In theory, the process of life insurance is fairly simple: obtain a policy, pay the premiums, and when the policyholder dies, get a death benefit from the insurance company. There are cases, however, when a policyholder simply goes dark, and it falls to the insurance company to determine whether the policyholder is alive or dead, and if dead, to make sure the death benefit is paid out.

Depending on state law, unclaimed life insurance funds might need to be turned over to a state fund, although recently completed audits by California suggest that numerous life insurers have been less than diligent in tracking down beneficiaries and in turning over unclaimed assets to state funds.

This, in turn, has kicked off a wide-ranging regulatory investigation into the procedures life insurers use to determine whether or not their policyholders have died, and whether they are in compliance with state laws dealing with turning over unclaimed funds. The investigations are already promising to provide some of the life insurance industry’s most intense regulatory scrutiny since the 1990s, pitting revenue-hungry states and private auditing firms against a life insurance industry that strongly asserts it has done nothing wrong.

This Time, It’s Different

The issue of unclaimed assets has come up repeatedly since the 1960s–and probably before as well, according to research by National Underwriter.

This time, however, it is the subject of probes not only by state insurance departments but also by state financial officers and in some cases, state attorneys general.

On May 17, the National Association of Insurance Commissioners announced that it had formed a task force to investigate life and annuity claim settlement practices. The task force is chaired by Florida insurance commissioner Kevin McCarty. McCarty says the task force is mounting the largest investigation of life insurance company consumer protection

practices and policies since the lengthy probe in

to the so-called “vanishing premium” issue of the mid-1990s.

According to McCarty, 10 states are members of the task force, which in March finalized a process to deal with life-settlement claims practices involving the 40 largest life insurance companies. The premium volume of those 40 companies, put together, constitutes 92% of all U.S. life insurance premiums.

“We are going to convert all of these investigations into multi-state investigations and examinations involving the top 40 groups,” McCarty said.

After the exams are completed, the task force will convene to discuss next steps, McCarty said. “As a practical matter, we have to bring the exams to closure and devise a global settlement protocol that addresses the company’s cooperation in this investigation and whether there are aggravating or mitigating circumstances,” McCarty said.

He said that, initially, four states–Florida, California, Illinois and Pennsylvania–are involved in six examinations that Florida is conducting.Three companies have been identified through subpoenas and other data as being involved. They are: Metropolitan Life Insurance Company; John Hancock Life Insurance Company, a unit of Manulife of Canada; and Nationwide Insurance Company.

The probe deals with evidence that life insurers are failing to determine if policyholders have died, and are not turning over unclaimed property to states on a timely basis. The probe also deals with preliminary findings that in many cases, insurers have what several insurance regulators and industry officials call “asymmetrical policies” regarding annuities–specifically, that they are far more aggressive in taking proactive measures to identify that annuitants are deceased.

In a statement disclosing that MetLife and Nationwide had been asked to appear, the Florida Insurance Department said that its “ongoing industry examinations have revealed that some companies may use the Death Master File to stop annuity payments, but fail to use this same information to investigate claims for life insurance proceeds to the detriment of policyholders and beneficiaries.”

The Death Master File is a database of some 83 million deaths maintained by the Social Security Administration. Weekly and monthly updates to it are sold by Department of Commerce, mainly to financial services companies and credit firms.

The Financial Question

Regulators are also examining whether the failure to deliver deceased clients’ death benefits promptly may have had an impact on the companies’ financial statements and reserves.

Another issue is whether there is a lack of clarity and commitment on the part of state regulators as to the responsibilities of insurers to comply with the law.

For example, the model law dealing with the issue crafted by the NAIC states that the responsibility to comply by the insurers does not begin until a death claim is submitted. McCarty cites this as a “flaw” that facilitates noncompliance.

Moreover, despite the fact that the issue, and subsequent investigations into it, havecome up repeatedly, only three states–Alabama, Illinois and Nevada–have this law on their books, as noted by one industry executive who asked not to be named.

McCarty implied that this is one issue that may be stressed, as state regulators focus on a cure for the problem.

The exams are being conducted by Verus Financial LLC, an auditing firm based in Waterbury, Conn. On Verus’ website, the company describes its specialty as working with state agencies “to reunite citizens with their unclaimed property.” According to legal documents, at least 38 states have signed contracts with Verus to audit the books of insurers doing business in their states. Industry officials and state regulators have provided documents indicating that Verus has signed contracts with the states. According to several industry officials, the deal is that Verus will get 20% of the unclaimed funds turned over to the states as a result of the audits.

McCarty confirmed that Verus “is an integral part” of the investigations.

Although state and industry officials have known of the probe since March, the first public notice was in late April, as the first of these exams, of John Hancock neared completion. It was at that time that Hancock entered into a settlement with the California Controller’s office.

California Controller John Chiang said the Hancock settlement was the result of an audit he initiated in July 2008, which revealed an industry-wide practice of companies failing to pay death benefits to the beneficiaries of life insurance policies.

Chiang said the audit determined that companies would draw down the policies’ cash reserves in order to continue collecting premium payments from the deceased.

Once the cash reserves were depleted, the company would cancel the policy. Chiang said the audits also found that insurers did not routinely cross-check the owners of dormant accounts with government databases listing the deceased.

“In other cases, the company had direct knowledge of the death of a policy owner, but still did not notify the beneficiaries,” Chiang said.

Most states have so-called “escheat” laws that require that the funds from unclaimed property be turned over to state unclaimed property program within three to five years of an insurer being unable to locate a beneficiary. To this end, at least two public hearings will be held to address company policies on determining if a policyholder has died; and what is to be done if the policyholder’s beneficiaries cannot be located.

Florida held a hearing on the issue May 19, subpoenaing officials of MetLife and Nationwide Insurance Company to answer questions about their policies regarding their procedures for determining whether policyholders are alive or dead. On May 23, California’s insurance commissioner will question MetLife officials about its policies dealing with unclaimed property.

They were asked to send a corporate representative to appear in Tallahassee to explain their company’s business practices regarding these issues.

In a statement announcing the hearing, McCarty said that, “although these are the first companies to receive subpoenas–the Office is examining other companies on this issue because the state Insurance Department’s information “encompasses a substantial part of the life insurance industry.”

In the first settlement, negotiated with California on behalf of an estimated 38 states, John Hancock agreed to restore the full value of more than 6,400 impacted accounts dating back to 1992.

It also agreed to create and adhere to methods for better identifying deceased policy holders and notifying their beneficiaries as well as to comply fully with California’s unclaimed property laws and cooperate with the Controller Chiang’s efforts to reunite more than $20 million of death benefits and matured annuities with their owners or, in many cases, the owners’ heirs.

According to settlement documents, John Hancock has agreed to pay California 3% compounded interest on the value of the held amounts from 1995, or from the date of the owner’s death, whichever is later.

Industry Reaction

Despite the settlement, the industry denies any wrongdoing. In a statement, the American Council of Life Insurers charged that recent reports regarding the probes contain egregious allegations against life insurance companies and their commitment to policyholders.

“These allegations are unfounded and contrary to life insurance companies’ long-standing business practices,” the ACLI said in a statement. “For over 200 years, life insurers have kept their promises to policyholders and beneficiaries.”

The statement said that “this commitment is the basis of every company’s business model and is the reason that millions of consumers turn to the industry for their financial and retirement security needs.”

An ACLI spokesman noted that in 2009 alone, life insurance companies paid a daily average of $1.6 billion to policyholders and beneficiaries in all lines of business.

“Life insurance companies are in the business of helping beneficiaries cope with the loss of a loved one and companies take their responsibilities seriously,” the statement said. “Life insurers have every legal, ethical and business incentive to honor their contracts with policyholders. To suggest otherwise simply does not hold up to scrutiny.”

John Hancock and Metropolitan Life Insurance Company have also issued statements.

In its statement, MetLife said “its first priority is to keep its promises to its policyholders.”

John Calagna, MetLife’s chief spokesman, added that, “MetLife pays billions of dollars in death benefits every year. In 2010 alone, MetLife made payments in excess of $11 billion to beneficiaries.”

In its statement, John Hancock acknowledged that it has entered into a resolution agreement with a number of states to resolve an abandoned property audit.

John Hancock officials added that the agreement “represents a landmark for consumers–one that helps John Hancock maintain its place in the forefront of caring for our insureds and their beneficiaries. The Agreement sets new industry standards for the complex issues involving abandoned property. These standards are well beyond those required by law or regulation.”

An insurance industry official who asked not to be named, cautioned that the probe will “fall hardest on companies that sold small face value policies.”

The official said that the companies that write the largest volume of small face value policies “are the ones most likely to fall through the cracks,” noting that these are policies of up to $30,000.

“The problem with this is that state officials want to create this image that insurance companies are ripping off the customers, as usual,” the official added.

Moreover, he said emphatically, “there is no incentive for an insurance company to fatten their balance sheets by breaking the law; this is a nonsense notion.”