No stalling on VA transfers, judge warns insurer

Kentucky case gives ammo to B-Ds making 1035 exchanges

Jan 2, 2011 @ 12:01 am

By Darla Mercado

A recent court decision against Pacific Life Insurance Co. may give advisers and broker-dealers legal leverage against insurers that take too long to perform Section 1035 exchanges of variable life policies.

“It’s a new hammer [for advisers],” said Larry J. Rybka, chief executive and president of ValMark Securities Inc. “Right now, there’s very little leverage in getting the insurers to do anything because the money is leaving. We can use this case to follow up on bigger 1035 cases.”

The decision in a case filed in U.S. District Court for the Western District of Kentucky concerned the timing around a requested exchange of a variable life insurance policy. Under Section 1035 of the Tax Code, the accumulated funds in one insurance policy can be transferred directly to another policy without creating a taxable event. A dispute over paperwork in 2008 between the plaintiff, Branch Banking & Trust Co., and Pacific Life led to a delay of three months before a requested 1035 exchange of a variable annuity was executed, transferring the policy to John Hancock Financial Services Inc. During that time, the market dropped and the policy declined in value by more than $250,000, according to the suit.

BB&T, which was acting as the trustee for the owner of the policy, the Charles A. Brown and Elise A. Brown Irrevocable Life Insurance Trust, filed charges accusing Pacific Life of violating its contractual obligations to perform a 1035 exchange without delay. BB&T claimed that the transaction was stalled by Pacific Life requirements, including one that the transaction be signed off by a Hancock corporate officer and notarized.

On Nov. 24, U.S. District Judge John G. Heyburn II wrote that “the policy’s surrender provision [gave the insured party] an outstanding, irrevocable right” to transfer his or her funds to another carrier.

The judge ruled that the transfer of funds was effective as of the date the surrender request was received.

“When you have policy language that says that surrender is effective upon receipt, if the insurance company delays because it thinks its internal procedures allow it to seek further assurances that the insured really wants to surrender — then they’re on the hook for losses that occur due to market changes,” said David A. Calhoun, an attorney with Wyatt Tarrant & Combs LLP who represents BB&T in the case.

BB&T has asked for $259,926 to make the trust whole. The judge gave the parties 30 days to file arguments. Pacific Life will file by Friday.

“We obviously believe the decision is wrong, and we’ll take whatever steps necessary to correct that,” said Patrick A. Shoulders, a partner at Ziemer Stayman Weitzel & Shoulders LLP who is representing Pacific Life in the suit.

Though the case appears to be the first of its kind, advisers report that it’s fairly common for 1035 exchanges of annuities and life policies to drag on for months. While the Financial Industry Regulatory Authority Inc. requires broker-dealer principals to review variable annuity exchanges within seven business days of an office of supervisory jurisdiction’s receiving a complete and correct copy of the application, insurers generally are under no deadline to complete an exchange.

As a result, the time required for an exchange varies by insurer. Outgoing transfers at Allianz Life Insurance Company of North America, for example, can take one day for variable annuities, five to 10 days for fixed annuities and 10 days for life insurance. On the other hand, variable annuity exchanges coming into Prudential Financial Inc. average about three weeks.

“In New York, it always takes three months to process variable annuity exchanges, and I’ve seen it take six months,” said Doug Flynn, an adviser with Flynn Zito Capital Management LLC.

Mr. Flynn said that one of the reasons for delay in New York is the state’s Regulation 60, which requires insurers involved in the exchange of life insurance policies and annuities to share sales materials and proposals with the carriers whose business they will replace.

But delays also occur in other states and involving a variety of insurance products.

“Where we really see it is in the indexed annuity space,” said Zachary Parker, senior annuities and insurance consultant at Securities America Inc.

He used as an example his own experience trying to move a contract for his parents. The policy was already out of its surrender period and he wanted to use another insurer with a better crediting method.

During the lengthy processing period, the new insurer announced a decrease in its crediting rates and bonus. After Mr. Parker threatened to call insurance regulators, the heel-dragging insurer rushed the transaction through to the new carrier.

“It was like pulling teeth; they sit on the paperwork as long as they can,” Mr. Parker said. “My opinion is that if advisers aren’t following up and checking the status of the application, they’re probably in the same situation.”

Advisers noted that some insurers faced with losing a client to a 1035 exchange try to retain the business by tipping off the carrier’s agents that the money is about to walk out the door.

“Insurance companies give the notice of the 1035 exchange request to their proprietary agents to call on the client — it becomes an orphan account,” said Steve Esposito, an adviser with Macro Consulting Group.

Delays in processing 1035 exchanges can result in ineffective product illustrations because the value actually swapped into a new insurance product may be less than originally expected, adversely affecting performance data shown to clients, Mr. Rybka said.

“We illustrate a point in time when the money is coming over and applied to the new contract,” he said. “If the money comes in two months later, there’s an interest factor on that period that’s now lost on that new policy.”

E-mail Darla Mercado at


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