Allstate Sued by Firm Alleging Non-Payment of Death Benefits

In 2013, we wrote about the sale of Lincoln Benefit Life, an Allstate company, to Resolution Life Holdings, Inc. It was the first purchase in the States for the UK company, run by British entrepreneur, Clive Chowdry, whose ambition, according to the Financial Times, was to “buy up and roll together a number of life assurance businesses and to run them for cash instead of hunting for new customers.” The runoff administration business model employed by the company and by some others who have entered the insurance field is designed to maximize profits on a closed book of business. At the time, we worried about cost of insurance increases in the block, but now comes a lawsuit accusing Resolution from failing to pay “death benefits owed” to Emergent Capital, Inc., a Boca Raton, Florida, life settlement company that owned the policies in question.  Although the lawsuit references only three policies directly, it notes that Emergent is owner of over 50 Lincoln Benefit Life policies.

Allstate is alleged in the lawsuit to have pursued the sale to Resolution without proper vetting and without the “good faith” that it owed Lincoln Benefit policyholders. The suit claims Allstate had a “fiduciary” duty to act in the“best interests” of policyholders, “use diligence and care in the investigation and evaluation of Resolution as a prospective purchaser,” and “refrain from acting solely on the basis of its own financial interests in the sale.” The complaint asserts that by “choosing to sell its wholly-owned subsidiary Lincoln Benefit to the highest bidder, Allstate improperly placed its own financial interests ahead of those of the insurance policy owners” and “ignored information readily available to it regarding Resolution’s well known claim practices that violate statutory and common law rules.” The suit claims that it was “understood in the life insurance industry that, at the time of the Lincoln Benefit sale to Resolution, Resolution may have had an internal practice and procedure of challenging and contesting every life insurance policy claim involving policies having life benefits that exceeded a certain high-level dollar amount.”

The three policies referenced in the lawsuit were issued in 2007 to trusts created by the insured, and shortly after policy issue, all three trusts “entered into a premium financing arrangement with Emergent,” apparently with the policies as collateral. Within approximately three years of policy issue, all three policies had their ownership changed to Emergent. Lincoln Benefit was alerted via “fully completed and fully executed” Lincoln Benefit service forms that policy ownership was changed with “the specific knowledge and consent of Allstate’s wholly-owned subsidiary, Lincoln Benefit.” After the change in ownership, both Lincoln Benefit and then Resolution accepted premium payments from Emergent.

According to the suit, Allstate “created and maintained an internal committee to research, vet, and approve qualified and reputable insurance premium financing companies, like Emergent, with whom it would do business and recommend to prospective life insurance applicants to help them afford to pay the exorbitant insurance policy premiums charged by Allstate and its wholly-owned subsidiary Lincoln Benefit.” Emergent “was one of a small group of life insurance premium financing companies affirmatively approved” by the carrier and its subsidiary company.

When the insured on each policy passed away, Lincoln Benefit took the position that death benefits need not be paid on the three policies because they and “others similarly situated had never been active or in force” since “any life insurance policy issued by Allstate’s wholly-owned subsidiary Lincoln Benefit (whose assets were sold by Allstate to Resolution) and financed through a life insurance premium finance arrangement, like the one the Frankel ILIT, the Matz ILIT and the Pohl Trust, and others, had with Emergent, constituted a “stranger owned life insurance policy” (or “STOLI”) and, therefore, were all void ab initio.”

Emergent is asking that compensatory and punitive damages be awarded in the case and estimates compensatory damages alone to “exceed $32 million..with the potential of exceeding $100 million.”

While we have Lincoln Benefit policies under management we have never had any issues with death benefit payments or even service levels at the carrier since the sales transaction took place.

We will report back with updates as the suit winds its way through the court.

Trustee Alert: Don’t Be a Casualty of the Life Insurance Illustration War

In the 1980s when current assumption universal life (CAUL) hit the market, sales illustrations were created showing cash value returns of 10% and more every year – for a product that was invested in fixed instruments.  When equity markets soared and variable universal life (VUL) became the rage, many sales illustrations projected 12% returns – again, every year.

Life insurance illustrations are at best a guide – they do not guarantee the future, they are based on hoped-for returns which do not occur as projected.  All else equal, in a universal life chassis without secondary guarantees, the higher the rate of return assumption, the lower the premium that has to be shown in a sales illustration to carry the policy to maturity (or some other goal).

The premium shown in a sales illustration is not the cost of the policy – costs are shown on the expense page of the illustration.  An unreasonably high return assumption can easily hide higher policy charges.  Why?  Because over the lifetime of the policy, the highest expense is typically the monthly deduction for the cost of insurance – the mortality charges.  Those charges are based not on the death benefit, but on the net amount at risk, which is the difference between the death benefit and the cash value. (For a more detailed explanation of net amount at risk, go to Chapter 6 of the TOLI Handbook, available as a free download here.)  As the cash value climbs, the net amount at risk drops and the actual charges deducted drop.  A high assumed rate of return creates a double-edged cycle – a higher return creates higher cash value which lowers costs which creates higher cash values.  A perfect situation – for a disaster.

The CAUL policies issued in the 80s and into the 90s with unreasonable returns crashed and burned with policy lapses that fueled the rise the rise of secondary death benefit policies, guaranteed universal life (GUL).  The 12% returns of VUL policies did not hold up either and after the market crash of 2007-08, many people fled to equity indexed universal life (EIUL). These were considered more “conservative” because while the returns were tied to an equity index, an interest rate floor – typically 0%, limited the downside – “you could not lose money” with this product. (Note that even though the investment component may not be negative, policy charges still accrue so cash value does drop.)

The policy also has a limit on the upside, called the cap, set by the carrier.  A policy with a cap of 10%, which is typical, means that any returns over 10% will be lost.  This is one reason that the rate of return assumption in EIUL policies is tricky to project.  When we first started seeing these policies, the assumed crediting rate in sales illustrations was well above 7%, often approaching 8%.  Now with regulation AG 49 in force, sales (and in-force) illustrations are limited to a maximum return of around 7%.  One carrier has created an online tool that translates the actual return in an index, like the S&P 500, into the crediting rate applied to the policy.  For example, assuming a 10% cap and 0% floor, to credit a policy with a 7% rate, the actual return in the S&P 500 would have to be between 10 and 11 percent.

However, there is more.  Regulation AG 49 capped the rate of return that could be shown in the policy, but it did not stop the use of various interest bonuses and multipliers that might not be seen or understood in an illustration.  We are in the midst of an illustration war with carriers determined to create products that illustrate better in a sales situation.  According to one life insurance expert, these AG 49 compliant illustrations can take a “6.75% illustrated rate” and “generate a 9% illustrated internal rate of return on cash value.” (1) The industry is turning lead into gold.

Unfortunately for the TOLI trustee taking in a new policy, this creates issues. As a fiduciary, you must make sure that the assumptions on the asset in the trust are reasonable.  As a business person, you must make sure your clients are not disappointed by policy performance – when the policy crashes, it will be your problem.

So what is the answer?  First, have skilled life insurance professionals on staff.  An untrained administrator will not be able to decipher today’s sophisticated products.  If you do not have skilled staff – find them or outsource the service.

Second, do not accept policies with assumptions you deem unreasonable.  Hopefully the current crediting rates on new current assumption policies and dividends on whole life policies are bottoming out, and rates will be rising – a plus.

For variable universal life policies, review the asset allocation and develop a conservative assumption for the expected returns.  If you think 8% is reasonable in an equity-rich allocation, also show the outcome at 5.5% or 6%.  If a more balanced allocation generates an assumed return of 7%, also show 4.5% or 5%. Show the clients the downside funding needs, you will be glad you did.

For equity index UL policies, get an illustration assuming a crediting rate of 5% along with the 6-7% return that is usually shown.  And make sure you (and your grantors) understand the bells and whistles of the policy. (See Chapter 10 of the TOLI Handbook for a thorough discussion of the equity index UL policy.)

Document the higher carrying costs that come with a lower return assumption and have the client sign a document acknowledging those additional costs and make that a part of your trust file.

Generate a report annually that shows the current condition of the policy and any premium changes that should occur to keep the policy on track.

Do not assume the aggressive assumptions made by salespeople to lower the projected premium and increase the chance of a sale will actually occur.  Your job is not to sell a policy – it is to deliver a death benefit.

Be careful out there.

  1. Voya ICAR & The Indexed UL Illustration War, Bobby Samuelson, The Life Product Review, October 11, 2018

 

Newspaper Headlines Highlight Changes in Life Insurance (and TOLI) Business

On October 30th, Voya Financial, a company we wrote about because of a lawsuit filed against it for cost of insurance increases that occurred on universal life policies sold in the past under the Security Life of Denver banner, announced in its third-quarter earnings call it would be ceasing all life insurance sales as of the end of the year.

The company, which was spun out of ING Group, a large financial services firm operating in 40 countries around the world, is not leaving the market because of any litigation.  It is leaving because the permanent life insurance business faces a “sluggish environment” according to a Wall Street Journal report. (1)  The article reports that “since the 1980s, sales of individual life insurance policies have dropped 45%” and in the last few years have been flat.

Voya’s life insurance business the last few years has been bolstered by sales of equity index universal life policies which made up the bulk of Voya’s life sales, a product being packaged by the industry as a retirement supplement vehicle, as the life insurance industry moves from death benefit to retirement funding sales.  As the WSJ article points out many consumers today “are more concerned about outliving their savings than dying prematurely.”

Voya is leaving life insurance sales to focus on pure retirement funding investment management and employee benefit opportunities.  In a Voya press release, Rodney O. Martin, Jr., chairman and CEO, said that going forward Voya would be “focusing on the workplace and institutional clients” and that stopping the sale of new life insurance “aligns with our plans to focus on our higher-growth, higher-return, capital-light businesses: Retirement, Investment Management and Employee Benefits.”  (2)  Voya will continue to administer the current block of in-force business.

The individual life insurance market suffers from an aging workforce and lack of “new blood” to the industry. The average age of a life insurance agent is approximately 60, there are fewer opportunities for new agents to join the industry and according to one survey, the younger generation views life insurance as boring. (3)  As the old guard retires, there may not be enough seasoned agents to replace them.  This is unfortunate, especially in the “higher end” market where wealthy individuals use sophisticated products and strategies in trust-owned life insurance (TOLI) policies and put pressure on a TOLI trustee to be well versed in the changing permanent product landscape.

Ironically, another headline posted the same day points out the new direction of the market.  Ethos, a Silicon Valley start-up that says it can “process life insurance in a matter of minutes” raised $35 million in a funding round that values the firm at “more than $100 million.” According to an industry article, the company “uses data analytics to predict a person’s life expectancy” and this enables it to “cut the time normally taken to apply for life insurance from 10 weeks to 10 minutes.”   The company’s funding has come from big business names like Google and entertainment figures like Jay Z, Robert Downey Jr, and Will Smith.   The company is focused only on term insurance providing 10 to 30 years of coverage for those in the “prime” of their life.

Making life insurance easier to purchase is a great selling point, and many carriers are stepping up with AI and algorithms to speed the underwriting process along, but in the high-end market where life insurance is still used for estate planning, permanent products, not term insurance is typically used.  Term is more of a commodity sale, the only real differentiators being price, carrier stability, and conversion options, so it lends itself to this quick online sales process. Permanent products need consultation, as their nuances and application are harder to explain.

In the TOLI market, there will always be a need for a good advisor to oversee the purchase and management of life insurance.  As we move forward, we think that role will fall more to the TOLI trustee, who more than ever will have to be a specialist in this asset.

  1. Another Insurer to Cease Selling Life Insurance to Individuals, Leslie Scism, Wall Street Journal, October 30, 2018
  2. Voya Financial, Inc. (NYSE: VOYA) today announced financial results for the third quarter of 2018, Business Wire, October 30, 2018
  3. One in four insurance agents will be gone by 2018, Caitlin Bronson, insurancebusinessmag.com, February 23, 2015.
  4. Google, Accel, and Jay Z invest in life insurance start-up Ethos, valuing it at more than $100 million, Ryan Browne, cbnc.com, October 30, 2018

Life Insurance Settlement Association (LISA) Challenges Lincoln Enhanced Buyback Offer

Back in the spring, we reported on the Lincoln National “Enhanced Cash Surrender Value” offer the carrier began making to a select group of policyholders.  These unsolicited offers would allow policyholders to receive an amount higher than the current cash surrender value to return their policies to the carrier.

As we noted, the offers were similar to some made on mispriced variable annuities after the 2008-09 financial crisis.  Those annuities had guaranteed minimum income benefits that the carriers felt were too rich in the current investment climate.  The Lincoln offer, however, is the first enriched buyback offer we have seen for life insurance policies.

Life Insurance Settlement Association (LISA), a trade association that promotes the rights of policyholders selling their policies in the secondary market, is now challenging this enhanced offer.  In a letter addressed to the Commissioner of the Florida Office of Insurance Regulation, LISA, through its attorney, alleges that the enhanced cash value offer violates a “slew of consumer protection laws,” citing five separate Florida statutes, and accuses the carrier of “acting as a life settlement provider without the required license.”

According to the LISA letter, the offer was made on 5,300 Lincoln Life Guarantee SUL 2009 policies.  These survivorship policies, which pay out after the second insured dies, are often used in trust-owned life insurance (TOLI) trusts since estate taxes for a married couple are typically paid at the second death.

We oversee 81 policies that have received offers – so far.  While in both the offer letters and the FAQ brochure provided by Lincoln, the carrier notes that their “records indicate” the policyholder has “stopped making regular premium payments,” for a number of our policies, premiums have been paid to date, some each year since policy issue.  The carrier suggests that “missing premium payments can be an indication that your insurance needs may have changed” and asks the policyholder to “consider whether you still want or need the death benefit protection provided by this policy,” or whether the Lincoln enhanced offer “is more important to you than your need to leave a death benefit to your beneficiaries.”

LISA notes that in an attempt to “entice” policy owners to accept their offer Lincoln is using “many of the arguments made by life settlement providers in their marketing,” pressuring “the consumer to act” by providing the option for “a limited time only.”  According to the LISA letter, Lincoln seeks “to entice agents to solicit their clients” to take advantage of the offer “by holding out the possibility of additional commissions” if the client uses the proceeds to purchase a new Lincoln product, noting that “an internal replacement into any new policy or contract will be considered new business and agents will be compensated using the same rate schedule used for new premium.”

A life settlement also pays a commission to those who facilitate the transaction.  Whether a life settlement would be more beneficial for the policyholder is probably not contingent on commissions paid but the facts and circumstances around each policy, specifically the health of the policy and the insured.  Lincoln is offering to pay a premium of between 35% and 200% above the cash surrender value for the policies we manage, without having any knowledge of the insured’s current health. In a life settlement transaction, at least one life expectancy (LE) report is obtained, providing the investor with insight as to the health of the insured, which greatly affects the price offered.

Why would Lincoln do this?  In our portfolio of 81 policies, there is $292 million of death benefit.  Lincoln is offering an aggregate amount of $41 million to re-purchase the policies. The 81 policies have a total surrender value of $25 million, but without surrender charges, the cash values would be $31 million.  We have found that, in our portfolio, the average offer is slightly above the average premium paid. Lincoln is not paying much more than it has collected (and invested) since the policies were issued.  Lincoln is on record as saying that it is making the offer because for policies surrendered, they would “no longer be responsible for the death benefit on the policy.”  This would enable them to release “financial reserves and redeployment of the funds for a different use.”

The life insurance industry is struggling, and carriers are looking for alternative avenues to use their capital more profitably.  This will have repercussions, and in our next blog, we will discuss Voya’s decision to stop issuing life insurance and how it highlights changes in both the life insurance market in general and trust-owned life insurance (TOLI) in particular.

LISA is asking for the Florida Office of Insurance Regulation to investigate Lincoln’s Enhanced Cash Surrender Value Option, and to “take necessary enforcement action if, as we believe you will, you conclude that this program violates Florida law.”  As of today, none of our clients have taken Lincoln up on their offer, but almost all have until the end of March 2019 to do so.

We will report back with any updates.

Saskatchewan Government Squashes Investors Hope For Unlimited Returns Using Life Insurance

On October 29th the government of the Canadian province of Saskatchewan amended regulations dealing with premium deposits into a specially designed universal life policy.  The new rule limits deposits into “side accounts in life insurance policies to an amount equal to premiums required under contract.” (1)

The new regulation comes as a court battle rages between Canadian life insurance carriers and investors who purchased the policies hoping for guaranteed investment returns up to 5%.

The contracts in question were universal life policies issued in the 1990’s when fixed rates were much higher. The policies provide for a death benefit and an investment account – similar to the cash value in a traditional universal life policy.  According to a white paper put out by Muddy Waters Capital, a Canadian investment firm that has shorted Canadian carrier stock (2), one policy issued by Manulife, that is part of the court case, has a tax-exempt account and a separate taxable account. Cash goes into the tax-exempt account to pay the policy premium, and additional funds can be added.  On the policy anniversary date, a test is run, and any cash over a specific amount is moved from the tax-exempt account to the taxable account to preserve the tax status of the policy.  Both accounts have investment options, including an account that guarantees 4%. The tax-exempt account pays an annual bonus of .85 percent on the policy anniversary date. Cash can be contributed at any time.

Universal life policies issued in the United States have contribution limits based on the death benefit provided, but this Canadian policy and others like it can accept unlimited contributions, generating guaranteed returns for investors that are well above market rates.

A Wall Street Journal article recently featured Michael Hawkins, an Ontario businessman who purchased eight life insurance policies and contributed $11 million to them as a method to generate “extra income.” (3)  Hedge funds, investment houses and wealth management firms have purchased policies seeking a limitless cash cow.  Mr. Hawkins is now locked in the court battle that according to the Journal, is being funded in large part by investors, “in exchange for the potential opportunity to earn above-market rates in the side accounts.”

For every winner, there is a loser and if Mr. Hawkins were to win the carriers would be the big losers. The Muddy Waters white paper points out a Manulife expert testified in June of 2017 that a $100 million deposit would cause “an immediate reported loss to the insurer in excess of $45 million.”  However, it appears that the new regulation drastically cut the chances Mr. Hawkins will prevail.  Although some question the governments moves to amend “its insurance regulations in the middle of a judicial process,” the Wall Street Journal article points to one analyst who says the move “should substantially remove” any risk of litigation risk for the insurers in question.

Manulife, who had seen its stock drop 14% as a direct result of the case, saw shares rebound after the new regulation was announced.

(1)   Canadian Province Changes Rules, Benefiting Insurers in Dispute, Jacquie McNish,  Wall Street Journal, October 30, 2018

(2)  Manulife: An Insurance Company on Trial for its Life,  Muddy Waters Capital

(3)  Canadian Insurers Fight Cattle Farmer’s Investment Strategy, Fearing Stampede, Wall Street Journal, October 4, 2018

TOLI Trustee Alert: The Taxation of a Life Settlement Policy Sale

TOLI Trustee Alert: The Taxation of a Life Settlement Policy Sale

In our last two blogs, we discussed when and how to sell a life insurance policy.  In this blog entry, we want to talk about the taxation of a life insurance policy sale for the seller.

The death benefit of a life insurance held in trust is received free of both estate and income taxes, however, if a TOLI life insurance policy is sold, taxes may be due. The taxation of a life insurance policy is similar to, but not as simple as, a policy surrender for cash value, though the new tax law – the Tax Cuts and Jobs Act – did simplify the process.

Calculating the taxation of a life settlement is a three-step process.

First, determine total gain by subtracting the cost basis of the policy, typically the total premium paid, from the amount received from the sale by the policy owner.

LSChartfor#3_Sent_9.17.18Second, determine that amount which will be taxed as ordinary income, which is the difference between the cash value in the policy and the cost basis.  This is the same process used to calculate the taxable amount of a policy surrender.  The cost basis in both transactions is received free of income tax – it is the return of premium paid.  Before the new tax law, a policy seller would have to reduce the cost basis by the mortality charges paid in the policy, an arduous, sometimes impossible process, that increases the taxation of a policy sale.

Third, calculate that portion of the sale that will be taxed at capital gains rates by subtracting the amount taxed as ordinary income (second step) from the total gain (step one).  The amount above the cash value is taxed as capital gains.

As can be seen from the chart, if a policy with a cost basis of $250,000, and a cash value of $400,000 was sold for $800,000, the total gain for the seller would be $550,000 ($800,000 sale price minus $250,000 cost basis received tax-free), $150,000 of that amount ($400,000 cash value minus $250,000 cost basis) would be taxed as ordinary income and $400,000 ($550,000 total gain minus $150,000 taxed as ordinary income) would be taxed at capital gains rates. Note that if there is no cash value in the policy, the total amount received above cost basis is taxed at capital gains rates.

Understanding life settlements will grow more important for the TOLI trustee over the coming years.  For more information, review chapter 14 of the TOLI Handbook, available as a free download at http://www.TOLIHandbook.com.

 

TOLI Trustee Alert: Life Settlements – How to Sell a Policy

In our last blog, we tackled the question of when to sell a life insurance policy.  With the changes in the estate tax laws and the aging of the population in the typical TOLI portfolio, life settlements will become more prominent in the coming years, and the TOLI trustee must become aware of the sales process, so we wanted to provide a short primer for trustees who need a better understanding of this valuable policy option.

A typical procedure can be broken down into six steps:

  1. Initial Inquiry: If a life settlement is contemplated, the viability of a sale is gauged by submitting limited health and policy information to a licensed life settlement broker who can pre-screen the case and alert the trustee to the feasibility of a sale, without disturbing the grantor.
  2. Formal Underwriting: If it appears that a sale is a possibility, the grantor/insured will authorize the release of health information via signature on a HIPAA (Health Insurance Portability and Accountability Act of 1996) f Information is obtained from various health practices and physicians, and detailed information about the policy being sold and its funding needs are gathered. One or two life expectancy (LE) reports are obtained to estimate the lifespan of the insured.
  3. The Pricing Process: A package is sent to life settlement providers that includes the information that has been gathered. Providers will utilize internal proprietary spreadsheets and calculators to price the policy based on the life expectancy of the insured and the cost of funding the policy.
  4. Negotiation: In a typical life settlement sale, a broker, operating on behalf of the policy owner will facilitate several rounds of negotiation, a policy auction of increasing offers until a final price is determined.
  5. Offer Acceptance and Contracting: Once a price has been agreed upon, a contracting process ends with a closing conference and the delivery of the policy to the new policy owner.
  6. Contact After the Sale: Typically, contract language will allow the policy buyer to contact the insured periodically (usually quarterly) to update information, including secondary contacts.

While the life settlement industry could once be described as the “wild west,” today it is one of the most regulated financial sectors. If you are a trustee attempting to obtain the highest value for your client’s policy, it is best to work with a reputable broker who can act on your behalf.  Insist on a bid history sheet showing the number of providers and the offers obtained, and that should become a part of your trust file.  The price obtained can be significantly affected by the number of bidders competing for the policy.

Selling a trust-owned policy takes an entirely tax-free asset and potentially makes it taxable. How much would you pay in taxes if you sold a policy in your trust?  We will cover that in our next blog entry.