Penn Mutual gets sued: A lesson about participating life insurance
By Brandon Roberts
The Insurance Pro Blog
The mutual tag line isn't just a feel good marketing pamphlet, its grounded in a certain degree of legislative imperative.
It's dividend season among the mutual life insurers and this year, among the flurry of announcements regarding dividend payouts, there was one piece of news that doesn't appear to be all that positive.
No, it's not the announcement among those insurers who — despite having a great year and paying out even more dividends than last year — will see their dividend interest rates decline for 2013. This announcement is a tad more gloomy. We learned recently that on October 31st of this year, a Pennsylvania couple filed suit in Federal District court against the Pennsylvania Mutual Life Insurance Company for alleged failure to pay adequate dividends under Pennsylvania state law. Ouch.
And now, every IMO/BGA/etc. is basking in the glory of negative news to exploit a company that's unfriendly to their distribution model. You want par whole life? That company from Horsham is nice, but they're currently being litigated for not paying enough dividends (hee hee hee).
The case, which alleges Penn Mutual broke the law by retaining too high a percentage of its earnings over 16 of the last 17 years, references statute that requires insurers hold on to no more than 10 percent of earnings for "safety fund" establishment (aka surplus building). The statute does allow for exceptions if an insurer petitions the state commissioner and the complaint notes that Penn never did this and would not have needed to, due to its superlative finances.
So, should we avoid Penn Mutual?
While lawsuits certainly aren't high marks in any company's history, it's important to keep things in perspective. The lawsuit (which is seeking class action status) alleges damages in excess of $5 million. This is why the case is filed with and will be tried — if it makes it that far — in federal court. The complaint filed also states that while they are unsure of the exact number of people in the class, they suspect the number could reach 200,000 individuals.
Penn Mutual currently has approximately 270,000 ordinary life insurance policies in force, according to Vital Signs. If we were very conservative and estimated that just 10 percent of those policies are participating policies, $5 million in unpaid dividends would mean Penn underpaid each policy holder about $11 in dividends each year. Let's double the damages and assume the plaintiffs are correct in their alleged 200,000 people — this case would, after all, include those who had policies but lapsed them. That would mean Penn underpaid each policy holder on average $3 per year, or roughly $50 for the entire 17-year period.
Now, I understand that $3 is $3, and it's better in your pocket than in Penn's. But I'd like to tell you a little story about me and my credit card company. I've had one particular credit card since I was 18. I use it for almost every purchase I make and then pay off the balance when due the following month (I really should get a card with a points or airline miles program, but whatever). This past month, I made a little mistake. When I went to pay the card balance off, I accidentally chose the wrong bank account. On the drop down menu, an old account I had when I lived in New York (which was closed a few years ago) still appears. It's actually the default selected account for some reason. I foolishly submitted my payment without changing the account. Oops. First time ever, and it's been that way for a while.
For this minor oversight, I'm being charged $45. Leave the complaining about the ridiculous charge at home for a moment, and note that a foolish mistake on my end nets me a loss of almost as much as Penn may have underpaid its average policy holder over the last decade and a half. My point is, there are many other financial services companies out there doing much worse on a regular basis, and getting away with it.
As far as finances are concerned, Penn currently holds almost $2 billion in surplus, so I'm pretty sure it can cover that $5 million, if need be.
This is not the first time
While this is the first time Penn faces litigation for underpaid dividends, this is not the first time an insurance company has faced such litigation. Northwestern Mutual and Savings Bank Life of Massachusetts have both faced litigation in the past for alleged underpayment of dividends. Both settled the suits and their policies holders — both past and present — received their checks for enough money to buy a packet of chewing gum.
I also suspect this is not the last time this sort of lawsuit will be filed against an insurer that issues participating life insurance. People make mistakes, numbers get rounded and even auditors miss things (No way!). But out of this thought should come a swift sense of security, not despair.
Insurance law and the mutual tag line
Unless you started your insurance career this year, you've likely heard the mutual sales tag line. It goes something like this: Mutual insurers are more insulated from economic crisis because they are not beholden to Wall Street and stock holders whose only care in the world is that the company posts profitable quarters. Further, because mutual companies are owned by their policy holders, there is an alignment of goals where the company and the policy holder can work hand-in-hand in each others best interest.Yadda yadda yadda. I'm paraphrasing.
Actually, it's not just the mutual companies themselves that advance this line of thought. The ratings agencies are also very quick to point this out, and it may be the reason the mutual companies tend to dominate the top of a list ranking U.S. insurers by ratings.
OK, yes, but did that working hand-in-hand stuff happen in this case? That's for the court to decide. That's a subtle point I'm sure a lot of you missed, so let me get out my loudspeaker and hammer on it a tad more. By virtue of issuing participating policies Penn Mutual, (and other companies, not just mutuals, mind you) have a legal obligation to share in profits. And that's the very reason we have a lawsuit in the first place. The complaint itself quotes Pennsylvania statue regarding the legal requirement to pay dividends on participating business.
Not only do states have laws specifically speaking the requirement to pay dividends, they have laws speaking specifically to the amount of allowable retained earnings in a given year on a block of participating business. And this is where the lawyers are hoping to hook Penn.
What a sh**ty deal
Who remembers the congressional testimony of Goldman Sach's CEO Lloyd Blankfein and Senator Carl Levin's decision to read internal emails aloud. Emails where Goldman employees referred to financial products they were offering their clients as, well ... bad deals. Goldman still faces a pending lawsuit over the fact that they allegedly sold (i.e. made money on) investment products that they were also betting against — and stood to make good money betting against.
But keep in mind that many investors were burned by some exceptionally bad financial products sold throughout the 2000s. Goldman and others made serious money by setting their clients up for failure. I believe it was Randall Lane who referred to it as, "Heads I win, tails you loose and I still win," in his book "The Zeroes."
Keep in mind that while Goldman faces a suit for fraud, that suit will not indemnify the clients who lost substantial money at the hands of Goldman's bad deals.
Participating policies — by which we almost always mean whole life — have a very clear requirement to share the vast majority of net earnings with policy holders. And when people make errors about how much was supposed to be paid out, there is a process in place to correct such mistakes. On top of this, there are legal requirements for other insurance contracts to share in their profitability (i.e., better than expected mortality results under a universal life contract can force an increased interest rate to payout some of the earnings).The mutual tag line isn't just a feel good marketing pamphlet, its grounded in a certain degree of legislative imperative. There are no other financial products I'm aware of that not only place the clients financial interest at the forefront as a matter of principle, but also have a legal requirement to ensure it happens.