John Hancock To Raise Cost Of Insurance (COI) On Performance Universal Life Policies

In February of last year, we reported on limitations placed on inforce illustrations for John Hancock Performance universal life policies. At that time, the carrier announced a “temporary” situation, saying they were unable to provide current inforce illustrations because “regulatory standards that govern illustration practices . . . prevent us from illustrating currently payable amounts based on our current non-guaranteed elements.”

In that report, we mentioned that in the past, the inability to provide inforce ledgers was often a precursor to a cost of insurance (COI) increase. It appears as if it was for John Hancock.

On January 18th, The Life Settlements Report, a trade publication, reported that John Hancock will be raising the cost of insurance (COI) on 1,700 Performance policies. The publication cited a representative of the New York Department of Financial Services, who confirmed that the carrier had provided “voluntary” notice to the regulatory body.

In September of 2017, we reported on a regulation approved in New York state that required carriers to notify the department “at least 120 days prior to an adverse change in non-guaranteed elements of an in-force life insurance policy.” Though the regulation has not gone into effect, the agency spokesman did confirm that the carrier provided notice, according to the earlier report.

Our New York City office was told that John Hancock is “expecting to have illustration availability in early 2018.” We manage approximately 200 of the 1,700 policies affected and as soon as we receive the information and analyze it, we will report on the size of the cost increase.

The Start of Life Insurance Dividend Season

Earnings season for investors are the months that most corporations release their financial results.  Falling in the months of January, April, July, and October after the books are closed on the last quarters financials, they not only tell past performance, but in many instances, are a predictor of future earnings.  Bellwether stocks like Wal-Mart, Caterpillar and JP Morgan, offer an indication of the future performance of a market segment.
In the life insurance industry, we have the dividend season and it is now upon us.  In this industry, the “big 4” mutual carriers (1) are New York Life, Mass Mutual, Northwestern Mutual, and Guardian.  Two of the four have declared their dividends with two more to come this month. Both carriers reporting declared lower dividend interest rates.
Dividends are considered a return of premium and are more than just the dividend interest rate.  Dividends are driven by the operating performance of the company. The guarantees in the policy are based on very conservative assumptions for investment returns, mortality, and expenses. When the actual performance of the policy surpasses the guaranteed outcomes, a divisible surplus is created out of which a dividend is paid.  Each year, the board of directors approves the payment of dividends and declares the dividend interest rate (DIR), which is the investment component of the dividend.
Mass Mutual released a statement on November 6th announcing that their board of directors approved an approximate $1.6 billion dividend payout for 2018, the 150th consecutive year that the carrier will pay a dividend. However, the dividend investment rate for 2018 dropped to 6.40%, from the 2017 rate of 6.70% (which was down from the 2016 DIR rate of 7.10%).
Northwestern Mutual also declared a 2018 dividend, and their DIR is also down – slightly. In their October 25th announcement,
they reported a $5.3 billion dividend payout, the highest in the industry, and the 147th year in a row of dividend payouts.  But for the carrier, the DIR reported was 4.9%, down from the 2017 DIR rate of 5% (which was down from the 2016 DIR rate of 5.45%).
In the investment world, a decrease in earnings usually means a quick drop in the stock price, negatively affecting your investment portfolio performance, often overnight.  In the insurance world, a dividend drop is a slow bleed that takes its toll over time. Mass Mutual recently released a great marketing piece concerning its DIR (2) pointing out it is “determined using a portfolio average method that reflects the portfolio earnings on all assets that support our participating” products, “made up of investments purchased over a number of years, so changes in new money interest rates have a gradual impact on the DIR.”  Unfortunately, the long-term trend has been down, negatively affecting whole life policy performance over the last few decades.  The Mass Mutual piece includes their DIR for the last 30 years which is shown graphically to                                                   MM_DivScale_11.7.17.jpg                   the right.  The downward slope, as their marketing piece points out, mimics the slope seen when tracking Moody’s Seasoned Aaa Corporate Bond Yield, or the 10 Year Treasury, annual rate.  This makes sense considering the investments backing the cash value in whole life policies consist primarily of high quality bonds.  In other words, you cannot expect the carriers’ DIR to magically increase until the corresponding rates in high quality bonds begin to tick up, since just as “new money interest rates have a gradual impact on the DIR” on the way down, it has the same effect on the way back up.  It is still disappointing to see (at least for these two carriers) we may not have hit bottom in DIR.
When will we see interest rates rise?  That is hard to tell.  I wrote a blog  in 2014 on the subject of dividends, and had hoped at that time that we might be seeing a bit of a turnaround in rates, but three years later we have not moved forward much.  I have written a number of pieces on the current interest rate environment,
citing the low and even negative interest rate phenomena, the effect it has had on universal life insurance life cost of insurance increasesand industry executives’ view of the future if rates do not rise. The “persistent low rates” are “destroying the viability of insurance companies,” according to one executive, the CEO of the world’s largest asset manager and biggest investor in insurance companies (3).
With the election of the new president, a “Trump Bump” in rates was forecast by some, and rates have gone up a bit since President Trump took office, with the Effective Federal Funds Rate jumping from .65% in January of 2017, to 1.15% as of this month (4).  The next meeting of the Federal Open Market Committee is December 12th and 13th, and many believe that rates will increase by .125% at that time. Although these increases are gradual, it will take a bit of time to get back to normal interest rates, considering a three-quarters of a percentage point increase is deemed “substantial” (5).
Is it substantial?  Maybe we have forgotten what normal is?  Remember when your bank was paying 5% or more for a guaranteed CD?  Let me take you back— even 6 month CDs were paying as much as 5.4% back in 2007 before the economic downturn.  CDs represent a “new money” investment and after bumping along at under 100 basis points since 2009, 1 year Certificates of Deposit have cracked the 1% mark.  So maybe we have turned a corner?  Maybe, but it will take a while for the new money to turn around the portfolios and general accounts of life insurance carriers like Mass Mutual and Northwestern Mutual.
We will report back when the other two carriers – Guardian and New York Life report their 2018 dividend payouts.
  1. Mutual companies are insurance companies legally owned by their policyholders.  They do not issue stock, their policy holders share in the “profits” of the company – the divisible surplus, by receiving dividends.  Stock life insurance companies issue stock that can be bought and sold by investors, who own the company.
  2. Mas Mutual Marketing Piece, “Historical Studies form Massachusetts Mutual Life Insurance Company (Mass Mutual)
  3. Low interest rate “destroying” insurance companies: BlackRock, Insurance Journal, April 21, 2015
  4. Information from the Federal Reserve Bank of Saint Louis – The federal funds rate is the interest rate at which depository institutions trade federal funds (balances held at Federal Reserve Banks) with each other overnight. It is a target and currently is 1-1.25%
  5. Fed Still Puzzled by Inflation, but Rate Increase Is on Track, Binyamin Appelbaum, New York Times, October 11, 2017

TOLI Trustees Should Not Throw Away A Tax Opportunity With The Policy

We have previously written about how changes in the estate tax laws have some grantors questioning their need for a large tax-free death benefit.  We can provide many reasons why retaining a policy still makes sense, but there may be other reasons (bad policy performance, cost of insurance increase, etc.) that necessitate a policy replacement, or even surrender. The IRS allows a tax-free exchange for policies that have a tax gain (when the cash value is greater than cost basis) through a 1035 Exchange – a carrier to carrier transaction that transfers the cash value from the existing policy to a new policy. This method can also be used to move the cash value of life policy tax-free into an annuity.  (1)

So, what happens if a policy has no gain?  A 1035 Exchange is typically more cumbersome than simply surrendering a policy and starting a new one.  Considering there is more paperwork and the transaction process is typically longer, one may wonder why not simply surrender a policy that has no tax gain?  Because by surrendering the policy you pass up another benefit of a 1035 Exchange, which is the carryover of cost basis.

Let’s look at an example: Assume your client has funded a current assumption universal life policy over 15 years at $20,000 per year.  The policy would have a cost basis equal to the total premium paid – $300,000.  Let’s further assume that the policy has a current cash value of $125,000.  If the policy was surrendered and the cash value was placed into another policy, the cost basis that transferred over would be $125,000 (Option #1). However, if the policy was transferred via a 1035 Exchange, the cost basis that transferred over would be $300,000, the cost basis of the existing policy (Option #2).  Option #2 allows you to keep an additional $175,000 cost basis, which is beneficial should the new policy be surrendered in the future. If the policy was exchanged for an annuity, the same $300,000 cost basis would transfer, again potentially sheltering up to $175,000 in gain.

10-11-2017_blog_img.jpg

We come across trustees surrendering policies whose value is not the minimal cash value, but the cost basis that has accrued. Planning strategies for policies that will be replaced, and especially those that will be surrendered, should be developed based on trust characteristics (for example, grantor trust status may allow the grantor to obtain some tax benefits) and client (beneficiary) needs.

Even a policy that has diminished value can still create more benefit for the trust and beneficiaries – and isn’t that the goal of a TOLI trustee?

1.) U.S. Code § 1035(a) states no gain or loss shall be recognized on the exchange of—

  • a contract of life insurance for another contract of life insurance or for an endowment or annuity contract or for a qualified long-term care insurance contract; or
  • a contract of endowment insurance for another contract of endowment insurance which provides for regular payments
  • beginning at a date not later than the date payments would have begun under the contract exchanged, or for an annuity contract, or for a qualified long-term care insurance contract; or
  • an annuity contract for an annuity contract or for a qualified long-term care insurance contract; or
  • a qualified long-term care insurance contract for a qualified long-term care insurance contract.

New York State Issues New Regulations Regarding Cost of Insurance (COI) Increases

In November of last year we reported on a regulation floated by the New York State Department of Financial Services to “govern life insurance company practices related to increases in the premiums” of life insurance and annuity policies. The goal was to “protect New Yorkers from unjustified life insurance premium increases.”

This week, the department issued their final regulation. According to a press release announcing the new regulation, the department will be able to review cost of insurance, premium or expense increases in life insurance and annuity policies by requiring carriers to notify the department “at least 120 days prior to an adverse change in non-guaranteed elements of an in-force life insurance policy.” In addition, carriers will be required to notify consumers “at least 60 days prior to an adverse change in non-guaranteed elements of an in-force life insurance or annuity policy.”

We have previously reported on life insurance policy COI increases and their effect on policy carrying costs. According to New York Financial Services Superintendent Maria T. Vullo, the new regulation “is designed to protect New Yorkers from unfair and inequitable cost increases in in-force policies.” According to the department, New York law, “prohibits life insurers from changing non-guaranteed elements in a discriminatory way for members of the same class of policyholders . . . only certain enumerated factors, which do not include profit, can be considered when seeking to change non-guaranteed elements.”

There are several COI increase lawsuits working their way through the courts that are focused on the legalities regarding how carriers can increase the cost of insurance on a policy, and whether the increases represent a breach in the insurance contact. One case, settled last week, favored the plaintiffs, and one consolidated case was granted permission to move forward earlier this month. The carriers maintain they have the right to raise COI costs in their policies. A Wall Street Journal article on this subject stated, “insurers maintain they are acting in accordance with policy provisions allowing higher charges up to a maximum amount, based on expectations of future policy performance.”

These final regulations were published after the department reviewed comments submitted when the original proposal was announced. It is not known whether other states will follow suit, but that same Wall Street Journal article noted the regulation “could be widely copied by other insurance departments.”

We will report on any updates as they become available. For a copy of the press release and new regulation, email mbrohawn@itm21st.com.

Lincoln National Consolidated COI Lawsuit Update – The Case Is Moving On

A little over a year ago we posted a blog about a Lincoln Financial cost of insurance (COI) increase on Legend Series Universal Life policies issued between 1999 and 2007 that originated at Jefferson Pilot (Lincoln Financial purchased Jefferson Pilot in 2006).  Earlier this year we reported on a class action lawsuit filed in in the Eastern District of Pennsylvania against Lincoln.  Other lawsuits soon followed, and in May we reported that four suits were combined in the Pennsylvania court into a Consolidated Class Action Complaint.

After the consolidated complaint was filed, Lincoln filed a Motion to Dismiss on June 8th. The Plaintiffs’ response was filed on July 28th, and Lincoln’s reply on August 17th.  On August 22nd the court held oral arguments, and on September 11thJudge Gerald J. Pappert issued a Memorandum in which the court ruled on Lincoln’s Motion to Dismiss, which he denied in part and granted in part.  As you will see, he mostly denied Lincoln’s requests, and the case will move forward.

According to the Memorandum, the policies in question, “give Lincoln discretion to determine the COI rate based on its expectation of future mortality, interest, expenses and lapses.”  The Plaintiffs alleged that Lincoln was attempting to “recoup past losses” with the increases.  The court found that the Plaintiffs “adequately supported” their allegation that Lincoln “subjected the Plaintiff owners to unlawful [cost of insurance] increases” and can proceed “with their contract-based claims.”

According to the Memorandum, Lincoln did “appear to acknowledge” that if they did raise the COI “based on non-enumerated factors, it would constitute a breach of contract.” But the Memorandum goes on to say that Lincoln denies this. The Plaintiffs point to Lincoln statements that show the “COI rate increase was based on impermissible, backward-looking considerations.” For example, they cite a notice from Lincoln that references “nearly a decade of persistently low interest rates, including recent historic lows, and volatile financial markets” and states “in response to the persistent low interest rates, including the recent historic lows (emphasis theirs), there will be pricing increases.”

The Plaintiffs also referenced an interview with the President/CEO of Lincoln Financial Group that occurred around the time of the COI increases in which he said the carrier saw in force pricing as a way to dampen the negative effect of the low interest rate environment.   The court decided that the Plaintiffs’ allegations were “sufficient to state a claim for breach of contract.”

The Plaintiffs contended that “lower investment income,” because of the low interest environment, was not a permissible consideration for a COI increase, and that the higher reinsurance rates that Lincoln referenced as a reason for the increase was not a future expense that the carrier could consider.  The court ruled that the Plaintiffs, “adequately alleged that Lincoln’s admitted consideration of lower investment income and higher reinsurance costs constituted breaches of the Policies terms.”

The Plaintiffs asserted that mortality, which is the “driving factor in setting the COI rate,” had improved since the policies were issued and was expected to continue to improve.  Lincoln responded that “general nationwide mortality improvement does not mean that mortality has improved for insureds of all ages and rate classes and, in any event, is not necessarily consistent with Lincoln’s own mortality assumptions or experience.”  The Plaintiffs claimed the carrier had “filed interrogatories with the National Association of Insurance Commissioners in each year from 2010 to 2014 stating its expectation that mortality will improve in the future.”  The court affirmed that the Plaintiffs had “stated a claim.”

The Plaintiffs claimed Lincoln “breached the policies terms by failing to apply the COI rate increase uniformly across policyholders in the same rate class,” citing rates on one insured “higher when the insured is 98 years old than when she is 99 years old.”  The court wrote that the allegations were “sufficient to state a claim.”

The Plaintiffs claimed the defendants “breached the contract by refusing to provide policyholders with illustrations during the Policy’s grace period.”   After a review of contract language concerning this right, the court wrote that they cannot say that the contract language “is unambiguous or plainly inconsistent with Plaintiffs’ reading at this stage, and Plaintiffs have stated a claim.”

The Plaintiffs argued for a claim of “breach of the implied covenant of good faith and fair dealing” which they said, requires the carrier to “act in a manner that does not frustrate policyholders’ reasonable expectations under the Policies, and—to the extent it has limited discretion to set the COI rates—to exercise that discretion reasonably and in good faith.”  Lincoln countered by saying that claim was “defective” since it was based “on the same facts as the breach of contract claim and therefore duplicative and cannot be adequately alleged that Defendants breached the implied covenant brought as a separate cause of action.”  The court ruled that the Plaintiffs had “adequately alleged that Defendants breached the implied covenant.”

The Plaintiffs requested “relief resolving the parties’ obligations under the Policies, the factors on which Lincoln may base a COI rate increase, the lawfulness of the COI increases and whether the policyholders must continue to pay the allegedly unlawful COI charges.”  Again, Lincoln countered that the claim should be dismissed “because it is duplicative of the breach of contract claim.”  After a review of the facts, the court granted the “Defendants’ Motion with respect to this claim.”

The Plaintiffs contended that Lincoln violated the “consumer protection laws of various states,” including California, North Carolina, Texas, New Jersey, New York, and the court wrote that these claims could move forward.

This outcome ensures that the case will move forward, and the clear majority of the Plaintiffs’ claims will be heard. As the case moves forward we will provide additional updates.  For a copy of the Memorandum, please email mbrohawn@itm21st.com.

Transamerica Cost Of Insurance (COI) Case Results In Win for Plaintiffs

Less than two weeks ago we reported on an interesting COI increase lawsuit. In that case, DCD Partners v Transamerica Life Insurance Company, a Los Angeles church pastor who enlisted an outside investor to finance life insurance policies providing burial funds for congregants had filed suit, along with the investor, against Transamerica for a 50% COI increase in policies issued to the group. In their lawsuit, the plaintiffs alleged among other things, breach of contract in violation of California law and breach of the covenant of good faith and fair dealing.

On September 13th after a one week trial in the courtroom of Christina A. Snyder, US District Judge in the Central District of California, the jury handed down their verdict.

The Verdict Form asked four questions:

The first, under the heading, Breach of Contract, asked…Did Transamerica breach the insurance policy contract? The jury answered yes.

The second, under the heading, Implied Covenant of Good Faith and Fair Dealing, asked…Did Transamerica breach the covenant of good faith and fair dealing implied in the insurance policy contract? The jury answered yes.

The third, under the heading, Damages, asked…Did DCD suffer any damages caused by the breach of contract or breach of the implied covenant of good faith and fair dealing? The jury answered yes.

The fourth, since the jury said damages were caused, asked…How much damage did DCD suffer? The jury answered $5,608,495.57

The case involved 2,400 policies that were taken out in 2004. The death benefit of each $275,000 policy was split between the investor DCD $225,000, a charity started by the pastor, $35,000 and the insured’s beneficiary, $15,000. According to the Wall Street Journal, $50 million of the potential $660 million in benefits has already been paid out. (1)

While both the church pastor and the investment firm stated they relied on Transamerica reassurances that the chance of future COI increases were remote when purchasing the policies, court documents showed that both were aware that the costs within the policies could increase.

The lawsuit was originally filed in 2015 and alleged that Transamerica “impermissibly used race-based data” when calculating the COI increase as the policies insured members of a majority African American church. Transamerica denied the allegations as “categorically false and offensive.”

The outcome may bode well for plaintiffs in other COI increase cases still being litigated.

  1. Life Insurer Faces Off Against African-American Church in Battle Over Rates, Leslie Scism, The Wall Street Journal, September 1, 2017

WSJ Article Highlights Interesting Cost of Insurance Case

An interesting cost of insurance (COI) increase lawsuit has been playing out over the span of two years in a Los Angeles courtroom.  The case was featured in a Wall Street Journal today as the case is set to go to trial next week.  (1)

The case involves a Los Angeles church pastor and an investment group that financed life insurance policies on his church members.  Reverend Hardwick was the pastor of a predominately African American church who was concerned about the number of uninsured congregants in his flock.  In the 1960s, the pastor, along with a locally prominent, but not yet nationally known attorney by the name of Johnny Cochran, began to devise a program to provide life insurance to parishioners.  The idea finally came to fruition in 2004 when Transamerica issued 2,400 TransValue flexible premium universal life insurance life policies in two pools.

According to the lawsuit, during the negotiation process Reverend Hardwick met with officials of Transamerica and voiced his concerns that the carrier might charge higher rates for his group for the same coverage because his congregants were African American, a process known as red-lining.  The carrier, in written correspondence, assured Reverend Hardwick that the policy to be issued was “the same product that would be available for any similar group that might apply for coverage,” and that, “the charges, benefits and features are exactly the same as we would issue in all states where the policies have been approved.”

According to minutes from the case, the reverend was also concerned about future increases in the cost of insurance. The plaintiffs contend that Transamerica “repeatedly assured Hardwick that it would not raise the Policies’ MDR [monthly reduction rates] at any time in the future.”

In 2009, an investor, DCD Partners, took over the premium payments on the policies.  Each policy was issued with a $275,000 death benefit, with $225,000 to DCD, $35,000 to PIC Trust, a charitable organization run by Reverend Hardwick, and $15,000 to the insured.  Prior to entering the agreement, DCD reached out to Transamerica, and “received information regarding the policies” with Transamerica telling the investor that “it had only increased the cost of insurance once over the previous thirty years.”  DCD “reasonably relied on this representation in acquiring its interest in the policies.”

While both Hardwick and DCD stated that they relied on Transamerica reassurances as to the remote likelihood of a COI increase during their commitment to buy, the court documents show that it was “undisputed that Hardwick signed numerous documents acknowledging that the existing MDR was not guaranteed and could increase in the future.”  In addition, before investing in the policies, DCD hired an insurance expert who told them “the cost of insurance could go up so long as it went up for all similarly situated policyholders.”

In 2013, Transamerica raised the cost of insurance on the policies in the pools by approximately 50%, and per the Wall Street Journal article, the plaintiffs alleged that “Transamerica impermissibly used race-based data” when calculating the increase, which “makes the program unsustainable.”

In a statement referenced in the WSJ article, Transamerica responded, saying they “did not raise rates on the policies due to the race of those insureds, nor would we ever increase rates based on racial considerations,” saying the allegations were “categorically false and offensive.”

According to court documents, a Transamerica actuary “examined the profitability of the
Policies” by reviewing death claims over the prior life of the Policies” and after assessing census date, along with lapse and interest rate assumptions, “projected that Transamerica would lose money on the Policies in the future” without a rate increase.  The plaintiffs countered that the Transamerica actuary “reverse-engineered a death claim projection in order to support an MDR increase” and “did not consider data from the mortality experience” of another block of similar policies.

The policies were originally taken out to provide parishioners with a $15,000 burial fund and according to the WSJ article, to date they have “paid for 188 funerals.”  Per the article $50 million of the potential $660 million in benefits has been paid out.  Next week’s court date may tell how many will receive benefits in the future.

  1. Life Insurer Faces Off Against African-American Church in Battle Over Rates, Leslie Scism, The Wall Street Journal, online August 31, 2017, in paper September 1, 2017