Thursday, July 20, 2017

No. 226: The Age 100 Problem—The Achilles' Heel of Life Insurance—Lands in Court

On July 20, 2017, Gary Lebbin and a trust he created filed a lawsuit against Transamerica Life Insurance Company relating to what I have called "the age 100 problem in life insurance." The case involves universal life and illustrates problems faced by elderly insureds. The following paragraph is in the introductory section of the complaint:
2. For decades, life insurance carriers, such as Transamerica, sold permanent universal life insurance policies, marketed as "insurance for life," utilizing outdated mortality tables that did not take into account the fact that Americans were, and are, increasingly living to and past the age of 100. The result has been the improper termination of life insurance policies that were originally sold to policy holders as "permanent insurance." The life insurance industry has left its customers (who faithfully paid their premiums with the expectation that they would have coverage for the remainder of their lives) uninsured. Further twisting the knife, these terminations have exposed customers to adverse tax consequences that are in direct contradiction to the guarantees made when these policies were purchased.
The case was assigned to U.S. District Judge Theodore D. Chuang. President Obama nominated him in September 2013 and the Senate confirmed him in May 2014. (See Lebbin v. Transamerica, U.S. District Court, District of Maryland, Case No. 8:17-cv-1870.)

The Plaintiffs
Lebbin was born in September 1917 in Germany, came to the United States in 1938 to escape Nazi persecution, and married in 1944. His wife died in 2015 at age 97. He has two children, four grandchildren, and seven great-grandchildren. In 1990 he created a trust that purchased two second-to-die universal life policies from Transamerica with a total face amount of $3.2 million. His two children are the trustees of the trust.

The Policies
The policies are second-to-die policies on Lebbin and his wife. Now that she is deceased, the policies are single-life policies. They are based on the 1980 Commissioners Standard Ordinary (CSO) mortality table, in which the terminal age is 100. The terminal age is the age at which the table shows no survivors among insureds. In other words, the death rate in the year prior to the terminal age is 1 (or 1,000 deaths per 1,000 lives). Thus the table is based on the assumption that no one among the insured population survives to age 100. Lebbin will reach the terminal age in September 2017.

Marketing of the Policies
Lebbin says Transamerica represented the policies as "permanent" coverage that would insure him and his wife "for life," that would provide for the "cash value earnings" to grow income-tax-deferred, that the death benefit would be income-tax-exempt, and that "withdrawals (and thus the ability to determine when and if the cash value earnings would constitute taxable income) would be within the control of the Plaintiffs."

I visited the Transamerica website in July 2017. Here is how the company describes whole life and universal life:
Whole life insurance provides permanent protection for life as long as premiums are paid. In addition to guaranteed cash value that you can access through a loan, your loved ones are guaranteed to receive a death benefit. You should expect to pay a higher premium than you would for a term life policy, but your premiums remain the same throughout your lifetime.
Unlike term and whole life insurance, universal life provides an additional level of flexibility. It allows policy owners to modify the amount and frequency of premium payments as long as there is sufficient cash value in the policy to cover monthly deductions. When the insured dies, a guaranteed amount of money, or death benefit, is left to the named beneficiaries. In addition to the death benefit, universal life also contains a cash value. The cash value grows tax-deferred until funds are withdrawn.
The Insuring Agreement
The insuring agreement is the heart of any insurance policy. Here is the full insuring agreement in Lebbin's policies:
While the policy is in force, Transamerica Occidental Life Insurance Company will pay the death benefit to the beneficiary if both Joint Insureds die before the policy anniversary nearest Joint Equal Age 100, or will pay the net cash value, if any, to the owner on the policy anniversary nearest Joint Equal Age 100 if both or either Joint Insured is living on that date. All payments are subject to the provisions of this policy.
The definitions section of the policy says "Joint Equal Age" is "the adjusted age of the Joint Insureds which reflects a risk that would be equivalent to two people of the same age, class of risk, and smoking status." Since Lebbin's wife is no longer living, the policy is now a single-life policy. Here is the effective language of the insuring agreement:
While the policy is in force, Transamerica Occidental Life Insurance Company will pay the death benefit to the beneficiary if the Insured dies before the policy anniversary nearest age 100, or will pay the net cash value, if any, to the owner on the policy anniversary nearest age 100 if the Insured is living on that date. All payments are subject to the provisions of this policy.
Lebbin alleges that, on top of the loss of the death benefit, his (or the trust's) receipt of the cash values of the policies at age 100 will have adverse income tax consequences. I do not know the magnitude of the tax problem because I do not know how Transamerica calculates the amount of taxable income shown on the Form 1099 it sends to the policyholder. Nor do I have access to the statements that Transamerica promised to provide to the policyowner each year.

Extended Maturity Riders
The 2001 CSO mortality table has a terminal age of 121. According to the Lebbin complaint, some life insurance companies—but not Transamerica—offer the option of an Extended Maturity Rider (EMR) for universal life policyholders who own policies based on older mortality tables that have a terminal age of 100. Although EMRs are discussed in actuarial publications, I am not aware of any discussions of EMRs for traditional whole life policies. Here is Principal Life Insurance Company's brief description of its EMR for universal life policies:
If the insured reaches the stated maturity age, maturity is extended to the date of his or her death. The rider is automatically added to policies in states where approved, and there is no charge for the rider. There will be no charges during the maturity extension period. However, loan interest will continue to be charged. No additional premium payments, other than loan payments, will be allowed.
According to the Lebbin complaint, he wrote to Transamerica and asked the company to attach EMRs to his policies. The company declined the request.

The Complaint
The counts in Lebbin's complaint are breach of contract, negligent misrepresentation, fraud (intentional misrepresentation), violations of Maryland's Consumer Protection Act, unjust enrichment, declaratory relief, reformation, and rescission. He requests, among other forms of relief, a declaratory judgment, compensatory and punitive damages, an injunction, reformation or rescission, pre-judgment and post-judgment interest, attorney fees, and court costs.

General Observations
I first wrote about the age 100 problem in 2001, in two articles in The Insurance Forum. I also wrote about the problem in No. 141 (posted February 1, 2016), where I said I was writing to four companies in which my wife and I own life insurance to ask about the problem. Three letters went to policyholder service departments. They did not understand my inquiry. One, for example, sent beneficiary change forms.

The fourth letter went to an executive who understood my inquiry. He said his company writes to the policyholder several months before the insured reaches age 100. The company offers to hold the money after age 100, pay interest on it, refrain from charging further premiums, and pay the money at the insured's death. He sent me a sample letter. It did not address the question of whether the policyholder who accepts the offer would have constructive receipt (for income tax purposes) of the death benefit at the terminal age after having accepted the offer to allow the company to hold the money until the insured's death. The standard company response to the income tax question is to "consult your tax adviser," despite the fact that there is no way a tax adviser would be in a position to answer the question.

It is an understatement to say the age 100 problem is serious. Indeed, I think the problem is the Achilles' heel of life insurance. The bedrock principles of life insurance marketing are the income-tax-deferred inside interest and the income-tax-exempt death benefit. The problem is so serious that, as I said in my second Forum article on the subject, the companies do not want to discuss the matter. I further believe that neither the Internal Revenue Service (IRS) nor the income-tax-writing committees of Congress want to discuss the matter.

Now we have the Lebbin case. It is not a class action; indeed, there is no time for a class action because Lebbin is close to the terminal age. Even if the case survives the inevitable motion to dismiss the complaint, there would be no time for discovery, and there would be no time for a trial. I believe and hope that Transamerica and Lebbin's attorneys will be able to reach a confidential settlement that will solve his immediate problem.

I think the only way to force the industry and other interested parties to address the age 100 problem is to mount a class action. If it survives the motion to dismiss the complaint, and if a class is certified, the parties would have powerful incentives to avoid a trial, and any proposed settlement would be in the public domain.

Available Material
In No. 141, I offered a 37-page complimentary PDF consisting of the two 2001 Forum articles (4 pages), an excerpt from a variable universal life prospectus (1 page), a 2009 IRS request for comments (8 pages), a 2009 comment letter from the American Council of Life Insurers (22 pages), and a 2010 IRS revenue procedure (2 pages). The package is still available. Email and ask for the February 2016 package about the age 100 problem.

I am now offering a 54-page complimentary PDF consisting of the Lebbin complaint (20 pages) and an exhibit showing the $2 million Lebbin policy (34 pages). Email and ask for the July 2017 package about the age 100 problem.


Friday, July 14, 2017

No. 225: Genworth Financial—Voluntary Dismissal of a Class Action Lawsuit Filed by Long-Term Care Insurance Policyholders

On December 28, 2016, Erika Leifer and two other long-term care (LTC) insurance policyholders filed a class action lawsuit against Genworth Financial, two subsidiaries, and four executives. The plaintiffs had been notified of substantial increases in the premiums for their policies. The plaintiffs alleged that the premium increases had harmed millions of current and former Genworth LTC insurance policyholders, that the defendants had wrongfully depleted reserve liabilities, and that the defendants had enriched themselves. (See Leifer v. Genworth, U.S. District Court, Eastern District of Virginia, Case No. 3:16-cv-1008.)

The Original Complaint
The situation faced by Leifer, a resident of New York, illustrates what prompted the lawsuit. In September 2002, at age 51, she bought an LTC insurance policy from Genworth Life Insurance Company of New York (GLICNY). The quarterly premium was $500.24. About two years later, she bought another LTC insurance policy from GLICNY. The quarterly premium was $270.40. Here is a paragraph of the original complaint:
26. By letters dated February 20, 2016, GLICNY informed Plaintiff Leifer, now age 65, that the premiums on both of her long-term care insurance policies would be increasing by 60%, and warning that "it is possible that your premium will increase again in the future." In that letter, GLICNY explained that the decision to increase premiums was not based on any change in health or "the current economic environment." Rather, "Our decision to increase premiums is primarily based upon the fact that the expected claims over the life of your policy are significantly higher today than was anticipated when your policy form was originally priced, and as a result, a premium increase is warranted."
I reported on the case in No. 197 (posted January 13, 2017). There I offered readers the 61-page original complaint.

The Motion to Dismiss the Original Complaint
The defendants did not respond to the original complaint. Instead, on March 27, 2017, they filed a motion to dismiss the original complaint. They also filed a memorandum and several other documents in support of the motion. They said the motion was based on the "lack of subject matter jurisdiction (due to a lack of standing)" and "failure to state a claim upon which relief can be granted."

The Amended Complaint
The plaintiffs did not respond to the motion to dismiss the original complaint. Instead, on April 10, they filed a 114-page amended complaint on behalf of 19 policyholders. They are residents of California (2), Florida (2), Maryland, Michigan, New York (2), North Carolina (2), Pennsylvania (5), South Carolina, Texas (2), and Virginia.

Aside from the expanded version of the "parties" section in the amended complaint because of the increased number of plaintiffs, the 58-page "factual background" section in the amended complaint was about twice the size of the corresponding section in the original complaint. Also, there were eight counts in the amended complaint, compared to seven counts in the original complaint. Here are the first and last paragraphs of the expanded "introduction" section in the amended complaint:
1. This case concerns the financial harm caused to current and former policyholders of Genworth long term care ("LTC") insurance policies in the United States, as a direct result of Genworth's deliberate misconduct in wrongfully depleting needed policy reserves—which is the portion of an insurer's revenue held aside to pay future claims—while masking its true financial condition by not disclosing facts required by the National Association of Insurance Commissioners ("NAIC") and statutory accounting fundamentals.
31. Consequently, Plaintiffs, as well as other similarly situated policyholders that comprise the Classes, now seek either restitution, damages for the diminution in their LTC policies' economic value, or damages for out-of-pocket losses incurred by former policyholders who have had to pay higher premiums for new LTC coverage to replace terminated Genworth policies.
The Motion to Dismiss the Amended Complaint
The defendants did not respond to the amended complaint. Instead, on May 22, they filed a motion to dismiss the amended complaint. They also filed a memorandum and several other documents in support of the motion. They used the same reasoning they used in the motion to dismiss the original complaint.

The Plaintiffs' Notice of Withdrawal
The plaintiffs did not respond to the motion to dismiss the amended complaint. Instead, on June 10, they filed a notice of withdrawal of the amended complaint and of voluntary dismissal of the case "without prejudice." That expression means the case can be refiled later. On June 26, the judge endorsed the notice and said "so ordered."

General Observations
Why the plaintiffs dropped the case is a mystery. I asked one of the plaintiffs' attorneys, with whom I am acquainted, for an explanation, but received no reply. I will not speculate on why they dropped the case. I will say I am perplexed in view of the enormous amount of resources that must have gone into preparation of the original and amended complaints.

The dropping of the Leifer case is reminiscent of a class action lawsuit I wrote about in No. 110 (posted July 17, 2014). There the 105-page complaint (and 67 additional pages of exhibits) alleged phony reinsurance transactions with affiliates and participation in a Racketeer Influenced and Corrupt Organizations Act (RICO) enterprise. The lead plaintiffs were Clarice Whitmore, an Arkansas resident who bought an annuity in 2012 from Security Benefit Life Insurance Company, and Helga Maria Schulzki, a California resident who bought an annuity in 2013 from EquiTrust Life Insurance Company. The defendants were Guggenheim Partners LLC, Guggenheim Life and Annuity Company, Security Benefit Life, and EquiTrust Life. The complaint was withdrawn without explanation one day after it was filed. In No. 110, I offered readers the 172-page filing. (See Whitmore v. Guggenheim, U.S. District Court, Northern District of Illinois, Case No. 1:14-cv-948.)

Available Material
I am offering a complimentary 118-page PDF consisting of the amended complaint in the Leifer case (114 pages) and the notice of voluntary dismissal (4 pages). Email and ask for the July 2017 package relating to the Leifer lawsuit against Genworth.


Friday, July 7, 2017

No. 224: Savings Bank Life Insurance Company of Massachusetts—The Plan to Convert into a Mutual Company

On May 19, 2017, James Morgan, president and chief executive officer of Savings Bank Life Insurance of Massachusetts (SBLI), notified policyholders about a plan to buy out the stockholders and convert the organization into a mutual company. He said the board of directors had unanimously approved the plan, and implementation required the approval of a majority of the policyholders who vote on the plan. He said a special meeting of policyholders was to be held on June 28. He urged them to vote in person at the meeting, or by another method. A "Summary Policyholder Information Statement" accompanied the notification letter and described the plan. Policyholders interested in further details were invited to request a more lengthy "General Policyholder Information Statement."

On June 22, 2017, Leslie McEvoy, a policyholder who received the notice, filed a class action lawsuit in state court against SBLI. She also filed a motion for a preliminary injunction blocking implementation of the plan, and she asked for an expedited hearing. The case was referred to Superior Court Justice Mitchell Kaplan. (See McEvoy v. SBLI, Suffolk Superior Court, Commonwealth of Massachusetts, Case No. 2017-1961.)

The Plan
SBLI has 30 stockholders who are savings banks in Massachusetts. SBLI plans to buy back all the shares of Class A common stock for $500 per share and all the shares of Class B common stock for $128 per share, for a total of $57.3 million. SBLI plans to obtain the money by issuing a surplus note (explained later). The Massachusetts insurance commissioner has approved the plan, subject to approval of the policyholders.

The Complaint
The general thrust of the plaintiff's opposition to the plan is that the notice to the policyholders is "grossly defective," that the policyholder vote based on that notice would not be valid, and that the plan should not proceed until SBLI provides an adequate notice. Some of her objections to the plan are mentioned in the first paragraph of the complaint:
Plaintiff is seeking preliminary and injunctive relief related to the imminent vote of SBLI's policyholders — scheduled to occur at a Special Meeting on June 28, 2017 — on SBLI's proposed Plan of Conversion. Plaintiff seeks to enjoin the Special Meeting and block the policyholder vote on grounds that the Notice disseminated by SBLI to its policyholders and holders of annuity contracts eligible to vote, whose affirmative vote is statutorily required to secure approval of the Plan of Conversion, is false, deceptive and misleading. Plaintiff and the Putative Class of its participating policyholders will be irreparably harmed if the Special Meeting is allowed to convene and/or the policyholder vote, which is based on the grossly defective Notice, is allowed to proceed. [Emphasis in original.]
The Alleged Problems
The plaintiff alleges that SBLI's notice is "false, deceptive and misleading" because of several major problems. Here are five of those alleged problems.

First, SBLI has $219 million of net operating losses (NOLs) to carry forward. If the Internal Revenue Service deems the conversion a "change of control" transaction, SBLI may be deprived of a significant portion of the NOLs. The notice did not disclose the likelihood or the consequences of such a development.

Second, the notice did not disclose that Piper Jaffray (PF), SBLI's financial advisor, analyzed the plan and prepared a fairness opinion. The plaintiff alleges that PF said the plan would provide a windfall to the stockholders and adversely affect the policyholders.

Third, the notice did not disclose that the costs of the surplus note may adversely affect the policyholders. A surplus note is a debt instrument that increases the issuing (borrowing) company's surplus because the company is not required to establish a liability for the amount borrowed. A surplus note is subordinate to the issuing company's other obligations, can be issued only with the prior approval of the insurance commissioner in the issuing company's state of domicile, and interest and principal payments can be made only with the commissioner's prior approval.

Fourth, when a stock company issues participating (dividend paying) policies, invariably there are questions about the relative interests of the shareholders and the policyholders in the earnings and surplus of the company. The plaintiff alleges that SBLI's plan will dilute the interests of the policyholders, and that the notice does not adequately address the problem.

Fifth, the notice asserts shareholders have a 37.5 percent interest in SBLI's original surplus. The plaintiff alleges that the assertion is false.

Other Filings
In addition to the complaint, the parties have filed many other documents. Here are a few of them. The plaintiff filed a motion for a preliminary injunction, with a supporting memorandum. SBLI filed an opposition to the motion for a preliminary injunction, with supporting memoranda. SBLI also filed the general policyholder information statement, frequently asked questions, an independent auditor's report, and financial statements.

The Milliman Opinion
SBLI retained Steven Schreiber, FSA, MAAA, of Milliman, Inc., an actuarial consulting firm, to provide an opinion as to whether the proposed plan of conversion is fair to the policyholders from an actuarial standpoint. The opinion, dated January 4, 2017, is appended to the general policyholder information statement offered to policyholders. The plaintiff alleges that the Milliman opinion is "flawed," and that SBLI's use of the opinion in connection with the proposed plan is "irrelevant and erroneous." Therefore the plaintiff alleges that inclusion of the opinion in the general policyholder information statement is "misleading."

The Milliman opinion says it can be used as necessary in connection with the proposed plan, but any other use of the opinion requires Schreiber's consent. I asked him for permission to provide it as part of a complimentary package I plan to offer to my readers. He declined to grant permission, citing "Milliman's longstanding policy of not discussing or distributing client work product."

The Hearing
On June 27, Judge Kaplan held a hearing on the plaintiff's motion for a preliminary injunction. It is my understanding that the judge expressed concern about SBLI's notice in several areas. However, because the special meeting of policyholders was the next day, and because the plan could not be implemented quickly, he decided not to issue an injunction immediately. The reason why the plan could not be implemented quickly is that SBLI has not completed arrangements for the surplus note.

The Special Meeting
On June 28, the special meeting of policyholders was held. It is my understanding that about 60,000 of SBLI's 480,000 policyholders voted, and that about 90 percent of those voted in favor of the plan.

The Order
On June 30, Judge Kaplan issued an order denying the plaintiff's motion for a preliminary injunction. He analyzed the plaintiff's allegations, generally sided with SBLI on them, and said the plaintiff was not likely to succeed on the merits of her allegations. The judge also said that "speed is more important than a carefully crafted explanation of the court's reasoning, so that the plaintiff may consider any other opportunities for the relief she requested."

Since the early 1990s, most insurance company reorganizations have been demutualizations. In such a reorganization, a policyholder-owned (mutual) company converts into a shareholder-owned (stock) company.

During the same period, some mutual companies have partially demutualized by creating a mutual holding company (MHC). In some such cases, the companies later dissolved their MHCs and demutualized; however, some MHCs still exist. I have expressed the opinion that creating an MHC is contrary to the interests of policyholders.

Prior to the early 1990s, most insurance company reorganizations were mutualizations, in which a stock company converts into a mutual company. An example is Equitable Life Assurance Society of the United States. Originally it was a stock company. However, after revelations in the Hughes-Armstrong investigation of 1905, the company mutualized. In 1992, the company demutualized under the sponsorship of AXA, a French company, and became AXA Equitable Life Insurance Company.

The Provident Case
Provident Mutual Life Insurance Company of Philadelphia, which at the time was an old and highly-regarded company, had an experience about 20 years ago reminiscent of the SBLI case. Provident notified its policyholders that the board of directors had approved a plan to create an MHC. The Pennsylvania insurance department held a hearing, the company amended the plan, the department approved the plan, the company asked the policyholders to vote on the plan, and 89 percent of those voting approved the plan.

However, a group of policyholders had filed a lawsuit in a Pennsylvania state court seeking an injunction blocking implementation of the MHC plan. They alleged that the policyholder information statement omitted important information, and that the policyholder vote therefore was not valid. Two days after the vote, the judge issued a preliminary injunction blocking implementation of the plan. Later the judge made the injunction permanent. Provident eventually scrapped the MHC plan and demutualized under the sponsorship of Nationwide Corporation.

As the Provident case progressed, I wrote extensively in The Insurance Forum about the case; the last major article was in the November 1999 issue. Jason Adkins, the lead plaintiff's attorney in the SBLI case, was involved in the Provident case.

General Observations
In general I agree with the plaintiff's allegations about the shortcomings of SBLI's notice to policyholders. Therefore I disagree with Judge Kaplan's order. In my opinion, the motion for a preliminary injunction should have been granted, the initial policyholder vote should have been voided, SBLI should have modified the notice and sent it to the policyholders, and another policyholder vote should have occurred.

I do not know whether the plaintiff can appeal Judge Kaplan's order or take some other action to seek relief. I plan to report significant further developments in the case, should they occur.

Available Material
I am offering a complimentary 68-page PDF consisting of SBLI's notification letter (1 page), SBLI's summary policyholder information statement (18 pages), McEvoy's complaint (29 pages), Judge Kaplan's order (14 pages), and the article in the November 1999 issue of The Insurance Forum (6 pages). Email and ask for the July 2017 package about SBLI's mutualization plan.


Friday, June 23, 2017

No. 223: Long-Term Care Insurance—Why It Is Wrong for States To Help Private Companies Sell the Product

In May 2017 an Indiana resident shared with me a long-term care (LTC) insurance promotional mailing he had just received. The mailing purported to be from the Indiana Partnership for Long Term Care, but in reality it was from a lead-development company in Texas. I wrote major articles in the July 2008 and January 2012 issues of The Insurance Forum about the California and Indiana LTC insurance partnerships. Here I provide an update and explain why I think it is wrong for states to help private companies sell LTC insurance.

LTC Insurance State Partnerships
LTC insurance state partnerships began in the late 1980s as a demonstration project funded by the Robert Wood Johnson Foundation. The original four states selected to participate were California, Connecticut, Indiana, and New York. Section 6021 of the Deficit Reduction Act of 2005 resulted in the expansion of the program into almost all the other states.

An LTC partnership program affects a state's Medicaid system. When a person buys a "partnership qualified" (PQ) policy, the person receives a one-dollar "disregard" for Medicaid qualification purposes for each dollar of LTC benefits received. For example, if an insured with a PQ policy receives $100,000 in LTC benefits, the insured would be able to keep $100,000 of assets beyond the minimal asset level required for Medicaid eligibility. It is important to recognize there is no "disregard" merely from ownership of a PQ policy. Stated another way, there is no "disregard" until the insured receives LTC benefits. Thus an insured whose claim for LTC benefits is denied by the LTC insurance company would receive no "disregard" for Medicaid qualification purposes.

The American Association for Long-Term Care Insurance (AALTCI), founded in 1998 and based in Westlake Village, California, describes itself as "the national professional organization exclusively dedicated to promoting the importance of planning for long-term care needs" and "the nation's leading independent organization serving those who offer long-term care insurance and other planning solutions." Its members are agents and companies selling LTC insurance, it provides information about state LTC insurance partnerships, and it offers various services to its members.

When I checked AALTCI's website ( in May 2017, I found a list of state partnerships as of March 2014. When I inquired, AALTCI provided a list as of February 2017. The updated list shows for each state the status of enabling legislation, whether the state provides reciprocity with other states, the effective date of the partnership, and whether the partnership is operational. Also, for each state, there is a description of the BIO, which is the benefit inflation protection option.

My Two Articles
I wrote my July 2008 article after The Wall Street Journal carried an article critical of the California LTC insurance partnership. I examined the program, expressed the opinion that the problem of financing LTC cannot be solved through the mechanism of private insurance, and explained the reasons for my opinion. I also expressed concern that the promotional letter was over the signature of the California governor, thus giving the appearance of an endorsement by the state. I wrote my January 2012 follow-up article after seeing a letter over the signature of the Indiana governor promoting LTC and the Indiana LTC insurance partnership.

In both articles I described the mailings and indicated that the response forms were addressed to Senior Direct, Inc. (Rockwall, TX), a private lead-development company. I also said Senior Direct sold the response forms to insurance agents.

The Recent Indiana Package
The May 2017 Indiana package consisted of four items: (1) a one-page letter, (2) a response form attached to the bottom of the letter, (3) a postage-paid-by-addressee reply envelope, and (4) an outside window envelope with no return address. In the upper left corner of the letter were the words "Information Concerning" in small type followed by the words "The Indiana Partnership for Long Term Care" in large type. Next to those words was a partial outline of the state of Indiana. In the upper right corner of the letter was information about nursing home and assisted living facility costs in Indiana, with a footnote indicating that the source of the data was the "Indiana Department of Insurance." The salutation was "Dear Fellow Hoosiers" and the letter was unsigned. Following the text of the letter, the recipient was urged to send back the response form, which was addressed to "SD Reply Center" at a post office box in Rockwall. The response form showed the name and address of the addressee and asked for the person's age, the spouse's age, telephone numbers, and an email address. At the bottom of the response form was a single line of small print consisting of three sentences:
Please verify address. Fill out card in its entirety and mail in the enclosed envelope today. Not affiliated with or endorsed by any government agency.
I sent the Indiana Department of Insurance a copy of the components of the promotional mailing. I pointed out several of the ways in which the package, although in this instance not signed by the Indiana governor, had the earmarks of an endorsement by the state and the Indiana department. I also expressed the opinion that the small-print disclaimer at the end of the one-line note at the bottom of the response card was not enough to offset all the earmarks of an endorsement.

In response, a department official said the state and the department no longer endorse the sale of LTC insurance to Indiana citizens. Further, the official said that the department was launching an investigation of the recent mailing, but that the results of the investigation probably would not be available for some time. I decided to post this item now and prepare a follow-up after the results of the investigation become available.

General Observations
For at least five reasons, it is my opinion that it is wrong for states and state insurance departments to allow themselves to be drawn into efforts to sell private LTC insurance to their citizens. First, as explained in my July 2008 article, the problem of financing the LTC exposure cannot be solved through the mechanism of private insurance. Second, many of those who try to solve the problem through private LTC insurance will suffer disappointment in several ways, including large premium increases. Third, the problems have become widely known not only because of substantial premium increases but also by the withdrawal of many LTC insurance companies from the LTC insurance market. Fourth, among the few remaining LTC insurance companies, some have experienced significant declines in their financial strength ratings, and one has been placed in liquidation. Fifth, when a state or state insurance department endorses or appears to endorse LTC insurance, citizens will blame their state government when they encounter disappointment.

Available Material
I am offering a complimentary 11-page PDF consisting of the July 2008 and January 2012 articles in The Insurance Forum (7 pages) and a copy of the recent promotional mailing to Indiana residents with the name and address of the recipient redacted (4 pages). Email and ask for the June 2017 package about state LTC insurance partnerships.


Thursday, June 15, 2017

No. 222: The Surplus Limitation Law in Massachusetts and a Quiet Amendment

In No. 218 (posted May 18, 2017), I wrote about the March 2017 settlement of a July 2012 class action lawsuit against Massachusetts Mutual Life Insurance Company alleging underpayment of dividends on participating life insurance policies. The complaint alleged violations of an old Massachusetts surplus limitation law. One hour after No. 218 was posted, an alert reader informed me that the old law was amended effective August 10, 2016, four years after the plaintiff filed her complaint. In this follow-up, I discuss the amendment and other matters.

The Massachusetts Surplus Limitation Law
The surplus limitation law is Section 141 of Chapter 175 of the Massachusetts statutes. When the lawsuit was filed, the law allowed a mutual life insurance company domiciled in Massachusetts to hold a "safety fund" not to exceed 12 percent of reserve liabilities. The law also required the company to distribute to its participating policyholders, in the form of dividends, amounts in excess of the safety fund.

The amendment increased the allowable safety fund from 12 percent to 20 percent of reserve liabilities. The amendment was a small section of Massachusetts House Bill No. 4569. That was a huge bill relating to "job creation, workforce development and infrastructure investment." The bill consisted of 140 sections and 123 pages. The amendment was Section 113, which was buried on page 108 of the bill. Here is the full text of the amended version of the surplus limitation law incorporating the increase in the allowable safety fund:
Any domestic life company may from its surplus funds or profits attributable to its participating business accumulate and hold, or hold if already accumulated, as a safety fund, an amount not in excess of 20 percent of its reserve for such business or one hundred thousand dollars, whichever is greater, and, in addition thereto, any surplus that may have been contributed by the holders of the guaranty stock of the company, or which has been accumulated for the retirement of said guaranty stock and the margin of the market value of its securities over their book value, provided that in cases where the existing surplus or safety fund, exclusive of accumulations held on account of existing deferred dividend policies, exceeds the limit above designated, the company shall be entitled to retain said surplus or safety fund, but shall not be entitled to add thereto so long as it exceeds said limit, and provided that for cause shown, the commissioner may at any time and from time to time permit any company to accumulate and maintain a safety fund in excess of the limit above mentioned, for such period as the commissioner may prescribe in any one permission, by filing in his office his reasons therefor and causing the same to be published in his next annual report. This safety fund shall be in addition to any safety fund accumulated from a mutual domestic life company's surplus funds attributable to its nonparticipating business, which funds may be appointed [apportioned?] equitably, in the discretion of the company, as part of any annual dividend on participating business. This section shall not apply to any company issuing only nonparticipating policies.
I asked Massachusetts Mutual for a statement about the amendment. A company spokesman provided this statement:
The amendment of the statute allows our company and other Massachusetts mutual life insurers the option of maintaining additional capital, so that in times of economic difficulty, policyholders can be confident that claims will be paid and their loved ones will be protected.
The Pennsylvania Surplus Limitation Law
In No. 217 (posted May 11, 2017), I wrote about a similar class action lawsuit against Penn Mutual Life Insurance Company alleging violations of a similar Pennsylvania law. The law is in Section 614 of the Pennsylvania statutes. That section allows a mutual life insurance company domiciled in Pennsylvania to hold a "safety fund" not to exceed 10 percent of reserve liabilities, and requires the company to distribute to its participating policyholders amounts in excess of the safety fund.

The New York Surplus Limitation Law
As I said in No. 217, New York was the first state to enact a surplus limitation law. It was among the reforms enacted in New York in 1906 after the famous Hughes-Armstrong investigation of 1905. Among the parallel reforms, enacted in New York at the same time to prevent mutual life insurance companies from accumulating excessive amounts of surplus, was a law requiring the annual distribution of surplus.

A few other states, such as Massachusetts and Pennsylvania, enacted surplus limitation laws shortly after New York did so. I believe that Wisconsin also enacted such a law, which fell by the wayside during the 1979 recodification of Wisconsin's insurance laws led by Spencer Kimball.

The current surplus limitation law in New York is Section 4219(a)(1). That section allows a domestic mutual life insurance company to maintain a surplus not exceeding the largest of four figures: (1) $850,000, (2) 10 percent of reserve liabilities, (3) 10 percent of reserve liabilities plus (a) 300 percent of authorized control level risk-based capital [which is equivalent to 150 percent of company action level risk-based capital] minus (b) asset valuation reserve, and (4) minimum capital and surplus required by any state where the company is licensed.

Background in New York
Because of the importance of New York's surplus limitation law, some background seems appropriate. The New York legislature created a committee in 1905 "to investigate and examine into the affairs of life insurance companies doing business in the State of New York." The committee was chaired by New York State Senator William W. Armstrong. The other members of the committee were two other state senators and five members of the state assembly.

One of the causes of the investigation was the widespread sale of "deferred-dividend" policies, also called "semi-tontine" policies. The policies allowed the companies to accumulate large amounts of surplus and squander large amounts of money.

Charles Evans Hughes was appointed counsel to the committee. He so dominated the work of the committee that the investigation, normally called the Armstrong investigation, is often called the Hughes-Armstrong investigation. Public hearings began on September 6, 1905, consisted of 57 sessions, and ended on December 30, 1905. I devoted almost the entire 12-page January 2011 issue of The Insurance Forum to a discussion of the investigation.

The investigation led to an illustrious career for Hughes. Shortly after the investigation he was elected Governor of New York. Later he served for six years as an Associate Justice of the U.S. Supreme Court. In 1916 he was the Republican Party's unsuccessful candidate for President of the United States. He served for four years as U.S. Secretary of State, for two years as a judge on the Court of International Justice, and finally for 11 years as Chief Justice of the United States.

Buist M. Anderson, a prominent insurance statesman and author, was for many years general counsel of Connecticut General Life Insurance Company. He wrote an excellent 40-page paper entitled "The Armstrong Investigation in Retrospect," which was published in the 1952 Proceedings of the Association of Life Insurance Counsel. A three-paragraph section of the paper discussed New York's surplus limitation law. Here, without footnotes, is that section:
Mr. Hughes was bothered by the huge surplus funds which had been made possible by the deferred dividend system without annual accounting and he recommended that mutual companies should be limited as to their surplus funds. The limitation recommended was graduated from the larger of 20 per cent of "net values" or $10,000 in the case of small companies down to 2 per cent of "net values" in the case of companies with such values in excess of $500,000,000. The Legislature did not accept the lower limit as recommended but permitted a surplus graded down only to 5 per cent.
Mr. Hughes was obviously not sufficiently conservative in recommending the rather severe limit on surplus funds. He could not, of course, foresee the Panic of 1907, which depressed bond values at the year-end to a point where it was necessary for the Insurance Commissioners to permit the valuation of bonds on an average basis as of the year-end and as of the first of each of the months of 1907, a plan commonly known as the "Louisville Resolution" or the "Rule of Thirteen." Had this concession in valuation not been made, some important companies would have had their surpluses entirely wiped out as of the 1907 year-end. Amortization of bonds which serves to stabilize bond values was first permitted with the passage of enabling legislation in New York in 1909.
Surplus funds for life insurance companies were not regarded as nearly so important in 1906 as later. The surplus limitation in New York for the larger companies was raised from the 5 per cent imposed by the 1906 law to 7½ per cent in 1916 and to 10 per cent in 1920; and the limit was made the larger of 10 per cent of reserves and liabilities or $500,000 as of January 1, 1940, and as the larger of 10 percent or $750,000 as of April 16, 1949.
General Observations
I am not aware of any debate, hearings, or publicity about the recent amendment to the Massachusetts surplus limitation law. Nor do I know who arranged for the amendment. The amendment probably was the result of a quiet lobbying effort by Massachusetts Mutual or by a company trade association of which Massachusetts Mutual is a member.

I believe that the primary objective of the amendment was to reduce the likelihood of future litigation. I say that because of data in the lawsuit filed in July 2012 against Massachusetts Mutual. The plaintiff's estimates of the safety fund ranged from 12.02 percent to 15.87 percent of reserve liabilities from 1999 through 2010. Thus increasing the safety fund limit to 20 percent made future litigation unlikely.

Available Material
I am offering a complimentary PDF of the 12-page January 2011 issue of The Insurance Forum. Email and ask for the January 2011 issue of the Forum.


Thursday, June 8, 2017

No. 221: David McCullough's New Book—A Sparkling Gem

Readers of this blog know David McCullough is one of my favorite historians. He has received, among many honors, two Pulitzer prizes, two National Book Awards, two Francis Parkman Prizes, a Presidential Medal of Freedom, and 54 honorary degrees.

I have read all ten of McCullough's books, and every one is a treasure. In chronological order of publication, they are: The Johnstown Flood (1968); The Great Bridge, about the building of the Brooklyn Bridge (1972); The Path Between the Seas, about the building of the Panama Canal (1977); Mornings on Horseback, about the young Theodore Roosevelt (1981); Brave Companions, about several prominent historical figures (1991); Truman (1992); John Adams (2001); 1776 (2005); The Greater Journey, about the American writers, poets, artists, sculptors, composers, and others who drew inspiration from the time they spent in Paris during the 19th century (2011); and The Wright Brothers (2015).

When I heard about McCullough's latest book, a sparkling 167-page gem, I rushed to get it for Memorial Day weekend reading. It is entitled The American Spirit: Who We Are and What We Stand For. It is a collection of 15 of his many addresses at historic events and at college commencements. In chronological order, they were at: a joint session of Congress (1989); the University of Pittsburgh (1994); Union College (1994); an Independence Day Naturalization Ceremony at Monticello (1994); Dickinson College (1998); the University of Massachusetts (1998); Dartmouth College (1999); the bicentennial of the White House (2000); a National Trust for Historic Preservation Conference (2001); Ohio University (2004); Hillsdale College (2005); a celebration of the 250th birthday of the Marquis de Lafayette (2007); Boston College (2008); the memorial service at Dealey Plaza in Dallas marking the 50th anniversary of the assassination of President Kennedy (November 22, 2013); and the U.S. Capitol Historical Society (2016).

In the introduction to his new book, McCullough explained why he decided to publish it at this time. He mentioned his
hope that what I have had to say will help remind us, in this time of uncertainty and contention, of just who we are and what we stand for, of the high aspirations that inspired our founders, of our enduring values, and the importance of history as an aid to navigation in such troubled, uncertain times.
I was especially moved by McCullough's address at the bicentennial of the White House. He described how President John Adams, the first occupant, moved in on November 1, 1800. Early the next morning Adams wrote a memorable letter to his wife Abigail, who was at their home in Massachusetts. The letter adorns the inside front cover of the new book, and McCullough mentioned the letter on page 551 of his biography of Adams. President Franklin Roosevelt had two sentences of the letter carved into the wooden mantelpiece in the State Dining Room. When the White House was rebuilt, President Truman insisted that the inscription remain. President Kennedy had the inscription carved into the mantelpiece in marble.
I pray heaven to bestow the best of blessings on this house, and all that shall hereafter inhabit it. May none but honest and wise men ever rule under this roof.

Thursday, June 1, 2017

No. 220: Connecticut Violates the Constitutional Rights of Insurance Policyholders

Connecticut recently enacted a law that authorizes a Connecticut-domiciled insurance company to divide itself into two or more insurance companies. In this post I explain the reasons for my opinion that the law violates the constitutional rights of insurance policyholders.

An insurance contract creates a creditor-debtor relationship between the parties. The policyholder is the creditor and the insurance company is the debtor. Consider this loan contract analogy:
Sue borrows money by entering into a loan contract with a bank. The bank is the creditor and Sue is the debtor. Sue and her friend Jim later enter into a separate contract under which Jim agrees to take over Sue's obligations. Imagine the reaction of the bank's loan officer when she receives this letter from Sue:
"Effective immediately, my obligations to you have been taken over by Jim. You have no recourse to me in the event of Jim's failure to meet his obligations to you."
The problem is that a debtor cannot be relieved of his, her, or its obligations to a creditor without the consent of the creditor. In the case of an insurance policy, the insurance company (the debtor) cannot be relieved of its obligations to the policyholder (the creditor) without the consent of the policyholder.

If the policyholder consents, the transaction would be a "novation," in which another debtor is substituted for the original debtor. Stated differently, another insurance company is substituted for the original insurance company. Stated still differently, the obligations under an insurance policy contract are transferred from the original insurance company to another insurance company.

The two major types of consent to a novation are affirmative (positive) consent and implied (negative) consent. Affirmative consent occurs when the creditor signs a form granting permission to complete the novation. Implied consent occurs when the creditor does nothing and is deemed to have consented to the novation.

The Penn Mutual Case
In 1963 Mr. X bought a noncancellable and guaranteed renewable disability insurance policy from Penn Mutual Life Insurance Company. In the 1970s Penn Mutual stopped issuing new disability policies, but continued to administer its previously issued disability policies.

In 1986 Penn Mutual sent Mr. X a letter informing him that his disability policy had been transferred to Benefit Trust Life Insurance Company. In response to Mr. X's inquiry, a Penn Mutual official said that Benefit Trust had taken total control of the disability policies and the obligations under them, and that Penn Mutual had no further obligations under the policies. In response to my subsequent inquiry, a Penn Mutual senior officer said policyholders would have no recourse to Penn Mutual in the event of Benefit Trust's insolvency. None of the three Penn Mutual letters said anything about the need for Mr. X's consent to the transfer.

The Advisory Committee
The Penn Mutual case and other similar cases prompted me to write many articles in The Insurance Forum about policy transfers. I also volunteered to serve on an advisory committee appointed by a working group of the National Association of Insurance Commissioners (NAIC) when the regulators sought to deal with the firestorm my articles had created. I was one of nine members of the advisory committee; the other eight represented insurance companies.

All nine members of the advisory committee agreed an insurance company must obtain the consent of the policyholders in a policy transfer. Eight industry members agreed that implied consent was adequate. I disagreed, insisting that affirmative consent was essential.

The chairman of the advisory committee asked the industry members to draft a model bill or model regulation based on implied consent. The advisory committee then submitted its model to the working group. I drafted a model based on affirmative consent and submitted my model to the working group as a minority report of the advisory committee.

The Constitutional Question
When the advisory committee submitted its model based on implied consent to the chairman of the working group, he was concerned about whether such a model would survive a challenge under the U.S. Constitution. He asked the chairman of the advisory committee to obtain a legal opinion. The chairman of the advisory committee asked an attorney member of the advisory committee to write a legal opinion. Here is the final sentence of the legal opinion:
For the reasons set forth above, we are of the opinion that the implied consent provision of the proposed Model Act would withstand a challenge based upon the United States Constitution.
I asked an attorney who specializes in constitutional law to review the legal opinion that the advisory committee had obtained. He wrote a memorandum that included these two sentences:
Having carefully reviewed the [advisory committee's opinion] letter and the authorities it discusses, I do not believe that the analysis set forth in the letter is persuasive. For the reasons discussed below, it is far from clear that an implied consent provision would pass muster under either the Due Process or Contract Clauses of the Constitution.
The working group and the NAIC decided to rely on the advisory committee's legal opinion. The NAIC model, therefore, is based on implied consent. In an article in the August 1992 issue of The Insurance Forum, I showed the full text of each of the two opinion letters.

The Recent Connecticut Law
On February 16, 2017, a legislative committee held a public hearing on House Bill 7025 "authorizing domestic insurers to divide." In testimony at the hearing, the Connecticut Insurance Department (CID) endorsed the bill, saying in part:
Generally, this bill will authorize a Connecticut domestic insurer to divide into two or more resulting insurers. This type of corporate restructuring is the reverse of a merger: instead of combining two or more insurers into one, a division will divide the Connecticut domestic insurer into two or more resulting insurers... The domestic insurer is required to file the plan of division with the Insurance Commissioner and obtain approval of the plan. The Commissioner may hold a public hearing to consider the matter if it is deemed in the public interest.
At the same hearing, The Hartford Group also spoke in favor of the bill. A company official said in part:
Being able to segregate businesses would allow domestic insurers to pursue more focused management strategies tailored for individual lines of business. This bill also provides domestic insurers a practical way to segregate and sell businesses that are no longer part of their business strategy, something that Connecticut law doesn't currently provide.
A case in point: In 2012, The Hartford announced it was no longer writing certain life insurance business. Later that year, we transferred our individual life and retirement plans businesses to Prudential and Mass Mutual, respectively. However, The Hartford could not realize a full and final sale of these businesses. Instead, we used the only practical option available. We entered into reinsurance arrangements with those companies. As a result, we have ongoing obligations, administrative complexity and compliance risk associated with those businesses. The long term obligations under the reinsurance arrangements means that The Hartford will experience that complexity and risk for many years to come.
On April 5, 2017, the Connecticut House of Representatives approved the bill. On May 3, the Connecticut Senate approved the bill. On May 8, the bill became law as Public Act No. 17-2 after Connecticut Governor Dannel Malloy did not sign or veto the bill within five days. The law will take effect October 1. I am not aware of anyone testifying against the bill at the hearing, nor am I aware of any publicity about the bill.

Based on testimony at the hearing, I believe that Connecticut's division law is patterned after similar laws in Arizona, Pennsylvania, and Rhode Island. I plan to explore those laws and their origins.

The Debevoise Analysis
Debevoise & Plimpton is a law firm that represents insurance companies. On May 11, three days after the bill became law, Debevoise issued a "client update" on the new law. Debevoise said the new law
may prove to be a valuable tool for Connecticut domiciled insurance companies. It could be used to isolate a block of business for sale to a third party in a transactioon that without the statute could only be accomplished through reinsurance. It could also be used by a company to separate its active book of business from a troubled run-off block, potentially improving the capital position and credit rating of the active company.
General Observations
What Hartford failed to mention in its testimony is that the company could have asked the affected policyholders for their consent to novation of their contracts. Prudential and Mass Mutual would have taken over administration of all the contracts, and would have taken over Hartford's obligations under the contracts of policyholders who consented to the transfer of the obligations. With regard to the contracts of policyholders who did not consent to the transfer, Prudential and Mass Mutual would have continued to administer the contracts, but Hartford would have retained responsibility for the obligations under the contracts.

The "case in point" in Hartford's hearing testimony makes clear the objective of the "division law." The "reinsurance arrangements" were "assumption reinsurance agreements" under which Hartford transferred the policies to Prudential and Mass Mutual. Hartford would have been relieved of its obligations to each policyholder only with the consent of that policyholder, and would have had to retain the obligations to each policyholder who did not consent to the transfer. Because policyholder consent is not required for a "division" or for the sale of a company, Hartford is now able to place unwanted blocks of business in a second company and then sell the second company, thus transferring its obligations to all the affected policyholders without their consent.

Hartford is now permitted to write letters to their policyholders similar to Sue's letter to the bank in the loan contract analogy, and similar to Penn Mutual's 1986 letters to its disability insurance policyholders. In my opinion, the division law allows Connecticut-domiciled insurance companies to transfer their obligations without policyholder consent, and thereby to violate the constitutional rights of their policyholders.

Available Material
I am offering a complimentary 31-page PDF containing the full text of the division law (20 pages), the CID and Hartford testimony at the hearing (3 pages), the Debevoise client update (4 pages), and my article in the August 1992 issue of The Insurance Forum (4 pages). Email and ask for the June 2017 package relating to Connecticut's division law.