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NOTE: I am making public all of my work, notes and communications with a law firm in regards to a class action on Universal Life. First this is the working document that we used…
Universal Life Class Action
The objective of this executive summary is to provide a simple, short but comprehensive overview of the sales problems and abuses associated with the Universal Life policies. Our hypothesis is that the only way to address this problem in order to (1) compensate the victims, (2) correct the situation (3) punish the companies and employees responsible, and (4) changing the culture and business practices, is to do a class action to ensure that the fraudulent exploitation of consumers does not happen a third time. As mentioned before, these practices used to exploit the consumer, are occurring for a second time. The first situation and problem was the “Vanishing Premium”. It is important to ask why the class actions which were won in all countries in which this action was brought did not have the success necessary to discourage the subsequent use of the Vanishing Premium sales techniques used in the sale of Universal Life.
It is now recognized that the concept behind the “Vanishing Premium” was to tell consumers they could make a limited number of payments and premiums would disappear giving the impression that this was guaranteed despite the fact that this was based on factors that insurance companies knew as unrealistic and unachievable in the long term. In 1990, when interest rates began to fall, the premiums that had disappeared began to reappear. This created a lot of complaints that ultimately resulted in many class action lawsuits in several countries. The conclusion of these class actions was partially positive. Following the success of such actions, Richard Phillips and Phillips Smith, a law firm in the US which represented many plaintiffs published that today life insurance buyers should be less afraid of becoming victim of fraudulent business practices as those used in the “Vanishing Premium”. The cost of the dispute has caused the agents and company to monitor their business practices and regulators have taken actions to help eliminate abuses that took place during the “Vanishing Premium.”Yet we now find ourselves in the same situation and can only conclude that the fraudulent business practices did not disappear and were recycled to be used in the sale of Universal Life policies. We contacted Richard Phillips for his opinion and we learned that he shared our opinion since the same problem exists in the USA with the Universal Life. He replied that the creativity/culture of insurance companies did not change after the class actions and it did not take long before these companies began to introduce new and old approaches in order to increase their short-term profits at the expense of consumers. Richard Phillips and his law firm are now in the process of investigating the same issues and schemes that are described below. But it is important to learn from the past. We must ask why the class actions did not have the expected impact on the business practices employed by insurance companies.
The failure of class actions
The failure of class actions to change the fraudulent marketing practices employed by insurance companies can be attributed to the following reasons listed below. It is important to understand these elements to ensure that future class actions on Universal Life are a success but also to ensure that this time, these fraudulent practices are eliminated completely.
- Disclaimer clauses in the illustrations: the insurance companies really believed that a clause such as “dividends are not guaranteed and may change” would protect companies against any legal actions in regards to Vanishing Premium. But this defense had several flaws as shown in the class actions that were won by consumers. These flaws disappeared when the regulatory changes introduced a new mandatory page illustration called “illustration of the sensitivity to interest rates” which had to be signed by the customer. Theoretically insurance companies thought they had acquired a flawless defense (which is not true from our perspective) for any misrepresentations they made on their illustrations produced by their software system. This allowed the insurance companies to relax their surveillance by allowing their agents to produce unrealistic illustrations to boost the sales of Universal Life as it had happened with the Vanishing Premium. This lead to the war of cash surrenders values between insurers. Insurers rather than restraining themselves from any abuses modified their software to create the best possible cash values on their illustrations. Their illustrations became unrealistic and unrepresentative of the investments selected by the consumer. Insurers believed that since the consumer was signing a page stating that nothing was guaranteed, it allowed them to illustrate anything; even the impossible.
- Transfer of investment risk: With the Vanishing Premium, it was the insurance company that invested the sums of money paid into the whole life policies. With the Universal Life policies, it is the consumer who is investing the money in question and it has increased the insurers’ perceptions that they are not responsible if the consumers do not meet the objectives shown in their illustrations.
- Privatisation of distribution: Vanishing Premium was sold through a captive network of insurance branches employing insurance agents. This has changed and these agents became independent now selling through an independent intermediary called MGA. The position of the insurers is that they are only the manufacturer and are not responsible for the actions committed by their independent insurance agents. However, the independence of these agents has not been recognized in the insurance laws of many provinces (except for Québec which defines what an independent representative is).
- Paradox Loss / Gains Vanishing Premium: It is important to understand this paradox as it is also applying to the Universal Life. After talking with several victims of the Vanishing Premium, there is ambivalence on the part of these victims and as a result in the public perception of the abuses committed by the insurance companies. On one side the victims lost money because of the Vanishing Premium concept but they won money through the demutualization of insurance companies where they received shares as a result of the same policies. This mitigates the perception of losses. Several key people who want to remain anonymous told us about the link between the demutualization and the Vanishing Premium fraud. Regulators’ only concern was whether the insurers would remain solvent. Is demutualization the result of Vanishing Premium? Our answer is no, but it surely helped.
So we end up with the same paradox with the Universal Life. Consumers could not and have not achieved the values shown in their illustrations. However, the fall in interest rates has increased the value of certain Universal Life features such as a guaranteed minimum interest rate of 4%, or a cost of mortality which 40% less than what is commonly offered. For the victims who have lost money because the cash values shown on their illustration were misrepresented, they could cover part of their losses by selling their insurance contracts based on their fair market values to third parties who would and could capitalize on the Universal Life features that have become valuable. This explains why insurers are doing everything possible to prevent a “viatical settlement” market in Canada. If such a market was to exist, the consumer losses would become the losses of the insurer. This also explains why the insurers have allowed and grown the number of orphan policies; for example Manulife has in Quebec over 20,000 life policies that do not have a licensed insurance agent to service such policies resulting in these policies lapsing at a higher frequency.
The Universal Life
The fraudulent practices associated with Universal Life sales result from a pyramidal scheme. The first level of the pyramid applies to all insurers while levels above apply to some insurers.
- Level 1: Fraudulent illustrations associated with rates of returns for investments linked to market Indices (all companies). Most universal life policies, for equity types of investment, have on average a management fee of 4%. This management fee only appears in the contract and will not appear on the illustration. Absolutely no disclosure is provided on the illustration in regards to management fees. When an illustration is presented to consumers, before they see the contract (the contract is given to the delivery of the life policy which can happen months later after the illustration was shown) must magically understand that the illustration made at 8% is really the equivalent of a 12%. The insurance company does not reduce the rate of return shown on the illustration by 4%. It’s for consumers to do this mentally which is not possible without even having seen the contract.
- Level 2: Fraudulent illustrations associated with volatility. This applies to all companies except Maritime Life. When I was with Maritime Life, after recognizing the impact of volatility on the cash values achieved by the client versus the illustrated cash values, we modified the illustration software to illustrate what really happen when you invest in the market. We modified the illustration software to illustrate variable rates of returns based on an average rate of return. At that time, I thought this feature was revolutionary and that all insurers would modify their software. This did not happen. Insurance companies continued to illustrate equity investment using constant rates of returns. Volatility can have a serious impact on cash values that are achieved. Even if you achieve an average rate of return equaled to the constant rate of return shown on an illustration, your cash values could be lower than what was illustrated by more than 50%.
When Manulife bought Maritime Life, no effort was made by Manulife to take this feature developed by Maritime Life to adapt to its own software.
- Level 3: Conditional bonus applies to some companies such as Transamerica and Industrial Alliance (National Life). Here deception and fraud is not even in question. I publicly attacked Transamerica and Industrial Alliance stating that these companies acted criminally as fraudsters hoping that these companies would sue me but they know I am telling the truth and will not risk going into discovery…. Transamerica and Industrial Alliance know that they have committed fraud by offering a bonus conditional on a rate of return equaled to 8% (adding the management fee, 12%). Even if the customer reached the target of 12% gross rate of return, because of volatility the consumer would get the bonus 50% of the times at the most. However Transamerica and Industrial Alliance illustrated this with the consumer getting the bonus 100% of the times.
- Level 4: illustrations made with a rate of return of 8% and higher: several companies such as AIG. A prudent advisor should illustrate with a rate of return NO more than 5% (9% gross). An advisor is considered to be aggressive if he uses a rate of 6% -7% (10% -11%). Insurers have not put a realistic maximum rate of return in their illustration software. Insurers have continuously accepted illustrations with rates of return of 8% and higher despite their duty to supervise their agents. In the Thibault case (one of the biggest case of insurance fraud and bankruptcy in Quebec) we discovered that Thibault was doing illustrations at 11.45% (over 15% gross return). These illustrations should have been rejected by AIG. A 11.45% rate of return on an illustration is absolutely not justifiable.
The first thing is to decide whether a class action for each of the different levels must be introduced or if a class action may include several or all levels. This decision will have to consider the fact that it is now possible in Quebec to sue multiple companies at the same time under a class action for the same wrongdoing.
CHLIA representing the insurer is clear in its standards for illustrations.
This Guideline Reflects the principles of CLHIA’s Consumer Code of Ethics Including:
“To ensure that Illustrations of prices, values and benefits are clear and fair, and contain appropriate disclosure of amounts which are not guaranteed.” and “To advertise products and services clearly and straightforwardly, and to avoid practices which might mislead or deceive.”
Although insurers are the defendants in the class action we must wonder about the role of CHLIA and if that organization should be named in the class action. The regulators have also known about this fraud but they have knowingly ignored this fraud. Should they be named in the class action?
Finally, this time around, the class action must capitalize on public emotions. This is the only way to break the relationship between the powerful lobby of insurers and politicians. Universal Life is an abstract concept difficult for the public to understand and it will not create the feelings necessary to polarize the views of the public. To turn the public against the insurers, we need to introduce a second class action that immediately turns public opinion in our favor and against insurers. Such class action could be on orphan policies or life settlements where insurers have taken advantage of seniors and the terminally ill. By showing how insurers are willing to exploit these groups who usually have the sympathy of the public, we would be able to portray insurers as they are; profit hungry corporations which are willing to do anything to make a buck… If this can be revealed to the public and public’s sentiments can be polarized, this will force the political authorities, regulators and bureaucrats to distance themselves from the insurers.
It is extremely important to note that Insurers know they cannot afford to proceed with a class action because they cannot see their secrets revealed to the public. The goal is to win such a strong position that the insurers will negotiate on our ground which has not happened during the Vanishing Premium. It is with this bargaining strength that we will force the changes needed to prevent this fraud to happen a third time.