by John Darer® CLU ChFC MSSC RSP CLTC
How much public information was out there for prospective recipients of ELNY structured annuities, judges, plaintiff lawyers, parents, guardian ad litem, and financial advisers that should have given them pause when it came time to make, or dispense advice concerning, possibly the most important financial decision of a person's life?
Given what I am about to share with you, I think it is important to ask the difficult question, and to record for historical accuracy, WHY, with such readily available information, decisions were made by judges approving infant settlement orders (with a non delegable duty to protect minors), plaintiff lawyers, parents, guardians ad litem, financial advisers and adult plaintiffs, to agree to put a personal injury plaintiff's "eggs all in one basket"?
A. Baldwin-United Crisis
From 1979 to July 1983 (when the issuer was taken over by regulators) an annuity issued by now defunct Baldwin-United through agents and securities brokers, offered 14% interest for the first year with a guaranteed minimum for the next 10 years, and "a rock-bottom guarantee" of 5.5% to 7.5% interest! Purchasers usually bought the annuities with a single payment--typically $20,000. The parent company went belly up in 1983. with a total debt of $9 billion, which was at the time the largest bankruptcy ever. It was the #2 writer of annuities in the United States. This was front page financial news and on TV folks! Surely someone out of a group featuring a judge, plaintiff lawyer, parent, guardian ad litem, and financial adviser would have read it (or should have been aware of it)
e.g. Chronicle Telegram Business News "Baldwin-Loses $1.4 Billion" September 12, 1984 , in which it says a "significant portion of the company's assets continue to be subject to recoverability issues not yet quantifiable". which suggested that more restrictions on the ability of insurers to invest in their own securities or related companies was necessary.
Within days of and for the 3 months following the AIG bailout in September 2008, I received many calls from people concerned about their annuities. Even people with New York Life Insurance company annuities that had the highest ratings! Are we supposed to believe that none of the people responsible for making, or dispensing advice concerning the ELNY placement decisions was informed about flags as red as a baboon's bottom (right)?
What did the insurance industry do in response? There was an industry effort in 1984 to rescue holders of annuity contracts issued by Baldwin-United insurance company subsidiaries; eventually, in July 1987 MetLife assumed the assets of insolvent Baldwin-United and protected the annuity benefits of nearly 200,000 policyholders. The securities and insurance industries kicked in about $200 million to honor the minimum interest commitment made in Baldwin-United contracts. Baldwin did not write structured settlements to the best of my knowledge. It is worth pointing out that In 2012 Metropolitan Life is one of the biggest underwriters of structured settlement annuities.
B. Charter Security Crisis
A November 28, 1983 syndicated article appearing in the Toledo Blade "Charter Co. Struggling With A Clouded Image", about the problems facing The Charter Co., then Florida's largest Fortune 500 Company, was instructive to insurance and annuity purchasers of the time. The company, based in Jacksonville Florida, whose annuities were pushed by wire houses Merrill Lynch, Prudential Bache and Dean Witter was facing serious financial difficulties. Charter Security sold $4 billion worth of annuities to 196,000 customers according to the article. At the time of its impairment, annuities represented 42% of the Charter company profits while only representing 1% of its revenues. The small company was the leading underwriter of annuities in the US at the time due to its association with the wire houses.
As you can see from reading the linked copy of the article, an analyst from Raymond James said " I don't think Charter is going to go out of business but things are going to continue to get worse for a long time". But then again the article reported that "Insurance commissioners in New York, and New Jersey have all checked Charter's books and deemed the company sound". Harrumph!
What did the insurance industry do? MetLife bought the insurance subsidiaries of bankrupt Charter Company in 1984, protecting the benefits of 130,000 policyholders.
C. Executive Life
C. First Executive Corp was on the verge of folding in 1974 By the end of 1982, more than 15% of FE's portfolio was invested in the B- and BB-rated bonds known as junk bonds. Most of these bonds were issued by little-known companies. During first half of 1983 First Executive's portfolio paid a 12.6% yield compared to 9.9% for the rest of the market. In 1984 New York State fined ELNY for not cooperating with examiners.
In 1984 Executive Life Insurance Company issued the following statements in an advertising campaign in a Kansas newspaper hocking its Universal Life Insurance
"Executive Life has earned more than its projections in five of the last five years." [FYI- as a 23 year old Northwestern Mutual insurance agent in New York, competing with the likes of this in 1984, I could say that my company has been doing this for 50+ years. ]
In a telling statement Executive Life then asks " What happens if the company does not make projections?" The Executive Life answer is a chilling portend of things to come " you may be buying a policy that will require you to make up the difference in increased annual premium if your insurance company doesn't make its projected earnings (Sort of an annual balloon payment if you can pay it, less protection if you can't)
On Executive Life "The company is actually a kind of cross between an insurer and a bank. It made its mark by offering deposit-type products that paid above- market interest rates, which it covered by investing heavily in junk bonds that paid still higher rates. At the end of 1990 the company owned junk with a carrying value of $9 billion, an estimated market value of $6 billion, and a realizable value probably well below that if a sale were forced. Fortune Magazine May 6, 1991 (emphasis added)
"But it took a full year for California and New York regulators to act. When they finally stirred this spring, First Executive had suffered surrenders and withdrawals of about $5 billion, reported a loss for 1990 of $366 million, and acknowledged that the surplus -- or equity -- of the Executive Life companies had dwindled to a pittance. In late March the company's outside auditor, Price Waterhouse, also said that various regulatory and financial pressures had raised substantial doubt as to whether First Executive could continue as 'a going concern .'' Ibid.
So you have several small insurance companies which happened to be the top sellers of annuities in the relevant period of the 1980s "on thin ice" Even without today's flash-speed information disseminaton tools (smartphones, Ipads, Facebook, Twitter, blogs, The Internet as a whole), they were in the news at or about the time many of the annuities for the 1,500 ELNY shortfall cases were written.
This is a tough question, especially for those who were minors at the time and decisions were made for them. I would like to preface it by stating that I don't want to soil anyone's memory if they have passed in the intervening years. But despite the incompetent regulators who permitted the merchantability of the ELNY products and the ELNY executives who created it, who shares the responsibility for the decision?
Best Rate is Not Always Best Interest: Could Have Diversified With a Riskless Investment
Who can blame someone for seeking the best for themselves or their loved one? When it comes to consumers we are taught to shop for the best price on consumer items. But these are generally consumer items intended for near term consumption. You save a few bucks on gas or your utility bill. You use your Groupon for a store or restaurant. You hit the blue plate special, or use your frequent flier miles for the family vacation. You eat at your favorite diner because they throw in a free dessert.The all you can eat sushi between 530 and 7 gets tapped a few nights a week. Ok, maybe you go to North Carolina to buy a cheaper high end sofa or as one of my friends did, had a custom dining room table made in Peru, and then shipped. Unfortunately history has proved that such logic, absent other factors. does not always provide a foundation for the best long term financial decisions.
I have challenged the ELNY 1,500 to provide me with documentation of the sale pitch. I'm not cynical, but as an observer of consumer behavior in my years doing structured settlements, I've seen some people shun, or attempt to shun diversification because they want the highest rate. So who did, and who is willing to a admit it? We've all seen and read about the illogic of the retirees who lost everything with Bernie Madoff. Why?
When I joined the life insurance business in 1983, the first generation of Universal Life was all the rage (ELNY, EF Hutton Life a whole bunch of them). "Forget the portfolio rate" in which premiums and projections were based on a responsible blend of old and new money they said, "we've got an interest sensitive new money rate" (when short interest rates were sky high) and "you can have lower premiums because those high rates will support it" that "you can pay when every you want". "It's far more flexible" they said yadda yadda.
These policies fell apart because the people who bought the B.S., weren't disciplined enough to pay premiums, interest rates fell, mortality charges increased, and they were faced with enormous cash calls to keep the policies afloat. Had they purchased a whole life policy or a hybrid back then, they'd still be paying level premiums, or if a mutual company, might even have had sufficient dividends to "self complete paying off the mortgage". My whole life policy could paying for itself at any time now if I didn't choose to reinvest the difference.
So back to ELNY... How Many "Bought" The Rate?
I'd like to know to see if comparisons were made. What went into the decision? I imagine that some will be furious with me for asking this question. Others will be sad. In commenting on a post by Patrick Hindert, Kevin, an ELNY victim, says " simple greed fueled this action" in referring to what is going on now. How about then? Was there greed on both sides in some cases? Those of the ELNY 1,500 who "bought in" based on rate, who are suffering today are living proof of why plaintiffs and others going through an financial transition in connection with financial or insurance settlement need to consult with a structured settlement|settlement planning expert.
In previous posts I've discussed diversification with other annuities or even T Bonds, which is a common practice in long duration cases.
What may raise a question for the history books is what appears below the online article in above cited Charter Security story. The headline read "Treasury Bills Rise for Second Week At Monday Auction" The article reports that 3 month treasury bills were paying 8.90% (9.26% APR), 6 month treasury bills were paying 9.05% (9.65% APR)
Let's look at the historical rates for what was then considered a riskless investment (Source: United States Federal Reserve H15 rates on line) and could officially have been used as a "qualified funding asset" for a structured settlement from January 1983 as set forth in the Periodic Payment Settlement Act of 1982 [also see Internal Revenue Code 130(d)]
30 year Bond June 25, 1982 14.26%
30 Year Bond June 24, 1983 11.06%
30 Year Bond June 25, 1984 13.56%
30 Year Bond June 25, 1985 10.67%
30 Year Bond June 25, 1986 7.36%
30 Year Bond June 25,1987 8.40%
30 Year Bond June 24, 1988 8.87%
Do the math and put things in perspective. Ignoring costs and profit margin for the purpose of the example, let's say a life annuity was purchased on a 15 year old from a company in 1983 that used the 30 year US Treasury rate to back its obligation. Now its 2012 and the 30 years are almost up. Notwithstanding the possibility that the now 44 year old may have developed or exacerbated a medical condition in the intervening years, he or she has a projected 30-40 years life expectancy. What rates are available on a comparable investment today to back up that obligation taken on in 1983?
30 Year Bond May 10, 2012 3.07%
20 Year Bond May 10, 2012 2.64%
10 Year Bond May 10, 2012 1.89%
If a company cannot reinvest at comparable rates to back up those obligations with an asset then it must erode reserves and surplus, if any, to pay benefits. Bear in mind that ELNY took in no new premium after a certain point and went into run off.
A. What is reinvestment risk? The definition found at Investopedia is this
"The risk that future coupons from a bond will not be reinvested at the prevailing interest rate when the bond was initially purchased. Reinvestment risk is more likely when interest rates are declining. Reinvestment risk affects the yield-to-maturity of a bond, which is calculated on the premise that all future coupon payments will be reinvested at the interest rate in effect when the bond was first purchased".
B. How does the interest rate impact the income that can be purchased for a given settlement dollar? Using the 30 year historical US Treasury rates here are some illustrative examples.
If you were have invested $1,000,000.00 in 1982, in a 30 year T Bond that paid a rate of 14.26% annually, you would have received $54,553,999.04 at the end of 30 time periods
If you were to have invested $1,000,000.00 in 1988 in a 30 year T bond that paid a rate of 8.87% annually, you would have $12,801,082.24 at the end of 30 time periods
If you invest $1,000,000.00 in 2012 at the 30 Year T Bond rate of 3.07% annually, you would have $2,477,241.13 at the end of 30 time periods
For the purpose of the exercise, we assume no taxes and bonds held to maturity.
With a number of the ELNY structured annuities, the benefits included very high cost of living adjustments (COLA) that were grossly under-priced. This statement does not mean that the settlement numbers negotiated for a lost eye, leg, paraplegia or brain damage were not deserved by the plaintiffs who received them, it means that the cost of the cash flow should have been higher and the yield less to account for reinvestment risk.It's not too hard to see how failure to account for reinvestment risk can become a $1B problem!
Now remember, as Raymond James observed in the above cited article, "ELNY paid above-market interest rates, which it covered by investing heavily in junk bonds that paid still higher rates."
ELNY victims have been quick to jump on the insurance industry for its response.
If one compares the nominal value of the dollars to go into the Hardship Fund and the aggregate assessments from the statutory protection, the per annuitant amount seems to be multiples of the Baldwin-United and Charter Security scenarios which did not involve structured settlements. The statutory protection was not established in New York until 1985, in part instigated by the Baldwin-United and Charter Security fiascoes. Has anyone who was an adult at the time the ELNY annuity was established in 1985, who was told by an advisor, judge, guardian or insurance salesman that ELNY was guaranteed by the State of New York thus made an admission of sorts?
Now I'm not saying the injury to these folks is not horrible, but the life insurance industry as a whole did not cause these injuries.
To be continued...