Times are changing in the life insurance business. Age-old industry practices are being questioned by authorities and increasingly are a cause of litigation.
For instance, convicted felon Joseph Nacchio and his wife, Anne M. Esker, were recently awarded $14.2 million in a lawsuit against a division of
Goldman Sachs for a breach of advisory duties that resulted in disappointing performance of their life insurance. The couple initially paid $4.5 million for $95 million in coverage, but they were forced to cancel the policies and paid $26 million in order to replace what they thought they had initially purchased. The jury awarded the couple $14.2 million, or the equivalent of $30 million minus the $16 million they should have paid.
CLIENT MISUNDERSTANDING
According to a statement from Mr. Nacchio's attorneys, Mr. Nacchio and his wife had been working with an adviser at The Ayco Co. — a division of Goldman Sachs — for almost 14 years when, in 2000, they invested about $4.5 million in two life insurance policies with the help of the Ayco adviser.
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It was Mr. Nacchio's understanding that the policies would provide about $95 million in benefits upon his death to satisfy the inheritance tax on his estate. He also understood those policies would cover him until age 100, but in reality they would have lapsed once he reached the age of 72, leaving him and his wife uninsured.
The issue was discovered in 2010, prompting the couple to engage a new insurance adviser. Their new adviser ran numerous illustrations, and concluded it would have cost Mr. Nacchio about $14 million in 2000 to buy the life insurance policies he thought he was getting.
In other words, two different financial advisers, both with reputable firms and credible backgrounds, calculated the premium required to maintain the same death benefit, using the same information, and yet their calculations differed by an order of magnitude.
This case is yet another example of client disappointment and adviser vulnerability caused by relying on prevailing life insurance industry practices now considered “misleading” by the chief regulatory body of the financial services industry.
Had the advisers in this case applied to life insurance the same prudent investor principles widely accepted in other segments of the financial services industry, the result almost certainly would have been different and better for all involved.
VULNERABLE TO ACCUSATION
For instance, Mr. Nacchio's lawsuit charged, in part, that the recommended life insurance policy earned less than 1% over a 10-year period and that he was forced to spend $27 million to buy new policies. In other words, the lawsuit claimed that the policy cost was greater than expected because its earnings were less than expected. And because such cost and performance expectations were based on “misleading,” “fundamentally inappropriate” and unreliable illustration comparisons, the advisers here left themselves vulnerable to an accusation of breach of duties that clients reasonably and rightfully have come to expect from advisers.
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Had the advisers here examined policy costs and expenses and had they discussed the reasonableness of performance expectations instead of comparing hypothetical illustrations, Mr. Nacchio most likely would have paid more initially but less in total for the life insurance policies he thought he was getting, and the advisers could have defended the prudence of their recommendation without litigation.
INSULT TO INJURY
In fact, the jury found the adviser had breached his duty of care and made negligent misrepresentations of material facts that Mr. Nacchio relied on to purchase the recommended life insurance policies. Adding insult to injury, Mr. Nacchio, the former CEO of Qwest Communications (since taken over by CenturyLink), had been convicted of insider trading in 2007; he served five years in prison and paid fines of $70 million.
So if a convicted felon can successfully sue one of the industry's most highly regarded and sophisticated financial services firms, what does that mean for advisers with clients who don't suffer such credibility challenges?
It means times are a changin' in the life insurance business. Those who adapt to these changes can thrive. Those who don't are at risk.
Barry D. Flagg is the founder of Veralytic Inc., an online publisher of life insurance pricing and performance research, and product suitability ratings.
