insurance to Washington National, and a CNO press release. The demand letters assert that the assets held in trust by Beechwood under the reinsurance agreements do not comply with state laws and regulations, and threaten disciplinary action unless the problems are resolved promptly.

CNO's Complaint

CNO's complaint describes the close ties between Beechwood and Platinum. It alleges, for example, that Beechwood officials are also Platinum officials. The defendants are Moshe Feuer, Scott Taylor, and David Levy. (See Bankers Conseco Life v. Feuer, U.S. District Court, Southern District of New York, Case No. 16-cv-7646.)

The complaint describes how the reinsurance agreements came about, and how the defendants allegedly misled the plaintiffs into entering into the agreements. The complaint mentions SHIP's investments in Platinum's offerings, but does not mention SHIP's surplus note relationship with Beechwood. I discuss that relationship below. The complaint lists 12 counts of alleged wrongdoing, including three counts of violations of the federal Racketeer Influenced and Corrupt Organizations (RICO) Act:

1. Breach of Fiduciary Duty
2. Aiding and Abetting a Breach of Fiduciary Duty
3. Fraudulent Misrepresentation/Fraudulent Concealment
4. Aiding and Abetting a Fraud
5. Violation of RICO—18 U.S.C. §1962(c)
6. Violation of RICO—18 U.S.C. §1962(a)
7. RICO Conspiracy—18 U.S.C. §1962(d)
8. Civil Conspiracy to Commit Fraud
9. In the Alternative, Negligent Misrepresentation
10. In the Alternative, Negligence
11. In the Alternative, Gross Negligence
12. In the Alternative, Unjust Enrichment

CNO's complaint was assigned to U.S. District Court Judge Edgardo Ramos, a 2011 Obama nominee. U.S. Magistrate Judge Barbara C. Moses was also assigned to the case.

The SHIP/Beechwood Surplus Note

A surplus note is a debt instrument that increases the surplus of the borrowing company because the company is not required to establish a liability for the amount borrowed. A surplus note is subordinate to the borrowing company's other obligations, and can be issued only with the insurance commissioner's prior approval. Also, interest and principal payments can be made only with the commissioner's prior approval.

On February 19, 2015, SHIP borrowed $50 million from Beechwood by issuing a five-year surplus note with the permission of the Pennsylvania insurance commissioner. The interest rate is 6 percent. The surplus infusion was reflected in SHIP's December 31, 2014 financial statement, which was filed March 1, 2015.

Questions for SHIP
After the September 29 developments described above, I wrote to Brian Wegner, president and chief executive officer of SHIP. I asked:

1. Have you paid any interest on the surplus note? If your answer is yes, please indicate dates and amounts, and please send me the letter(s) you received from the Pennsylvania commissioner approving the payment(s). If your answer is no, please explain whether this means the surplus note is in default.


2. Did Beechwood agree to lend you the $50 million in exchange for your investment in Platinum's offerings? If your answer is yes, please indicate the date on which you began investing in Platinum's offerings. If your answer is no, please explain what prompted you to borrow from Beechwood (rather than someone else) and what prompted you to invest in Platinum's offerings.

I asked for answers "on the record" and indicated a response date. I did not receive a response directly from SHIP. Instead I received a telephone call on behalf of SHIP from a media relations person in New York. He said he would try to obtain detailed answers to my questions by the response date, but he was not able to do so. I plan to prepare a follow-up post when and if SHIP provides detailed answers.

General Observations
As mentioned in No. 180, exhibits of "other long-term invested assets" in recent SHIP statements show that the company had significant investments in Platinum's offerings. On September 15, 2016, Reuters posted an article entitled "Long-term care insurer SHIP works to dump Platinum cargo." According to the article, SHIP, as of June 30, 2016, had at least $100 million of Platinum's offerings (3.6 percent of SHIP's assets). The article quoted SHIP's Brian Wegner as saying that "the company is in the process of reviewing and shedding all Platinum-related investments—now down to about $50 million—and would be done by the end of 2016," and that "SHIP has experienced no losses and fully anticipates that will be the case as the remainder is divested."

Normally interest on surplus notes is payable semiannually. With regard to the 6 percent surplus note through which SHIP borrowed $50 million from Beechwood to increase SHIP's surplus, I think SHIP has missed three semiannual interest payments of $1.5 million each, for a total of $4.5 million. Therefore, I think SHIP is in default on the surplus note. However, I am not aware of any action taken against SHIP by Beechwood or by the Pennsylvania insurance commissioner.

I think the SHIP/Beechwood surplus note was not an arm's-length transaction, because an interest rate of 6 percent does not compensate Beechwood for the risk involved in lending money to SHIP, which was in fragile financial condition at the time of the loan, and still is. I believe that the $50 million was a gift from Beechwood to SHIP in exchange for SHIP making investments in Platinum's offerings.

Available Material
I am offering a 71-page complimentary PDF consisting of CNO's 14-page 8-K report (including the three exhibits) and CNO's 57-page complaint against three individuals associated with Beechwood and Platinum. Email jmbelth@gmail.com and ask for the October 2016 CNO/Beechwood package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 181: State Farm Insurance—Class Certification in a Lawsuit in Federal Court Alleging that the Company Subverted the Illinois Court System

On September 16, 2016, U.S. District Court Judge David R. Herndon issued a "Memorandum and Order" (Order) in an extraordinary case. He ruled that "the Court finds the class certification is proper and grants the motion for class certification."

Judge Herndon, a 1998 Clinton nominee, is in the Southern District of Illinois and is a former chief judge there. His Order grew out of a complaint filed in May 2012 and an amended complaint filed in November 2014 that describe, in significant detail, an allegation that State Farm Mutual Automobile Insurance Company (Bloomington, Illinois) subverted the Illinois state court system for the benefit of the company. (See Hale v. State Farm, U.S. District Court, Southern District of Illinois, Case No. 12-cv-660.)

The Avery Case
The underlying case—Avery v. State Farm—was a class action lawsuit filed in an Illinois state court in 1997. The plaintiffs were State Farm policyholders whose automobiles were repaired with parts that were not factory authorized or were not original-equipment-manufacturer parts, or who received compensation based on the cost of those parts. After a trial, the jury awarded the plaintiffs $456 million in breach-of-contract damages. The state court judge who presided over the trial added $130 million of disgorgement damages and $600 million of punitive damages, for a total award of $1.186 billion.

State Farm appealed the trial court ruling. In April 2001 the Illinois Appellate Court threw out the $130 million of disgorgement damages as duplicative, but affirmed the remaining $1.056 billion of the award.

In October 2002 the Illinois Supreme Court agreed to hear State Farm's appeal of the Illinois Appellate Court ruling. The case was fully briefed and argued by May 2003, but the decision was delayed more than two years. In August 2005 the Illinois Supreme Court, in a split decision, overturned the $1.056 billion judgment of the Illinois Appellate Court.

The Hale Case
Judges who serve on the Illinois Supreme Court are elected to their positions. In January 2005 the Avery plaintiffs allegedly received reliable information that State Farm had used financial and political influence to accomplish the election of Lloyd Karmeier, an Illinois trial court judge, to a vacant seat on the Illinois Supreme Court. Judge Karmeier won the election in November 2004 over Gordon Maag, an Illinois Appellate Court judge.

The Avery plaintiffs filed a motion to disqualify Judge Karmeier from participating in State Farm's appeal of the Avery ruling in the Illinois Appellate Court. State Farm's response to the motion allegedly misrepresented and concealed the magnitude of the company's involvement in the election of Judge Karmeier. The Illinois Supreme Court denied a motion by the Avery plaintiffs to disqualify Judge Karmeier. In August 2005 Judge Karmeier cast an important vote in favor of State Farm in the previously mentioned split decision that overturned the $1.056 billion judgment.

In December 2010 attorneys for the Avery plaintiffs began an investigation into State Farm's involvement in the election of Judge Karmeier. The investigation followed a U.S. Supreme Court decision overturning a West Virginia Supreme Court ruling in a case involving a party's financial and political influence to elect a judge whose vote it sought for an appeal. A retired special agent of the Federal Bureau of Investigation led the probe. It allegedly found evidence that State Farm had recruited Judge Karmeier, directed his election campaign, funneled as much as $4 million to the campaign ($4 million was the bulk of the campaign's funds), and concealed this information from the Illinois Supreme Court while the appeal was pending. The investigation also allegedly found evidence that State Farm had worked through Edward Murnane, president of the Illinois Civil Justice League, and William G. Shepherd, a State Farm employee who headed Citizens for Karmeier.

In May 2012 the plaintiffs filed the initial complaint in the Hale case alleging two counts of violations of the Racketeer Influenced and Corrupt Organizations (RICO) Act. In November 2014 the plaintiffs filed an amended complaint that alleged the same two RICO counts. The defendants are State Farm, Murnane, and Shepherd. The thrust of the allegations is that State Farm used financial and political influence to accomplish Judge Karmeier's election to the Illinois Supreme Court.

State Farm's Comment
I asked State Farm for comment on Judge Herndon's Order. A spokesman for the company provided this statement:

We are disappointed in the Court's decision on the class certification question, and respectfully disagree with it. We intend to ask the appellate court to review this ruling in the very near future. Plaintiffs have unsuccessfully asserted and reasserted these allegations for many years and should not be permitted to do so any longer.

General Observations
Readers of The Insurance Forum, my 2015 book entitled The Insurance Forum: A Memoir, and this blog are aware that I have reported over the years on many troubling cases. The Hale case, however, is one of the most troubling I have ever seen. Judge Herndon included, near the beginning of his Order and before his discussion of the class certification issues, a verbatim excerpt from the first six pages of the amended complaint in the Hale case.

The Hale case and its predecessor, the Avery case, have been around for almost two decades. Whether the end is near remains to be seen. If State Farm files an appeal of Judge Herndon's Order, presumably the company would do so in the U.S. Court of Appeals for the Seventh Circuit. However, Hale has the feel of a case that eventually may reach the U.S. Supreme Court. I plan to follow further developments in the Hale case and report on them.

Available Material
I am offering a complimentary 29-page PDF containing Judge Herndon's Order, which includes a lengthy verbatim excerpt from the amended complaint in the Hale case. Send an email to jmbelth@gmail.com and ask for the Herndon/State Farm Order dated September 16, 2016.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 180: Long-Term Care Insurance—An Update on Senior Health Insurance Company of Pennsylvania

Senior Health Insurance Company of Pennsylvania (SHIP), formerly Conseco Senior Health Insurance Company (CSHI), is a long-term care (LTC) insurance company in runoff; that is, SHIP is not issuing new policies. In 2008 Indiana-based Conseco, Inc. (now CNO Financial Corp.) announced a plan to separate itself from Pennsylvania-based CSHI, a financially troubled LTC insurance subsidiary. Over 11 years, Conseco had poured $915 million into CSHI to keep the company solvent.

I wrote about Conseco's separation from CSHI in the November 2008, January 2009, and June 2009 issues of The Insurance Forum. I also wrote about SHIP in Nos. 123 (October 27, 2015), 125 (November 6, 2015), 174 (August 11, 2016), and 175 (August 18, 2016). This update is based on SHIP's recent financial statements and other developments.

The Plan of Separation
The plan of separation provided for Conseco to create an independent trust in Pennsylvania, transfer ownership of CSHI to the trust, and rename the company SHIP. The Pennsylvania insurance commissioner approved the plan, and Conseco implemented it. The commissioner testified later in another matter that he approved the plan because Conseco said it would otherwise allow CSHI to become insolvent.

SHIP still has a relationship with CNO. According to a reinsurance exhibit in SHIP's 2015 financial statement, SHIP reduced its reserve liabilities by about $1 million through reinsurance ceded to Washington National Insurance Company, a subsidiary of CNO.

SHIP's Backdated Surplus Infusion
In this post I refer to "surplus" and "total adjusted capital" interchangeably because they are similar. On March 1, 2015, SHIP filed its financial statement for the year ended December 31, 2014. According to the statement, SHIP borrowed $50 million on February 19, 2015, to obtain a surplus infusion. SHIP backdated the infusion seven weeks by including it on the December 31, 2014 balance sheet. SHIP borrowed the money by issuing a five-year surplus note with an annual interest rate of 6 percent. The lender (the buyer of the surplus note) was Beechwood Re, a Bermuda-based company with which CNO has a reinsurance relationship.

A surplus note is a debt instrument that increases the surplus of the borrowing company because the company is not required to establish a liability for the amount borrowed. A surplus note is subordinate to the borrowing company's other obligations, and can be issued only with the insurance commissioner's prior approval. Also, interest and principal payments can be made only with the commissioner's prior approval.

SHIP's Situation at the End of 2014
At the end of 2014, without the $50 million backdated surplus infusion discussed above, SHIP would have had total adjusted capital of $68 million. That would have been below regulatory action level RBC (risk-based capital) of $82 million, and the commissioner would have been required to conduct a confidential investigation. With the surplus infusion, however, SHIP's total adjusted capital was $118 million ($68 million plus $50 million), which was well above regulatory action level RBC of $82 million and slightly above company action level RBC of $109 million.

SHIP's Situation at the End of 2015
On March 1, 2016, SHIP filed its financial statement for the year ended December 31, 2015. The statement shows that the company has not paid any interest on the surplus note. I do not know whether the commissioner denied the company's request for permission to pay interest, or whether the company did not request permission.

At the end of 2015, including the $50 million surplus infusion discussed above, SHIP had total adjusted capital of $94 million. That was below company action level RBC of $117 million, and the company was required to file a confidential RBC report with the commissioner indicating how the company proposed to deal with the problem. I do not know whether the company filed the report, and if so, how the company proposed to deal with the problem.

Platinum Partners
Norman Seabrook is a former official of New York City's Correction Officers Benevolent Association (COBA). Murray Huberfeld is a founder of Platinum Partners, a hedge fund.

On July 7, 2016, U.S. Attorney Preet Bharara of the Southern District of New York filed a grand jury indictment charging Seabrook and Huberfeld with one count of conspiracy to commit honest services wire fraud and one count of honest services wire fraud. The indictment alleges that a "kickback scheme" deprived COBA members of Seabrook's "honest services" when COBA's annuity fund and COBA's general fund invested in Platinum offerings. (See U.S.A. v. Seabrook and Huberfeld, U.S. District Court, Southern District of New York, Case No. 16-cr-467.)

On July 26, 2016, The Wall Street Journal ran a front-page article about Platinum. Beechwood was mentioned because of ties to Platinum.

Exhibits of "other long-term invested assets" in recent SHIP statements show that the company has significant holdings of Platinum-related investments. On September 15, 2016, Reuters posted an article entitled "Long-term care insurer SHIP works to dump Platinum cargo," by reporter Lawrence Delevingne. The article says that, as of June 30, 2016, SHIP "had at least $100 million of its assets [3.6 percent of its $2.8 billion of assets and 106 percent of its $94 million of total adjusted capital at the end of 2015] invested in Platinum's funds or companies backed by Platinum." The Reuters article quotes Brian Wegner, SHIP's president and chief executive officer, as saying that "the company is in the process of reviewing and shedding all Platinum-related investments—now down to about $50 million—and would be done by the end of 2016," and that "SHIP has experienced no losses and fully anticipates that will be the case as the remainder is divested."

SHIP's 2015 Premium Volume
SHIP's statement for the year ended December 31, 2015 shows the company received $105 million of LTC insurance premiums in 2015. The ten leading states (in millions) were Texas ($9.9), Florida ($9.5), California ($9.5), Pennsylvania ($8.9), Illinois ($6.9), Ohio ($5.3), North Carolina ($3.8), Indiana ($3.2), Maryland ($3.0), and Michigan ($3.0).

General Observations
What will happen to SHIP remains to be seen. The company's recent net losses were $56 million in 2014, $9 million in 2015, $3 million in the first quarter of 2016, and $20 million in the second quarter of 2016. As discussed above, SHIP's total adjusted capital at the end of 2015 was below company action level RBC. It is unclear how a company in runoff and with inadequate total adjusted capital can afford to pay the interest on a surplus note, let alone repay the principal.

As I mentioned in No. 174 (August 11, 2016), Penn Treaty Network America Insurance Company, another Pennsylvania-based LTC insurance company in runoff, has been in rehabilitation for several years. The Pennsylvania insurance commissioner is the court-appointed rehabilitator. The state court judge overseeing the case is expected to rule soon on the commissioner's petition to liquidate Penn Treaty. If the judge grants the petition, state guaranty associations would become involved in the case, and other insurance companies would be required to pay assessments.

Available Material
I am offering a complimentary 20-page PDF consisting of the articles in the November 2008, January 2009, and June 2009 issues of The Insurance Forum (9 pages), and the indictment filed against Seabrook and Huberfeld (11 pages). Email jmbelth@gmail.com and ask for the LTC/SHIP package dated September 19, 2016.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 179: Annuities, Pensions, and the Theft of Benefit Payments—Another Recent Example

In No. 177 (posted August 31, 2016) I reported on the practice of life insurance companies using the Social Security Death Master File in their efforts to deal with the theft of annuity benefits. I said survivors of deceased life annuitants sometimes pretend the annuitant is still alive and thereby steal annuity benefits that should have stopped when the annuitant died. I said the same problem applies to pensioners receiving benefits from pension plans and recipients of Social Security benefits.

I included a recent example of the problem. An individual was charged with grand larceny for allegedly stealing over $100,000 of pension benefits intended for his mother, who had died more than 11 years earlier. After posting that item I learned of another recent example involving an extra dimension.

The New Example
On September 1, 2016, in a joint press release, New York State Attorney General Eric Schneiderman and Comptroller Thomas DiNapoli announced the unsealing of an indictment charging Robert J. Schusteritsch, a 71-year-old Florida resident, with grand larceny in the second degree, a class C felony, and criminal impersonation in the second degree, a class A misdemeanor. He allegedly stole over $180,000 in benefits from a New York State pension plan. The benefits were intended for his brother, Martin Petschauer, who retired in 1986 and died in 2008. The indictment was filed in the state court in Albany County. Here is an excerpt from the press release:

According to documents filed with the court today, Petschauer was a New York State pensioner who retired as Chief of the Pooling and Audit Review Section of the New York Metro Milk Marketing Area in approximately 1986. He passed away on July 9, 2008. At the time of Petschauer's death, his pension benefits were being direct deposited into a bank account held in a trust for the benefit of Petschauer; Schusteritsch was the sole trustee for his brother and had exclusive access to the bank account.

When Petschauer died, Schusteritsch concealed his brother's death from the bank and the Retirement System and kept the trust account open to maintain the direct deposits. He then routinely accessed the pension deposits and spent the money for his own benefit. All told, prosecutors allege Schusteritsch stole over $180,000 in pension benefits until the Retirement System discovered Petschauer's death in October 2015.

The prosecution also alleges that when the Retirement System learned of Petschauer's death and stopped paying benefits into the trust account, Schusteritsch called the customer help line on November 2, 2015, pretended he was Petschauer, and asserted that he was not actually dead, in an effort to maintain eligibility for the pension benefits.

Schusteritsch was arrested in Florida and brought to Albany. At his arraignment, he pleaded not guilty. Bail was set at $10,000 cash or bond, and he was remanded in lieu of posting. If convicted, he faces "up to five to fifteen years" in state prison.

General Observations
In No. 177, I said I have seen examples of legal actions against persons who allegedly stole annuity or pension benefits, but have not seen discussions of the magnitude of the problem. I expressed the belief that there are large numbers of such incidents, but many thefts may not be large enough to warrant criminal charges.

Longtime readers of The Insurance Forum know I dislike life annuities. One reason is that the cost of the "protection against living too long" cannot be readily ascertained, and I dislike buying something whose cost is unknown. Another reason is that benefits stop at the death of the annuitant, at the end of a "period certain," or, in the case of a joint and survivor life annuity, at the death of a second annuitant.

My preference is for systematic (usually monthly) withdrawals, allowing the annuitant's family to receive the funds remaining after the annuitant's death. The annuitant runs the risk of living so long that the funds are exhausted before the annuitant's death. However, the risk is small if the annuitant sets the withdrawals each year at the required minimum distribution (RMD) level, even where RMDs do not apply. I explained and illustrated the procedure in the August 1998, November 1998, August 2012, and November 2012 issues of the Forum.

Available Material
I am offering a complimentary 13-page PDF consisting of the 2-page September 1 press release issued by the New York State attorney general and the comptroller, the 1-page article in the August 1998 issue of the Forum, the 4-page article in the November 1998 issue, the 3-page article in the August 2012 issue, and the 3-page article in the November 2012 issue. Email jmbelth@gmail.com and ask for the September 2016 package relating to the theft of annuity benefits and systematic withdrawals.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 178: Iowa's Accounting Rules and a Petition Seeking Access to Documents

In November 2014 I posted three items about Iowa's accounting rules (Nos. 71, 72, and 73). Later I posted several other related items. Also, under Iowa's open records law, I obtained some documents from the Iowa Insurance Division (IID). However, the IID and Commissioner Nick Gerhart denied access to other documents relating to eight limited purpose subsidiaries that Iowa-domiciled life insurance companies have created.

On September 2, 2016 my attorney filed, in the Iowa District Court for Polk County, which includes Des Moines, a petition seeking judicial review of the IID's and Commissioner Gerhart's denial of access to the documents. My attorney also filed nine exhibits: my letter requesting documents, Commissioner Gerhart's letter denying the request, a report by the New York State Department of Financial Services, comments by the U.S. Financial Stability Oversight Council, a report by the U.S. Office of Financial Research, and four news stories.

Because I am a litigant, I will not comment on the case. However, I am making available two complimentary PDFs containing publicly available court documents: the petition (32 pages) and the exhibits (75 pages). Email jmbelth@gmail.com and ask for the petition only, or the petition and the exhibits, relating to Belth v. IID and Gerhart.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com