Richard T. Phillips
A Presentation for
THE MISSISSIPPI BAR
“Summer School for Lawyers”
July 9, 1996
1. The “Vanishing Premium” Phenomena
In the 1980's an unprecedented sales phenomenon, that of “vanishing premiums” swept the life insurance industry. In the 1990's another unprecedented phenomenon is sweeping the industry. It is the vanishing premium litigation which has resulted in huge jury verdicts, multi-million dollar class action settlements, and changes that go to the very foundation of the life insurance industry.
What was “vanishing premium” life insurance? What is the litigation that is changing the way life insurance is illustrated and sold? This paper will address these and related questions from the perspective of the life insurance purchaser. It will also share insight into how the life insurance industry got into the “vanishing premium” quagmire in which it finds itself today — insight derived from depositions of current and former life insurance industry executives and three years' of litigation in vanishing premium cases in Mississippi, Texas, California and throughout the United States.
Unfortunately, it is impossible to discuss the “vanishing premium” phenomenon without at least a cursory overview of life insurance terminology . A few years ago the terminology of life insurance, like life insurance itself, was much simpler than it is today. In the 1970's, however, enhanced computer technology and the competitive environment described in Section II, below, gave rise to a myriad of complex, new insurance products which laid the groundwork for the situation being discussed today.
Historically, there were two types of life insurance policies: term insurance and whole life insurance . Term insurance provided pure insurance coverage without any associated cash value build up. Term life insurancesimply paid a predetermined sum (the face amount) to the named beneficiary if the insured died during a set number of years (the policy term). Whole life insurance paid the predetermined sum to the beneficiary when the insured died, regardless of when the death occurred. It was insurance for the “whole life.”
Generally, there were two types of whole life policies, ordinary life , in which premiums were payable throughout the lifetime of the insured, and limited-payment whole life, in which premiums were charged for a limited number of years only, after which the policy was “paid up” for its full face amount. The most extreme form of limited-payment life insurance was the single-premium whole life policy . Such a policy carried one large premium, was fully paid up from inception, and had a substantial immediate cash and loan value.
The most popular whole life products were participating products offered by mutual companies and fixed premium, accumulation-type products offered by stock companies. Both had accumulation values , or “cash values,” which the policyholder could access by either surrendering the policy, or where dividends had purchased paid-up additional insurance, by surrendering the additions with no impact on the policy proper.
In participating policies the policyholder participated in the company's experience through receipt ofdividends . Premiums were based on conservative mortality, interest, and expense assumptions. Dividends were set retrospectively, usually at the end of the year. They reflected deviations of actual from anticipated experience.
Prior to the 1970's all life insurance policies sold in the U.S. were fixed-premium policies issued on either a participating or guaranteed, non-participating, basis. In the late 1970's, the life insurance industry was revolutionized by computer technology. A myriad of new concepts and products were introduced, and a number of additional terms attained significance.
Adjustable life policies, introduced in the early 1970's, permitted the policy owner to select, within limits, the premium he wished and later to adjust, again within limits, the premium and/or the policy face amount. policies, introduced in the early 1970's, permitted the policy owner to select, within limits, the premium he wished and later to adjust, again within limits, the premium and/or the policy face amount.
Universal Life (UL) policies, introduced in the late 1970's, revolutionized the life insurance industry. UL policies provided an “unbundling” of the savings and pure insurance protection elements of whole life insurance, affording flexibility in premium payments and contemporaneous interest rates for the investment or savings aspect of the policies. Universal life policies were flexible-premium policies with adjustable-death benefits. policies, introduced in the late 1970's, revolutionized the life insurance industry. UL policies provided an “unbundling” of the savings and pure insurance protection elements of whole life insurance, affording flexibility in premium payments and contemporaneous interest rates for the investment or savings aspect of the policies. Universal life policies were flexible-premium policies with adjustable-death benefits.
Flexible enhanced ordinary life
Flexible enhanced ordinary life
Flexible enhanced ordinary life Flexible enhanced ordinary life products were introduced by a number of companies to compete with universal life. These products involved complex combinations of whole life insurance, term insurance, and paid-up additions in proportions allowing favorable premium levels and adjustable face amounts. Policy dividends, additional premiums, and “dump ins” were all used to purchase paid-up insurance that would offset the temporary term coverage.
The complex new products were all interest sensitive. They were illustrated and sold through the use of computer-generated “sales illustrations” produced by agents on PC's using software developed and distributed by the insurance companies.
“Vanishing premium” “Vanishing premium” was one of the most aggressive techniques used to sell the new products. Employing complex actuarial techniques, the computer-generated sales illustrations of the vanishing premium companies illustrated how a customer could “roll over” his cash value from an existing policy, or make only a limited number of premium payments, in some cases as few as four (4). Based upon the assumptions (frequently undisclosed) employed in the illustration software, the premium would “vanish” and no further cash outlay would be due.
3. Sine Qua Non of Vanishing Premium:
The Computer-Generated “Sales Illustration”
Vanishing premium life insurance never would have been possible without the development of the personal computer. Life insurance companies wanting to offer vanishing premium products developed software for agents to run on their PCs. The vanishing premium software generated individualized “sales illustrations” for each prospective customer. Based on the customer's age, smoking habits, and other classifications, the vanishing premium software would compute instantly the complex combinations of whole life, term life, “step-rate” coverage, paid up additions, etc. necessary to produce the desired result, i.e. to make the premiums “vanish” after a limited number of years. The complex pricing calculations were done internally by the sales illustration software. The software would then produce columns of figures illustrating the performance of the resulting vanishing premium “product.” The result was a highly effective new sales tool. Attached as Appendix A are sample Vanishing Premium Sales Illustrations.
II. VANISHING PREMIUM SALES
1. A “Creature of the Times”
The vanishing premium insurance sales phenomenon was strictly a creature of its times. A product of the computer revolution of the 1970's, it flourished in the laissez-faire business environment of the 1980's. Its collapse in the 1990's has given rise to financial problems for thousands of individual policyholders, and is costing its purveyors millions of dollars in damages. It has also caused unprecedented damage to the reputation of the life insurance industry as a whole. What is unfolding in the vanishing premium litigation may be viewed as yet another example of the legal “fallout” from the unique situation which existed in the financial industry of the 1980's.
2. The Competitive Environment of the 1980's
The insurance industry was faced with a fiercely competitive environment in the early 1980's. Interest rates were at historic highs and the life insurance industry was suffering a massive disintermediation of funds. Historically, the insurance industry, the securities industry, and the banking industry were three distinct entities. By the early 1980's, however, the life insurance industry had evolved into a full financial service industry competing with both the securities industry (E. F. Hutton, Merrill-Lynch, etc.) and the banking and savings and loan industry. Competition for investors' dollars was fierce.
Billions of dollars of “cash values” had built up over an entire generation in traditional whole life insurance policies earning low or fixed rates of interest. Policyholders nationwide were cashing-in these old policies, or borrowing their cash values, to invest in bank CDs, securities, and other investments earning double-digit rates of return.
At the same time a new laissez-faire regulatory attitude prevailed in the financial industry. An attitude of “anything goes” permeated much of the business community. Life insurance companies led by now defunct Executive Life Insurance Company, developed and marketed competitive new “interest sensitive” insurance products. The increasingly competitive environment of the mid-1980's spawned even more complex variations of these products and illustrations which rested on increasingly questionable, and ultimately downright deceptive, actuarial assumptions and devices.
3. The Vanishing Premium “Pitch”
The “pitch” for vanishing premium insurance was simple and effective: “Make just a limited number of premium payments and your life insurance premiums will ‘vanish.' The ‘dividends' will carry the premium from then on. You'll never have to make another cash outlay for life insurance.” There it was in “black and white” on the computer-generated sales illustration on company letterhead. Projected death benefits on “vanishing premium” illustrations increased to figures many times the original face amount of the insurance. So what if interest rates fell? If the policy produced only half the death benefit illustrated it was still better than the whole life policy on which the customer was then paying.
The success of vanishing premium as a marketing tool was immediately apparent to agents and the insurance companies. Aggressive home-office marketing departments and “creative” agents in the field quickly developed multiple variations of the “pitch.”
- Policyholders approaching retirement age were prime targets: “You're 58 years old. In seven more years you'll be 65 and ready to retire. Change to this new vanishing premium product and you'll only have to make seven more payments. It will be paid up when you reach 65.”
- Professionals made particularly attractive targets because most carried substantial traditional whole life policies. Many of those policies had accumulated large “cash values.” The “dump in” feature in the vanishing premium software allowed agents to illustrate how the policy owner could “roll over” the cash value from his existing policy into the new product. Only a few additional payments would be required thereafter before the premium “vanished.” Indeed, in some cases the cash value was sufficient to carry the full premium and the policyholder would never have to make another premium payment.
- Existing customers were especially prime targets. The rollover could come from their current whole life policy to the new “vanishing premium” product with the same company. The customer already believed the company was trustworthy. Why keep paying premiums for life when the company had a new product which would require only a few more payments?
From the perspective of life insurance marketing departments and sales personnel, “vanishing premium” was an immediate and unprecedented success.
4. The “Ticking Time Bomb”
As the vanishing premium sales phenomenon mushroomed, life insurance companies became more and more dependent on sales of these hot, new products. Competition among the companies was intense. The marketing and product development departments of aggressive insurance companies developed ever-more competitive variations of the vanishing premium products. More conservative companies had to follow suit if they were going to compete in the hot, new “vanishing premium” market which had captured the industry.
The competitive new products were driven by, and depended for their performance upon, significant assumptions not disclosed in the sales presentations. New and highly volatile portfolios were established to capitalize on interest rates which were at historic highs. Purchasers did not understand, and were not told that, even slight reductions in dividend interest rates would cause the “vanishing premiums” to “re-appear.” Critics within the industry warned that the overly aggressive and downright deceptive vanishing premium sales practices were creating a “time bomb” that would some day explode in the face of the industry.
The problem was exacerbated when, just as vanishing premium sales reached their zenith, interest rates started to fall. For years a primary marketing tool in the life insurance industry had been the assertion: “Our company's dividend projections are very conservative. We've never failed to exceed our projections.” Agents continued to use this line, although the products they were now selling were highly volatile, interest-sensitive products. Companies had become addicted to the substantial stream of income generated by vanishing premium sales. A reduction of a single percent in the dividend interest scale would cause the “vanish year” on these highly leveraged products to extend for years, rendering them uncompetitive in the vanishing premium market. No company wanted to be the first to reduce their interest scales.
Hoping interest rates would turn back up, the companies began a game of “playing chicken.” Each was waiting for the other to reduce its dividend scale first. Without telling customers, many companies were illustrating at rates no longer supported by their earnings. The companies were gambling that interest rates would turn back up. Prospective purchasers, however, were not told of the gamble. They had no idea that, for their premiums to vanish as illustrated, the company would have to go back to earning interest at rates it had not seen since the early 1980's.
Interest did not turn back up, but continued to decline throughout the rest of the decade. By 1990, the house of cards had started to crumble and the vanishing premium “time bomb” was ready to explode.
III. THE VANISHING PREMIUM LITIGATION
1. The Scheme Unravels
By 1990 premiums which, according to the sales illustrations were supposed to have “vanished,” were starting to come due. Complaints were being logged by the thousands from policyholders who thought their policies were “paid up.” The consumer financial press picked up on the problem. Martin Weiss' newsletter, SAFE MONEY REPORT, carried headlines “The ‘Vanishing Premium' Rip-off,” and “The ‘Policy Illustration' Deception.” MONEY MAGAZINE dubbed vanishing premiums one of “The Eight Biggest Rip-Offs in America”. NEWSWEEK called for a federal investigation similar to the “Armstrong Commission” which had uncovered massive deception in the life insurance industry at the turn of the century. CONSUMER REPORTS magazine, in an in-depth examination of the “vanishing premium” problem, concluded that nothing short of legislation on the scale of the Federal Truth-in-Lending Act would curb deceptive sales practice abuses rampant in the life insurance industry.
By 1992, so many policyholders were facing the prospect of paying substantial additional premiums or losing their insurance protection, that the United States Senate stepped in. On June 23, 1992 the Senate Subcommittee on Antitrust Monopolies and Business Rights held the first of several hearings on “Concerns Relating to the Adequacy of Financial Disclosures Made in Connection with the Purchase of Whole Life Insurance Policies.” Tired of the excuses from their insurers, and unable to wait on congressional action on the scale of a Truth-in-Lending Act, policyholders across the nation turned to the courts. The wave of vanishing premium litigation had begun.
2. Cases for Deceptive Sales Practices
Early suits alleging deceptive sales practices were won by insurance companies who blamed sales abuses on individual “rogue” agents. By late 1993 and early 1994, however, things had begun to change. The industry was hit with a number of high-profile sales scandals such as the Met-Life “nurses retirement” scam. Initial investigations into Met Life sales practices soon widened into industry-wide probes. Information regarding the nature and extent of deceptive sales practices employed by vanishing premium companies emerged in the regulatory investigations. Additionally, the legal approach employed by the plaintiffs in litigation began to change.
Recognizing that the problem rested not with the policies, but with the method by which policies were illustrated and sold, vanishing premium plaintiffs began to focus on the sales presentations and sales illustrations generated on company-produced software. Liability of companies, as well as individual agents, arose from fraudulent inducement, intentional misrepresentation, and fraudulent concealment.
In January, 1994 a $21 million verdict was returned in Texas against New York Life and its Corpus Christi sales agent, Oscar Herrera. The WALL STREET JOURNAL covered the verdict in a front-page story, reporting:
“The Herrera case is sending shock waves through the life-insurance industry. For years, it has blamed abuses such as those admitted by Mr. Herrera on individual “rogue” agents. Now, after years of fraud and deceit by some agents, many people find that excuse wearing thin. Courts, government officials and the public are beginning to conclude that the industry itself is a rogue that must be brought to heal.”
3. The Crown Life Litigation
In the meantime, north Mississippi policyholder Hal Ferrell had been getting the “run around” from his insurer, Crown Life Insurance Company. Crown Life was an old, established Canadian insurer which had been very competitive in the “vanishing premium” market during the 1980's. Unable to get a satisfactory explanation for why his policy had failed to perform as illustrated, Ferrell filed suit in the United States District Court of Mississippi in February, 1993.
The Ferrell suit was filed at a time when life insurers were still winning the “vanishing premium” deceptive sales practices suits. Crown Life took a hard-line approach to the case. The insurer denied the existence of documents relating to “vanishing premiums” and threw up a barrage of actuarial issues and factual defenses.
The plaintiff, Ferrell, was persistent and aggressively pursued discovery in the case. Numerous motions to compel discovery and motions for sanctions were filed. Aided by United States Magistrate Judge J. David Orlansky, the plaintiffs were able to obtain documents not produced by the insurer in “vanishing premium”cases pending against Crown throughout the country.
When NEWSWEEK carried an article on the Mississippi Ferrell case in early 1994, an informal “network” of attorneys representing Crown policyholders emerged. Mississippi became a “clearinghouse” for Crown materials. Documents and depositions were exchanged among representatives of policyholders from throughout the nation. Attorneys for Crown policyholders traveled to Batesville, Mississippi from California, New York, Oklahoma, Texas and elsewhere to study the growing bank of Crown documents. Each brought additional materials and more insight into Crown's sales practices. Mississippi evolved into a repository for Crown Life materials and the Mississippi Ferrell and Dunlap cases became two of the most widely-watched of the “vanishing premium” cases.
Among those who traveled to Batesville to share information were representatives of Austin, Texas, policyholder, Randall Ferguson, whose case against Crown was set for trial in August of 1995. After a four week trial in state court, the Austin, Texas jury returned a verdict in the amount of $50 million in the first “vanishing premium” case to go to trial against Crown Life.
4. A “New Ballgame”
The vanishing premium litigation was now a “new ballgame.” Multiple state investigatory proceedings and extensive discovery had educated policyholders and their representatives on the deceptive sales practices employed in the vanishing premium sales scenarios. Defenses employed by the companies were no longer supported by known facts in the vanishing premium cases:
- Disclaimers on the illustrations.
Many illustrations contained language in footnotes such as “Dividends are not guaranteed and are expected to change.” At first blush this language appeared an absolute defense and vanishing premium companies attempted to rely on it as such. The disclaimers were significant, however, as much for what they omitted as for what they said. Universally omitted from the illustration language was any information about the multiple significant assumptions upon which the illustrations depended, the highly leveraged nature and extreme volatility of the vanishing premium products, the rate of interest upon which the dividend factor depended, or the effect of even slight reductions in the dividend interest rate in causing the “vanished” premiums to “re-appear.”
Additionally, many agents simply removed footnote pages and the disclaimer language from the illustrations they employed in selling the vanishing premium products.
Frequently the disclaimer language not only omitted significant facts, but actually contained misstatements of facts. The disclaimers of a number of companies contained language such as “Dividends are based on the current scale and reflect the company's current investment experience .” Where current earnings were less than the rate being employed to generate rapid “vanishes” on the vanishing premium sales illustrations, this statement was an outright lie.
Few of the companies selling “enhanced” whole life vanishing premium products identified on their illustrations the dividend interest rate being employed to generate the illustrated results. Disclaimer language to the effect that dividends reflect current earnings said, in effect, “Trust us. We're earning it,” when in fact many companies were NOT.
- Illustration not a contract.
The defense that the policy, not the illustration, was the contract floundered as well. The vanishing premium cases arose not from the policy “contracts” but from the deceptive sales practices, misrepresentations and omissions which induced the purchase of the contracts.
- Statute of Limitations.
Because the bulk of the vanishing premium sales occurred in the mid-1980's, defendant companies frequently raised the statute of limitations defense. Active fraudulent concealment, however, extends the statute of limitations. See, e.g., MISSISSIPPI CODE § 15-1-67.
Not only had the companies concealed material matters at the time of the sale, but they continued to conceal the volatile nature of the products as interest rates declined. Efforts to “explain” the problem to customers without revealing the deceptive nature by which the sales had been induced took the form of continued active concealment.
- Non-actionable statements regarding future events.
Efforts by insurance company defendants to portray the alleged misrepresentations as “relating to future events” also failed. No one knew what interest rates were going to do in the future. Claims for fraudulent misrepresentation cannot be predicated on promises relating to future events. The misrepresentations and concealment upon which the vanishing premium cases were predicated, however, were not promises relating to future events. They were misrepresentations of current matters and the omission and concealment of material facts currently known to the vanishing premium purveyors at the time of sale.
The tide turned with a vengeance. Insurance companies which had sold massive amounts of vanishing premium coverage in the 1980's now faced million dollar jury verdicts in “vanishing premium” cases. More cases were obviously on the way and the cost to the industry would be staggering.
4. Class Actions and Multidistrict Litigation
Vanishing premiums have given rise to a crisis in the life insurance industry. Millions of policyholders are enraged. Documents obtained in the initial cases show that the conduct of companies, both at the time of sale and upon discovery of the extent of the problem, unquestionably warrant punitive damages. Experience has shown that juries will award such damages in massive amounts. Something had to be done to stem the growing number of individual suits being filed nationwide, each a valid case for substantial actual and punitive damages.
The solution for both the industry and millions of policyholders appears to lie in class actions and multidistrict litigation.
a. Class Actions
Cases filed against a number of major insurers seek class status on behalf of all policyholders alleged to have been deceived. Two such cases were filed in Texas against Crown Life. One was filed on behalf of approximately 2,000 Mexican nationals who purchased Crown Life vanishing premium policies. The other, in which the author of this paper is co-counsel for the plaintiffs, is filed on behalf of the approximately 24,000 U.S. policyholders. Class actions have been filed in federal court in the Northern District of Mississippi against a total of seven (7) additional vanishing premium companies.
New York Life was the first carrier to seize upon the class action as a means of resolving its vanishing premium problem on a “global” basis. On August 14, 1995, New York Life announced it was settling a state court class action brought on behalf of all its vanishing premium customers.
The New York Life settlement, initially announced as $65 million, was subsequently estimated by the company to cost $87 million plus fees and expenses. The settlement was hailed by the life insurance industry as good news for New York Life. Having watched closely the courses taken by Crown and others, on the one hand, and that of New York Life on the other, additional carriers followed New York Life's lead. Negotiations with a number of the major vanishing premium insurers are on-going by class representatives at this time.
b. Multidistrict Litigation
As news of large verdicts and settlements surfaced, rapid multiplication of vanishing premium cases occurred within the federal system and across the federal and state systems. Management of the litigation demanded invocation of complex litigation procedures. The vanishing premium cases against various purveyors were ripe for coordination under 28 U.S.C. §1407.
Under the Multidistrict Litigation (MDL) procedures of 28 U.S.C. § 1407, the Judicial Panel on Multidistrict Litigation is authorized to transfer civil actions pending in more than one district to a single district for coordinated or consolidated pretrial proceedings if the actions involve common questions of fact and transfer “will serve the convenience of the parties and witnesses and promote the just and efficient conduct [of the actions].”
Petitions to consolidate and transfer were filed before the MDL Panel in a number of the vanishing premium cases. Since the first of this year, the author of this paper has appeared before the Judicial Panel on Multidistrict Litigation in New Orleans, Louisiana, Palm Springs, California, and Washington, D.C., for hearings on coordination of class actions in multiple districts in the Sun Life, Crown Life, New England, and ManuLife cases. The Panel has found coordination proper in each of the vanishing premium cases addressed to date, and the author is on committees coordinating class proceedings in New Jersey (Sun Life) and California (ManuLife).
Purchasers of life insurance today have less to fear in the line of deceptive sales practices involving “vanishing premium” insurance. The costly litigation discussed above has caused agents and companies alike to monitor more carefully their sales practices. Actions by state regulators also have helped eradicate many of the abuses prevalent during the “heyday” of the vanishing premium sales phenomenon.
For thousands of policyholders who purchased their life insurance in reliance upon “vanishing premium” misrepresentations, the problem remains very real. Many of these purchasers are now seeing premiums “re-appear.” Others are reaching retirement age only to discover they still face massive whole life premiums for years to come. For policyholders now uninsurable or financially unable to meet undisclosed premium obligations, the situation is particularly tragic. Recompense of these policyholders is one task of the vanishing premium litigation.
A second aspect of the litigation involves modification of the long-term practices of the life insurance industry. Respected observers from within the insurance industry view the vanishing premium phenomena as yet another example of abusive sales practices driven by short-term profit motives. Their concern is that such practices are causing irreparable damage to the life insurance industry. Industry insiders acknowledge: “What will force change is litigation's effect on the bottom line.”
A comparison of the vanishing premium practices of different insurers shows there exists a “spectrum of culpability” among the companies who illustrated and sold vanishing premium products. Much of the litigation that remains to be done lies in determining where the various vanishing premium defendants fall within the spectrum, and resolving cases in such a manner that (1) existing policyholders are equitably compensated, and (2) companies into whose hands policyholders place their trust are compelled by economic necessity to avoid abusive practices in the future.
RICHARD T. PHILLIPS
Smith, Phillips, Mitchell, Scott & Rutherford
Attorneys At Law
695 Shamrock Drive
Batesville, MS 38606
Tel: (662) 563-4613
Fax: (662) 563-1546
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