From the November 2010 issue of Investment Advisor • Subscribe!

November 1, 2010

Life Insurers Under Fire

Retained asset accounts have drawn criticism in the press; here's what you and your clients should know

At the end of July, in the midst of one of the most financially troubled summers in recent memory, headlines at Bloomberg blazed with charges that insurance companies were profiting from the deaths of servicemen. Beneficiaries weren’t getting the full amount of death benefits their loved ones had bought so dearly, trumpeted the press, because insurance companies were holding onto the money and profiting from the interest on it. Servicemen had been sold out by the Veteran’s Administration and the insurers, who had a “secret” verbal agreement when a written one was mandatory. Funds weren’t insured against loss by the FDIC, so they weren’t safe.

The story was picked up by National Public Radio, then other outlets, and news of the accounts—little known outside the insurance industry—spread widely. Accusations flew thick and fast, and the response was immediate.
New York Attorney General Andrew Cuomo launched a “major fraud investigation.” Other investigations followed; lawsuits were filed. Insurance commissioners reviewed documents to see what all the fuss was about; Sheila Bair at the FDIC announced that the agency was reviewing disclosure documentation; and Congress got into the act, holding a hearing and proposing legislation. Outraged veterans’ groups protested; the VA defended itself and began its own investigation. Insurance companies were vilified in the press, accused of duping families and profiteering on the results.

Insurance companies cried foul. “Not so”, they said. “Sure, we hold the money till beneficiaries claim it. But the money is safe, and people don’t have to make immediate decisions at a tough time—and they were all told how this works. It’s the compassionate solution to a difficult situation; not only that, our customers love it.”

So who’s right, and what’s the real story on retained asset accounts? As is generally the case, there are arguments on both sides.

What It’s Not
A retained asset account is not the check that comes in the mail when a loved one dies. Instead it’s an insurance benefit that, instead of being paid by check to the beneficiary, is held in an account at the insurer. The money draws interest and the beneficiary is paid interest—although not as much as if the beneficiary put it into a higher-yielding vehicle of his or her choice.

The beneficiary is sent, instead of a single check to be deposited in that account of choice, a “checkbook” that, according to Bob DeFilippo of Prudential Financial, contains drafts similar to credit union drafts. And they’re not insured by the FDIC, because the insurance company is not a bank, he points out. But they are insured by the state insurance guaranty fund, which pretty much regards those funds as if they were that lump-sum check that used to be commonplace until 20 or so years ago.

The choice, if there is a choice, of whether the death benefit will be paid out in a lump sum check or via an RAA is made either by the client—in the case of servicemembers, that would be the military and not the insured; in the case of civil servants, it’s the federal government; and in the case of civilians, often it’s the employer who purchases a group life insurance plan for its employees—or by the beneficiary at the time of death. Paperwork sent to the beneficiary will offer whatever options are available: a lump-sum check, an RAA checkbook, or other options sometimes offered.

Aha, There’s the Rub
Problems start when a beneficiary doesn’t understand the distinction between an RAA distribution and a check—or doesn’t go through the paperwork that explains the difference. The loss of a loved one is a catastrophe; it’s tough to take in information at such a time, particularly when the beneficiary might be hostile toward the benefit itself.

Helen Modly, a planner with Focus Wealth Management in Middleburg,Va., says that she doesn’t have “any issue with this approach as long as the beneficiaries understand that this is not a normal checking account and the ‘checks’ can only be used to access and move the money, not to pay bills.” But she goes on to add that professional advisors don’t usually allow clients to leave the money with the insurance company for long. And beneficiaries without advisors may not know, despite disclosure forms at the time of death, that those “checkbooks” don’t work the way their own checkbooks work.

Says Modly of the insurance companies, “They give the beneficiary what looks like a normal checkbook and instruct them to write a ‘check’ to themselves whenever they want to access some or all of the money. Unfortunately, the account is not a checking account at a bank with FDIC protection, it is an account on the insurance company’s books. The ‘checks’ are really drafts against the insurance company and cannot be used to pay bills or other routine uses.”

She goes on to say that there is no fraud protection, “since neither the insurance company nor the bank that processes the drafts are required to verify signatures.” However, she adds, “On the flip side, these accounts give beneficiaries a relatively safe place to keep the money until they decide what to do with it.”

Three of Modly’s widowed clients received “checkbooks,” she says, and “none of the three understood the distinction.” If this is typical of people who have financial advisors, would the general public, without the benefit of such advice, have a much better understanding of such things?

DeFilippo says, “One thing we make available through the military VA account is free financial counseling—not through Prudential, but through a third-party vendor.” And he stresses that any beneficiary at any time can pull all the money out: “What’s key here is whether or not you have the ability to take out the money whenever you want, and do what you need with it.”

Regarding the possibility of fraud, as Bloomberg reported in one of its articles, Joe Madden, a spokesman for MetLife, had this to say: “As the Bloomberg News article cited two cases, one of which was more than a decade old, it is important to put this in the appropriate context and note that almost 5 million Total Control Account [MetLife’s RAA] drafts have been successfully processed since the beginning of 2007. In 2009 alone, MetLife’s designated processing bank cleared over 1.3 million TCA drafts. MetLife has always had and continues to have strong procedures in place to prevent losses to its account holders due to forgery or otherwise. Drafts written from a Total Control Account, like checks written from a bank account, are cleared through normal banking channels. MetLife contracts with a third-party bank to provide draft clearing services for the TCAs. The bank is required to use care and comply with accepted industry standards in verifying signatures and clearing drafts, and the protections afforded by the Uniform Commercial Code (‘UCC’) apply. Liability for fraudulent, forged or unauthorized signatures on drafts follows the UCC provisions governing negotiable instruments like checks and drafts.”

Show Me the Money
Another complaint concerns accessibility. While the Bloomberg report also mentioned “checks” from an RAA being declined when a beneficiary attempted to use them at stores to purchase goods, these are not like bank checks. They’re more like third-party checks if one presents them at a store, and that entails a whole new set of problems, since some places won’t accept them—a batch of complications a bereaved family does not need to deal with.

Larry P. Ginsburg, of Ginsburg Financial Advisors Inc. in Oakland, Calif., said that a few clients had told him they “had the opportunity” to have an RAA, and he told them “No, get a certified check.” The main issue he as an advisor is concerned about is access. “You want to know your money is safe, and that you have immediate access to it. It’s supposed to be liquid reserves. If it’s not supposed to be liquid, there are better opportunities than leaving it in an insurance company [account].”

Insurance Not Insured?
The fact that these accounts are not FDIC-insured has been a major sticking point for many of those who rail at the insurance companies. But, as mentioned above, insurance companies are not banks, so they do not fall under the purview of the FDIC. Instead the proceeds of an insurance policy are covered by state life and health guaranty associations, which provide protection to consumers in case insurance companies fail. The insurance limits of the guaranty associations are generally $300,000 for individual policies in most states, whereas the FDIC insures up to $250,000. So the death benefits are guaranteed, and the insurance companies themselves tout their stability as proof that such worries are groundless.

However, if the past two years have taught the public nothing else, it is that no financial establishment is “too big to fail” if there’s a bailout available.

So How Old Are They?
RAAs have been around for more than 20 years. They haven’t been standard policy at the VA, however, for Servicemembers’ Group Life Insurance (SGLI) until 1999, when a verbal agreement was made between the VA and Prudential to allow them instead of the lump-sum cash benefits.

[Read more about Servicemembers’ Group Life Insurance.]

Reports characterized the agreement as “secret,” which Prudential disputes in an open letter to the military community: “As for the allegation that there was some secret agreement between Prudential and the Department of Veterans Affairs relating to the use of the Alliance Account [the RAA], characterizing this as a secret is laughable. Every beneficiary gets information about the Alliance Account before they receive their distribution. If this is a secret deal, it’s the most public one in history. The use of the account-based settlements was an established best practice within the life insurance industry at the time the VA agreed to incorporate it in the Servicemembers Group Life Insurance (SGLI) program.”

Still, the written agreement, according to Bloomberg, specified that death benefits were to be paid in lump sums; this was not amended in writing till 2009.
FEGLI has used those accounts from MetLife for quite some time, according to Madden: “MetLife has been pleased to serve as the primary insurer and sole administrator for the Federal Employees Group Life Insurance (‘FEGLI’) program since its inception in 1954. The TCA [Total Control Account—another RAA] account has been used as the settlement option for the FEGLI program since 1994, and beneficiaries under the FEGLI program had the option to request that benefits be paid by TCA prior to 1994.”

Taking an Interest
A big sticking point has been the question of interest. Funds for RAAs are kept in the general account of the insurance company, and interest on some of the investments within that account is considerably higher than the interest rate paid to beneficiaries. According to reports, that means that the insurance companies are profiting on assets that rightly belong to beneficiaries.

In fact, those reports quote the man who apparently invented the RAA, Gerry Goldsholle, as having devised them in order to help MetLife earn money on the spread—the difference between what it holds and what it pays out to beneficiaries—by holding onto death benefits as long as possible. Beneficiaries would still earn interest, but so would the insurance company.

DeFilippo says it’s not that simple. He points out that there are different types of investments in that general account—both short- and long-term vehicles that pay different rates of interest. Some are very short-term, so that the company has the ability to pay out to beneficiaries on demand. “To pay interest to beneficiaries on demand,” he says, “we have to invest money in short-term interest-bearing investments. It’s comparing apples and oranges to compare the total return on the general fund to the interest rate we pay on the Alliance Account. It’s more accurate to look at the portion of the general account invested in short-term assets so that we have liquidity.”

Madden says pretty much the same about how things work at MetLife: “Each TCA account holder is provided with a Customer Agreement when the account is established. The Customer Agreement has a specified guaranteed minimum rate of interest. MetLife never credits below that annual effective rate of interest during the lifetime of the account. Current guaranteed minimum interest rates are 3%, 1.5% or 0.5%, depending on the age and origin of the account.”
He continues, “Moreover, the interest rate paid on TCAs always equals or exceeds the rate of at least one of the two objective indices referenced in the TCA Customer Agreement, one of which is an index of government money market mutual fund rates and the other an index of rates paid by the country’s largest banks and thrifts on money market accounts. TCAs are obligations of MetLife, and the assets backing these accounts are held in the Company’s general account. MetLife—not the account holders—bears the investment risk of the assets backing these accounts. Because MetLife bears the positive or negative investment experience of these assets, it may realize a profit from these assets.”

No one disputes that beneficiaries could earn higher interest if they took the whole amount and transferred it to CDs or investments of some kind. The problem is that some beneficiaries leave the money with the insurance company, believing it to be more like a bank account than it is and perhaps not aware of the ramifications of their inaction. Estimates vary, but between 30% and 40% of beneficiaries leave money in insurance company accounts after a year.

The Fire’s Not Out
Angry citizens already hurting from bereavement and financial insecurity have not hesitated to lash out at the companies they already view with suspicion. Veterans’ groups regularly denounce insurance companies on the Web, and social media enables people to offer their opinions—and spread the word—from one end of the country to another.

Several states have taken action to prevent or limit RAAs; state insurance commissioners are looking into the matter, and NAIC created a special working group just to review RAAs and ensure that proper consumer protections are in place.

And with all the investigations, lawsuits, and Congressional actions that have been launched in the wake of that first article, only one thing is fairly sure—insurance companies will have a public relations nightmare for some time to come.

And the end lesson for advisors? Educate your clients, have them think about what they might need the money for if a loved one dies, and plan with them ahead of time how that distribution will be handled.     

Marlene Y. Satter can be reached at msatter@sbmedia.com.

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