Firm News Archives - Page 60 of 76

Care for a STOLI? Careful! You May Find Yourself in Trouble.

Stranger Originated Life Insurance, also known as a “STOLI,” is a life insurance policy financed or held by a person who has no relationship to the person insured under the policy. In the typical STOLI transaction, an investor encourages an elderly person to purchase a life insurance policy and name the investor, who pays the premiums, as the policy beneficiary. Normally, the elderly insured is also paid a sum of money to entice them to enter into the transaction.

In late 2010, the Central District of California issued two rulings, a few weeks apart that help explain the propriety of STOLI transactions in California. They were: SEC v. Private Equity Mgmt. Group, LLC, 2010 U.S. Dist. LEXIS 126337 (C.D. Cal. Nov. 18, 2010) and Ohio Nat’l Life Assur. Corp. v. Davis, 2010 U.S. Dist. LEXIS 130510 (C.D. Cal. Dec. 1, 2010).

In Private Equity Management Group, the SEC, after the appointment of a permanent receiver, obtained an August 2009 preliminary injunction preventing any suit against PEM without leave from the court. In September 2010, Principal Life Insurance Company (“Principal Life”) sought leave to file an action against the receiver of PEM in order to challenge “the validity of an insurance policy issued on the life of Barbara Doricott … which was among PEM’s investment life insurance policies.” Principal Life sought to void the policy on the grounds of fraud and “a lack of insurable interest.”

In determining whether or not to lift the stay, the court applied a three-factor test from SEC v. Wencke, 622 F.2d 1363 (9th Cir. 1980): “(1) Whether refusing to lift the stay genuinely preserves the status quo or whether the moving party will suffer substantial injury if not permitted to proceed; (2) the time in the course of the receivership at which the motion for relief from the stay is made; and (3) the merit of the moving party’s underlying claim.”

In applying the last of the Wencke factors, the court found that Principal Life had a “colorable claim” justifying a lifting of the stay. The court placed credence in Principal Life’s contention that the life insurance policy was void because it lacked an insurable interest:

Likewise, although it is unclear whether the Policy would ultimately be deemed void for lack of an insurable interest, the Court finds that Principal Life has alleged a colorable claim to that effect. In opposing Principal Life’s motion, the Receiver relies on Lincoln Nat. Life Ins. Co. v. Gordon R.A. Fishman Irrevocable Life Trust, in which the court held that life insurance policies were not void for having been procured by STOLI practices where the trust, its settlor, and its beneficiaries had insurable interests in settlor’s life at time of inception. 638 F. Supp. 2d 1170, 1177 (C. D. Cal., 2009) (“an interest in the life or health of a person insured must exist when the insurance takes effect, but need not exist thereafter or when the loss occurs.”).

* * *

Ms. Dorricott’s daughter allegedly sold 1% of the interest in the policy less than three weeks after the policy was issued. Thus, while further factual development is necessary to establish whether the Policy is actually void for lack of insurable interest, based on the forgoing, the Court finds that Principal Life’s claim has sufficient potential merit to satisfy the third Wencke factor.

In Davis, supra, the defendant, an attorney, allegedly obtained two life insurance policies (“the Policies”) for two insureds (Smith and Griffin) with each life insurance policy providing a death benefit of $1,000,000.00. Davis also set up two irrevocable life insurance trusts (collectively, “the Trusts”). The owners were the Trusts, Davis was the trustee, and the insureds’ wives were the beneficiaries. Ohio National filed a Motion for Preliminary Injunction, seeking an order to enjoin any policy changes. The Court, in ruling on the preliminary injunction, had to consider the “likelihood of success on the merits.”

In evaluating whether Ohio National met this test, the court first noted that under California law (specifically California Insurance Code section 280), “no life insurance contract is valid unless the insured has an ‘insurable interest.’” The court explained that the critical question was whether the Trusts had an insurable interest in the insureds because it was the Trusts that obtained the life insurance policies. The court determined that the Trusts used to apply for the Policies presumably had insurable interests in the lives of the Insureds because the beneficiaries of the Trusts were the insureds’ wives. See Cal. Ins. Code § 10110.1(a). However, the court aptly explained that under California Insurance Code section 10110.1(e) “[a]ny device, scheme, or artifice designed to give the appearance of any insurable interest where there is no legitimate insurable interest violates the insurable interest laws.” Specifically, any arrangement by which a life insurance policy is initiated for the benefit of a “third party investor” who has no insurable interest in the insured’s life at the time the policy is issued is deemed a STOLI, which is a prohibited “fraudulent life settlement act.” See Cal. Ins. Code §§ 10113.1(w), 10113.2, 10113.3(s). The Court further explained:

Ohio National presents allegations that strongly support inferences that the Policies were indeed STOLIs.

To begin, Ohio National alleges that Davis solicited and induced Griffin and Smith to apply for life insurance policies promising no premium payment obligations yet receiving payments for their participation. In the process, Griffin and Smith were convinced to sign irrevocable trusts naming Davis as the trustee and the Trusts as owners of the Policies. Morady seemingly rubber stamped the life insurance applications without ever seeing the proposed Insureds or examining their financial records. In addition, Davis, as trustee, was given unfettered discretion to purchase life insurance policies and to borrow money for the same. Further, Davis was given the power to assign the Policies and the proceeds of the Policies to any lender. Accordingly, it seems highly likely that Ohio National would succeed in establishing that the procurement of the Policies were STOLI transactions. Specifically, Ohio National has demonstrated that Davis and Morady did not have insurable interests in the lives of the Insureds yet the Policies were initiated for their benefit. Therefore, based on the unopposed papers and other submissions, Ohio National has established a likelihood of success on the merits.

The court therefore granted Ohio National’s motion for a preliminary injunction.

The State of California’s requirement that a life insurance policy is invalid without an insurable interest at the time of the policy issuance is a very basic and fundamental requirement that is not to be overlooked or underestimated when dealing with STOLI or STOLI-like transactions.

What is Insurance Bad Faith?

This article will be the first in a series of articles addressing and answering basic questions concerning insurance law. “Bad faith” will be the first concept addressed.

When an insurance company denies a claim, that denial decision might not only be incorrect under the terms of the insurance policy, but also might be in “bad faith.” As a matter of law, every insurance contract contains a covenant of good faith and fair dealing. If this covenant is violated, the insurance company is said to have acted in “bad faith.” A tortious breach of this implied covenant involves something beyond breach of the specific contractual duties or mistaken judgment. To establish a bad faith claim in first party cases (such as those involving life insurance, health insurance, disability insurance, property and casualty insurance, auto liability insurance, and homeowner’s insurance), it must be shown that an insurer’s delay or withholding of benefits under the policy was unreasonable or without proper cause.

In general, policies involving health insurance, life insurance, or disability insurance that are paid for and provided by an employer are governed by the Employee Retirement Income Security Act of 1974 (ERISA), which precludes recovery for insurance bad faith.

When an insurance company acts in bad faith (that is, when an insurance company violates the covenant of good faith and fair dealing), the policyholder or insured can sue the insurance company for both breach of contract and the tort claim of bad faith. In addition to contract damages, damages available under a tort claim for bad faith can include foreseeable financial losses, emotional distress, and attorney’s fees incurred by the insured to force the insurance company to pay the policy benefits (Brandt fees). If the insurance company acted with malice, oppression or fraud, the insured may also recover punitive damages. Punitive damages are meant to punish the insurer, and are not available in a breach of contract lawsuit.

When determining whether or not an insurer acted in bad faith, a court will use the “reasonable” standard. This means the court will evaluate the actions of the insurers and determine if they were reasonable under the circumstances. If the insurer did not act reasonably, then the insurer has acted in bad faith in dealing with the insured.

Some examples of bad faith are:

interpreting the language of the policy in an unreasonable manner;
unreasonably failing to reimburse the insured for the entire amount of the loss;
unreasonably failing to settle the lawsuit;
unreasonable refusal to defend a lawsuit;
unreasonable delay in paying benefits; and
unreasonable delay in investigating the claim or improper valuation of the claim.

If an insurer does not act reasonably in complying with the terms of the insurance policy, then they have breached the covenant of good faith and fair dealing (a.k.a. bad faith) and will be held accountable by the court. For additional information on this and other insurance matters you can visit the FAQ section of our website: www.mslawllp.com.

If you need to consult with an attorney about a possible insurance bad faith or ERISA matter, please contact our office.

Ninth Circuit Clarifies ERISA’s Full and Fair Review Standard by Imposing New Requirements on Plan Administrators in Salomaa Case

ERISA requires that an administrator provide a claimant with a “full and fair” review of a denial decision. In a recent ruling entitled Salomaa v. Honda Long Term Disability Plan, __ F.3d __, 2011 U.S. App. LEXIS 4386 (9th Cir. Cal. Mar. 7, 2011) the Ninth Circuit Court of Appeals imposed a new requirement that an insurer must meet in order to conduct a full and fair review. Specifically, an administrator must provide a claimant with copies of the internal medical reports it generated and relied upon when making the decision when it denies a claim. The Ninth Circuit held that the failure to provide the claimant with copies of the medical reports, and also to sufficiently explain what additional information might be needed to support the claimant’s claim for benefits, constituted a violation of ERISA’s full and fair review requirement.

Samuel Salomaa was an employee of the American Honda Motor Company, Inc. for more than twenty years. His supervisor described him as “the best employee to have worked for me” and Salomaa never called in sick, never left work early and never came in late. Unfortunately, in October 2003 Salomaa developed what he thought was the stomach flu. However, this “flu” was followed by grossly excessive fatigue, headaches, insomnia and excessive sensitivity to stimuli.

Before his illness, Salomaa used to jog the two miles to and from work. However, because getting up and getting dressed for work often left Salomaa too exhausted to even drive to work, he began to stay home. When he did make it to work, his severe fatigue rendered him only able to “do paperwork for a few minutes.” Salomaa underwent a battery of tests and examinations at Kaiser Permanente and was eventually diagnosed with Chronic Fatigue Syndrome (“CFS”).

Because he was no longer able to perform his job duties, Salomaa filed a claim for disability benefits with Life Insurance Company of North America, which is a wholly owned subsidiary of CIGNA. Salomaa made his claim though the ERISA-governed disability insurance plan offered by his employer. However, his claim for benefits was denied after CIGNA concluded that because his “thyroid, calcium, albumin, serum electrolytes, and CBC results were normal,” his medical records contained “no positive objective physical findings” supporting disability.

With their decision, CIGNA ignored the explanation by Salomaa’s physicians that for those suffering from CFS “laboratory tests are always normal and there is no test that is available at the present time for chronic fatigue syndrome.” CIGNA’s decision to ignore this explanation was especially egregious given that both the Center for Disease Control and CIGNA’s own health care guidelines explain that there are no specific diagnostic studies specific to the diagnosis of CFS and that chronic fatigue syndrome is diagnosed by excluding other underlying diseases.

After CIGNA denied his claim for disability benefits, Salomaa filed a lawsuit. In reviewing CIGNA’s decision, the Ninth Circuit noted that because CIGNA both administers the insurance plan and pays benefits out of its own pocket it is operating under a conflict of interest and “has a financial incentive to cheat” Salomaa and other claimants.

While the district court upheld the CIGNA’s claim decision, the Ninth Circuit ruled that CIGNA’s decision was “illogical, implausible and without support.” In holding that CIGNA abused its discretion, the Ninth Circuit noted that every doctor who personally examined Salomaa determined that he was disabled and that CIGNA unreasonably demanded objective tests to prove the existence of a condition for which there are no objective tests.

The Ninth Circuit also determined that CIGNA failed to provide Salomaa with a full and fair review of his claim. Specifically, while CIGNA’s internal physicians concluded (without examining Salomaa) that he was not disabled, CIGNA did not “give Salomaa and his attorney and physician access to the two medical reports of its own physician upon which it relied.” The Court also criticized CIGNA for telling Salomaa that he should provide “x-rays, CT, MRI reports, etc. that support your physician’s assessment,” but failing to tell him exactly what tests it wanted. Indeed, the Ninth Circuit classified this request as “absurd” since CIGNA was well aware that x-rays, computerized tomography and magnetic resonance imaging are not used to diagnose CFS. The court explained:

The plan evidently based its denial in large part on review of Salomaa’s file by two physicians, one for the first denial, another for the final denial. They both wrote their appraisals for the plan administrator. Yet the plan failed to furnish their letters to Salomaa or his lawyer. The regulation, quoted above, requires an ERISA plan to furnish “all documents, records, and other information relevant for benefits to the claimant.” A physician’s evaluation provided to the plan administrator falls squarely within this disclosure requirement. The disclosure requirement serves the purpose of facilitating what the regulation also requires, providing claimants “the opportunity to submit written comments, documents, records, and other information relating to the claim for benefits.” Had the plan met its duty of providing copies of its physicians’ evaluations, then Salomaa’s treating physicians could have provided such comments and performed such additional examinations and tests as might be appropriate. By denying Salomaa the disclosure and fair opportunity for comment, the plan denied him the statutory obligation of a fair review procedure.

As stated by the Salomaa court, in order to “conform to the claim procedure required by statute and regulation,” a plan administrator is required to “explain, upon denial, any additional ‘information needed’” to support a claim for benefits. The Salomaa court concluded:

The administrator’s procedural violations are similar to those in Saffon v. Wells Fargo & Company Long Term Disability Plan and Boonton v. Lockheed Medical Benefit Plan. There, as here, the administrator did not provide material sufficient to meet the requirement of “meaningful dialogue.” We held in those cases, where the denials were based on absence of some sort of medical evidence or explanation, that the administrator was obligated to say in plain language what additional evidence it needed and what questions it needed answered in time so that the additional material could be provided. An administrator does not do its duty under the statute and regulations by saying merely “we are not persuaded” or “your evidence is insufficient.” Nor does it do its duty by elaborating upon its negative answer with meaningless medical mumbo jumbo. In this case, the skeptical look required by us in a case of a conflicted administrator requires us to conclude that the administrator acted arbitrarily and capriciously, both procedurally and substantively, thereby abusing its discretion in the denial of Salomaa’s claim.

Finally, the Ninth Circuit criticized CIGNA for failing to consider Salomaa’s Social Security disability award and for shifting the reason for its denial decision after Salomaa and his physician’s refuted CIGNA’s initial denial decision.

After concluding that CIGNA abused its discretion, the Ninth Circuit remanded the case to the district court with instructions that Salomaa be awarded the disability benefits he initially sought.

Plan participants will certainly want to use this decision as a key component of their arguments that plan administrators/insurers did not give them a full and fair review.

California Homeowner’s Insurer Not Required To Pay Extended Repair Limits Until Homeowner Shows Proof of Repair

Under standard homeowner insurance policies the insurer is typically required to pay only the “actual cash value” of a loss—i.e., the fair (depreciated) market value—unless and until the insured actually incurs repair costs in excess of the actual cash value to repair the home. In Kelly Minich, et al. v. Allstate Insurance Company, __ Cal.App.4^th __, 2011 Cal.App. LEXIS 270 (March 11, 2011) (Minich), a California appellate court recently rejected a homeowner’s creative interpretation of its Allstate homeowner’s insurance policy to get extended repair or replacement cost policy limits without regard to actually repairing or replacing the fire-damaged home.

In Minich Allstate issues a homeowner’s insurance policy to Kelly and Debbie Minich. A fire destroys the Minichs’ home. The policy requires Allstate to pay the Minichs the “actual cash value” of their home up to the $129,840 policy limit. An extended policy limits endorsement requires Allstate to pay up to 150% of the policy limit in excess of the actual cash value if the Minichs actually repair or replace the home.

Allstate pays the $129,840 policy limit, less the $250 deductible, within 2 weeks of the fire. Allstate refuses to pay the $64,920 extended limit until the Minichs demonstrate to Allstate 15 months after the fire that they in fact are rebuilding the home.

The Minichs sue Allstate for breach of contract and bad faith, claiming that Allstate should have paid them the $64,920 immediately after the fire. The Minichs contend that Insurance Code §2051 and §2051.5 2 require that an insurer pay the “policy limit” of a homeowner’s policy whenever the house is destroyed, irrespective of whether the insured rebuilds the house, and that the “policy limit” includes the $64,920 provided for in the endorsement.

Allstate files a motion for summary judgment and argues that it timely paid the Minichs the full “policy limit” under §2051(b)(1), and that the additional $64,920 represents an amount above the policy limit. Allstate maintains that it is not required to pay the additional $64,920 unless and until the Minichs rebuild their home.

The Minichs oppose Allstate’s motion and argue that §2051 and §2051.5 require that an insurer pay the “policy limit or the fair market value of the structure, whichever is less” (§2051(b)(1)), without regard to whether the insured repairs the structure. The Minichs maintain that the “policy limit” of their policy includes the $64,920 provided for in the extended limits endorsement.

The trial court grants Allstate’s motion, and enters judgment in its favor. The Minichs appeal.

The appellate court concludes that the Minichs’ interpretation of the policy is flawed, and that neither the statutes nor the policy require Allstate to pay the extended limits under the endorsement without regard to repair or replacement. The appellate court interprets the endorsement to refer to an amount in excess of the policy limit, and not to extend or increase the policy limit.

The appellate court also notes that public policy supports its interpretation; otherwise the homeowner would be “bettered” by receiving replacement cost benefits above the actual cash value of the home without ever having to actually replace the home—a benefit not bargained for in the insurance contract. And a benefit that the California legislature could easily have mandated in the statutes, if it had so intended.

Since the appellate court determined that Allstate timely paid the Minichs all benefits owed under the policy, it also affirmed summary judgment and dismissal of the Minichs’ bad faith claims. The Minich decision reaffirms that a homeowner must actually start repairs of its damaged home in order to collect policy benefits under an extended repair or replacement cost limits endorsement over and above the actual cash value of the loss.

New ED CA Decision is a Feast of First-Party and Third-Party Insurance Coverage and Bad Faith Principles

Every now and then a court decision comes along that is a virtual one-stop shop for basic insurance coverage and bad faith principles—a primer for newbie insurance attorneys and a refresher for seasoned litigators. Chief Judge Anthony Ishii’s recent decision granting in part and denying in part an insurer’s motion for summary judgment on a farm-owners insurance policy is one. Ted Gaylord, et al. v. Nationwide Mutual Insurance Company, et al., 2011 U.S. Dist. LEXIS 21736 (Eastern District of California, March 4, 2011). The Gaylord decision also sounds a cautionary note to policyholder attorneys to be mindful that first-party and third-party claims in a single action may be subject to different limitations periods.

The Facts

Gaylord owns and operates a livestock operation, raising his own cattle and raising cattle for others. In June 2008 some of the cattle die suddenly. By September and October 2008 cattle begin dying at an alarming rate. Gaylord suspects feed poisoning. Autopsies and feed testing confirm that the cattle are dying from liver failure caused by toxic plants in the alfalfa feed. There is no known cure, so Gaylord gets permission from the Department of Agriculture to sell the cattle off for early slaughter—but at a financial loss for Gaylord and the other cattle owners.

Nationwide issued a farm-owners insurance policy to Gaylord in March 2008. One part insures against physical loss to covered property (first-party); one part insures against third-party liability claims. Gaylord says he moved his farm-owners insurance from Fireman’s Fund to Nationwide because his long-trusted insurance agent told him that Nationwide had better coverage, including coverage for cattle loss from poisoned feed. But Gaylord’s agent says he told Gaylord that a “custom feeding of livestock” endorsement was necessary to cover cattle loss from poisoned feed, and that Gaylord declined it because it was too expensive.

Gaylord makes a first-party claim with Nationwide for the cattle loss on October 2, 2008. Nationwide denies the first-party claim on October 3, 2008, and advises Gaylord that he has until May 21, 2009, to file a legal action under the one-year contractual limitations clause. It isn’t clear how Nationwide comes up with the May 2009 deadline. Nationwide continues to investigate the third-party claim, and denies it in April 2009.

A third-party sues Gaylord in September 2009 for the loss of its cattle in Gaylord’s care. Gaylord tenders his defense to Nationwide in October 2009. Nationwide seeks the advice of coverage counsel, and denies the tender in January 2010. Gaylord sues Nationwide in March 2010 for breach of contract, bad faith and declaratory relief on both his first-party and third-party claims. Nationwide moves for summary judgment.

FRCP 56(c) Summary Judgment Standards

All too often attorneys moving for summary judgment cut and paste points and authorities from older cases, parroting the standards for summary judgment under FRCP 56(c) in archaic and stilted prose. Judge Ishii articulates the standards in clean, non-legalese prose. Cut and paste this. Not that.

Insurance Contract Interpretation

Ditto. Cut and paste this. Not that

The One-Year Contractual Limitations Clause Bars Gaylord’s First-Party Claim

The policy has a one-year limitations clause giving the insured one year to file suit for the denial of a first-party claim. The period commences when damage becomes sufficiently “appreciable” to put the insured on notice to make a claim. The district court concludes that Gaylord knew by October 2, 2008, when Gaylord first reported the cattle deaths to Nationwide, that his loss was “appreciable,” and that Nationwide’s October 3, 2009, denial is “unequivocal.”

The district court also finds that Nationwide’s (standard) offer in its denial letter to consider any new or different information that the insured might furnish does not render the denial equivocal, and does not continue the tolling. Accordingly, the limitations period was tolled for one day, and Garylord had until October 3, 2009, to timely file suit on his first-party claim. The district court grants summary judgment on Gaylord’s first-party claim because Gaylord waited until March 2010 to file suit.

The Conflicting Agent and Insured Declarations Create a Genuine Dispute over Third-Party Coverage

The district court assumes for purposes of the motion that a contractual liability exclusion and a custom feeding exclusion in the policy encompass the third-party liability claims against Gaylord. But livestock operations endorsement (LOE) modifying the liability coverage provides that “In consideration of the premium charged for this endorsement, the liability coverage of this policy applies to your livestock.” Gaylord and Nationwide each offer conflicting interpretations of the LOE, each of which the district court finds to be reasonable—hence ambiguous. Standard rules of insurance contract interpretation would resolve the ambiguity in favor of Gaylord. But…

Gaylord says the agent told him that poisoned cattle were covered. The agent says he told Gaylord that a more expensive endorsement was necessary, and Gaylord declined to pay for it. The district court concludes that the trier of fact will have to resolve this conflicting extrinsic evidence in order for the district court to interpret the policy. If Gaylord is believed, he wins. If the agent is believed, Gaylord loses. So, the district court denies Nationwide’s motion for summary judgment on Gaylord’s third-party liability claim.

A “Genuine Dispute” over Coverage Defeats Bad Faith

When an insurer’s denial of a claim is unreasonable or without proper cause, the insured may be able to recover tort damages. The district court point out, however, that “bad faith” implies conscious unfair dealing, and mere negligence or mistaken judgment is insufficient. Nieto v. Blue Shield of Cal. Life & Health Ins. Co., 181 Cal.App.4th 60, 86 (2010); Chateau Chamberay Homeowners Assn. v. Associated Internat. Ins. Co., 90 Cal.App.4th 335, 345(2001). When there is a “genuine issue” or “genuine dispute” as to the “insurer’s liability under the policy for the claim asserted by the insured, there can be no bad faith liability imposed on the insurer for advancing its side of that dispute.” McCoy v. Progressive W. Ins. Co., 171 Cal.App.4th 785, 793 (2009).

The Ninth Circuit apples the genuine dispute doctrine to duty to defend disputes. See Lunsford v. American Guar. & Liab. Ins. Co., 18 F.3d 653, 654, 656 (9th Cir. 1994). In Lunsford the insurer refused to defend a counterclaim against the insured for abuse of process. The Ninth Circuit found the insurance policy ambiguous and resolved the ambiguity in favor of the insureds, thus mandating that the insurer cover the defense costs. Despite finding a breach of the duty to defend, the Ninth Circuit held, “Because [the insurer] investigated the insureds’ claim and based its refusal to defend on that information and a reasonable construction of the policy, [the insurer] did not act in bad faith, and we conclude that [the insurer] was entitled to summary judgment on the implied covenant of good faith and fair dealing claim.” Id. at 656.

After reciting California insurance bad faith standards in a way that presages the insured is going to come up short, the district court quickly dispatches Gaylord’s first-party bad faith claim based on the contractual limitations period. The district court then concludes that there is no material dispute that Nationwide conducted a reasonable investigation into the third-party claim, sought the advice of outside coverage counsel, and that its interpretation of the contractual liability and custom feeding exclusions under the facts and circumstances is not unreasonable. So, the district court also grants summary judgment on Gaylord’s third-party bad faith claim, including the punitive damages claim.

The take-away—beside some great cut-and-paste points and authorities—is that policyholder attorneys need to be mindful when analyzing limitations periods that the insured may need to file suit early to protect a first-party claim, even when the third-party claim may not be ripe.

California Insurance Commissioner Jones Announces New Regulations On Annuities For Seniors

In recent years there have been many cases of insurance agents selling unsuitable annuities to members of the public, especially seniors. These annuities typically involve large premiums and very large cash surrender charges. The large cash surrender charges are often in place for at least the first five years of the annuity and usually exist because of the very large commissions that are paid to the insurance agents selling them. Also, the rates of return in the annuities are often misrepresented. Insurers and their agents also often sell unsuitable annuities as part of 412(i) plans (named by the IRS Code section which applies to them), and sometimes the IRS disallows deductions, classifying them as abusive tax shelters. In order for these annuities to be financially viable for persons or businesses buying them, the purchasers must keep them in force for many years. Because many individuals and some businesses are not in a position to keep them in force for many years, and because they do not provide flexibility, they are often grossly unsuitable for the individuals or businesses purchasing them.

On March 7, 2011, Insurance Commissioner Dave Jones announced new regulations aimed at protecting seniors from financial abuse by those selling seniors an unsuitable annuity. Here is the press release:

“Seniors and their family members need to know that not all annuities are a good fit for their individual circumstance,” Commissioner Jones said. “While a new annuity may seem like a good idea, all too often, unsuitable annuities have cost some seniors their life savings.”

An annuity is an insurance contract that is created when an individual gives a life insurance company money which may grow on a tax-deferred basis and then can be distributed back to the owner, either immediately or over a period of time. These new regulations are an important step towards ensuring that seniors are not deceived into tying up their money in long term annuities when they cannot pay their living expenses, and are fully aware of the products they are purchasing.

The purpose of the new regulations is to require insurers to establish a system to supervise recommendations and to set forth standards and procedures for recommendations to consumers aged 65 and older that result in the sales of annuities so that the insurance needs and financial objectives of consumers at the time of the transaction are appropriately addressed. The proposed regulations are based on the National Association of Insurance Commissioners Suitability in Annuity Transactions Model Regulations of March 2010. The regulations require insurers to establish a system to supervise the recommendations made by the insurer or by the insurers’ agent to a consumer that result in the purchase of an annuity. The regulations exempt certain transactions — direct response solicitations where there is no recommendation made based on information collected from the consumer, for instance, as well as annuities used to fund certain other investments, such as ERISA plans.

The regulations set forth duties of insurers and insurance producers that in recommending to a consumer the purchase of an annuity, or the exchange of an annuity, the producer or insurer must have reasonable grounds for believing that the recommendation is suitable for the consumer based on information given by the consumer about her finances and investments. The regulations make it clear that insurers and insurance agents shall not sell an annuity unless there is a reasonable basis to believe that the annuity is suitable based on the consumer’s financial needs and objectives. The regulations require insurers to establish a supervision system designed to achieve the insurers’ and the producers’ compliance with suitability standards and allow insurers to contract out the supervision function. The regulations require that all insurance producers be adequately trained pursuant to California law prior to soliciting the sale of an annuity. The regulations give the Commissioner the authority, among other things, to order an insurer to take corrective action when he determines that a violation of the regulations has occurred. The regulations also specify record-keeping requirements for producers transacting annuities. The new regulations have been filed by Commissioner Jones with the Office of Administrative Law, where they are available for public comment and review before becoming law.

Purchasing insurance and other financial products such as annuities that meet an individual’s specific needs can be challenging. Since an individual’s financial situation may change over time, it is important to review and understand any insurance policy or contract to decide if it is still appropriate. Insurance Commissioner Jones offers the following tips to seniors who are considering purchasing a new or replacement annuity policy:

•    Obtain all proposals in writing.
•    Don’t be pressured into buying any insurance product. Take enough time to review the information before making any decisions.
•    Do not sign anything you do not understand.
•    Consider having a trusted family member, friend or advisor participate in discussions concerning the purchase of any insurance product.
•    Make sure the agent, broker and insurance company are properly licensed to sell the product you are considering purchasing.
•    Make sure you receive a full disclosure of all information relating to the benefits and possible negative consequences regarding the replacement of an existing annuity.
•    Obtain a full disclosure of all surrender charges and related time frames in connection with an annuity prior to purchase.

This information provided is not all inclusive and does not negate or preempt existing California law. If a senior or anyone has questions or wishes to discuss any insurance matter, the officers at the CDI Consumer Hotline are available to help. Please call 1-800-927-HELP (4357) or visit www.insurance.ca.gov. “