ALIC Annual Meeting: Navigating Through Uncertainty: Life Insurance Regulation and Unclaimed Property Audits

1. Marlys A. Bergstrom Phillip E. Stano Steuart H. Thomsen Mary Jane Wilson-Bilik May 22, 2012 ALIC Annual Meeting: Navigating Through Uncertainty: Life Insurance Regulation and Unclaimed Property Audits

2. Contributing Authors Marlys A. BergstromAttorney404.853.8177marlys.bergstrom@sutherland.com Phillip E. StanoPartner202.383.0261phillip.stano@sutherland.com Steuart H. ThomsenPartner202.383.0166steuart.thomsen@sutherland.com Mary Jane Wilson-BilikPartner202.383.0660mj.wilson-bilik@sutherland.com

3. Overview • Where are we now? • Audits, market conduct exams, settlements and AG subpoenas • Conflicting guidance: the New York 308 Letter vs. the Verus Settlements • Two worlds collide – Insurance law vs. unclaimed property law • What to consider if you are under, or may be under, an unclaimed property audit, market conduct exam and/or AG subpoena on these issues • Where are we headed? • State Treasurers/Comptrollers • NAIC/State Insurance Regulators • State Attorneys General • Litigation/Legislative (NCOIL) • Questions?

4. WHERE ARE WE NOW?

5. Where Are We Now? A Timeline • 2008: Verus starts unclaimed property audits of life insurers • April 2011: First unclaimed property settlement announced • May 2011: NAIC forms Executive Task Force to coordinate multi-state exams of claim settlement practices • Florida and California conduct hearings • California DOI appoints Verus as market conduct examiner • June 2011: New York AG subpoenas • July 2011: New York 308 letters • October 2011: First multi-state market conduct exam (FL lead) • MN administrative subpoena and MN DOC/AG unclaimed property letter • November 2011: NY AG and Controller announce largest investigation of life insurance industry • CA Controller hires major law firm

6. Where Are We Now? A Timeline • January 2012: Second unclaimed property settlement • February 12, 2012: First multi-state market conduct exam settlement with 20 states • February 14, 2012: MN DOC/AG issues follow-up letters • February 2012: Massachusetts AG issues subpoenas • February 2012: NCOIL does not approve model • April 2012: Third unclaimed property/regulatory settlement agreement • April 2012: Mayor Cuomo announces results of NY 308.

7. Where Are We Now? • Verus Unclaimed Property Audits • Verus Financial LLC is comprised of plaintiff attorneys and financial services and life insurance professionals • More than 35 states have hired Verus to conduct unclaimed property audits • Approximately 25 life insurance companies are currently under audit • Since the inception of the audits, two settlements have occurred • Verus has been hired by 30+ states to conduct market conduct exams

8. Where Are We Now? • Verus Unclaimed Property Audits • Nondisclosure agreements • Permits sharing of data with “other agencies” • Addition of states can be ongoing • Document and data requests • Processes and procedures for life, annuities and retained assets over the period 1996 - 2011 • Unlike “standard” unclaimed property exams, requests are related to general processes, not just unclaimed property • Data requests encompass life, annuities and retained asset accounts • All policies, contracts and accounts in-force and out-of-force from 1996 - 2011 are reviewed on an “actual basis” • More than 100 data fields for each policy, contract or account • System programming frequently necessary to gather data • Dormancy trigger • Date of death

9. Where Are We Now? • The Social Security Death Match – Verus Style • Run the entire data file against the Social Security Death Master File (SSDMF) • Applying proprietary algorithm to determine “matches” • Actual matches and “fuzzy” matches on four categories • SSN, DOB, Last Name, First Name • Potential matches equal potential unclaimed property liability • Four-point exact match • Three-point exact plus fuzzy • Two-point exact plus two fuzzies • One-point plus three fuzzies • Four-point fuzzies

10. Where Are We Now? • Unclaimed Property Audits – Verus Style • Dormancy trigger – “date of death” • Limited time to search for the beneficiary • Risk of early escheatment • Threat of large interest payments • Use of “fuzzy matches”

11. Where Are We Now? • NAIC Executive Task Force formed May 17, 2011 • Florida Insurance Commissioner Kevin McCarty, current NAIC President, announced NAIC Task Force called “Investigations of Life/Annuity Claims Settlement Practice (D) Task Force” • Purpose. Coordinate targeted multi-state exams of life insurance companies on claims settlement practices • Membership. Florida, California, Illinois, Iowa, Louisiana, New Hampshire, New Jersey, North Dakota and Pennsylvania

12. Where Are We Now? • NAIC Executive Task Force formed May 17, 2011 • Focus. Initial focus is top 40 life insurance writers, comprising 92% of U.S. life insurance market • Potential liability. North of $1 billion • No guidance expected. NAIC leadership has “no appetite” for guidance • Prefer to wait for the result of coordinated market conduct exams • Coordination with Verus • Work papers of unclaimed property audit become the work papers of the market conduct exams

13. Where Are We Now? • Tallahassee, Florida, Hearing on May 19, 2011 • Insurance Commissioner McCarty, the FL State Controller and the FL Attorney General conducted evidentiary hearing • Representatives of MetLife and Nationwide were subpoenaed to attend • Controversial positions of regulators: • Claim is matured on “knowledge” of death. Even if a claim for a death benefit is not filed, a claim is matured on the insurer’s books and records for UP purposes, if a company “knows” the insured has died • “Asymmetrical” use of DMF is problematic. Use of DMF to stop annuity payments to deceased annuitants, but not identify life insurance deaths to pay benefits

14. Where Are We Now? • Controversial positions of regulators: • Taking premium and fees (or lapsing a policy) after death is problematic. Focus on whether insurers “true-up” on paying claim • Dormancy period begins on date of death, not when insurer “knows” of a death, receives a claim or “proof of death” • Sacramento, California, Hearing on May 24, 2011 • Similar to Tallahassee hearing • CA DOI appointed Verus as market conduct examiner • Examine 10 life insurers on: • Use of DMF • Practices for paying benefits under insurance policies and annuities, and • Payments to holders of retained asset accounts

15. Where Are We Now? • New York Attorney General Subpoenas: • On June 21, 2011, the NY AG issued subpoenas to nine life insurers on their use of the DMF and their compliance with the NY unclaimed property laws • Two weeks to comply • Look-back to January 1, 2001, to present • All documents and communications on insurers’ policies and procedures for: • Determining when to cease making payments of benefits due to a death • Use of death record databases, like the DMF • Locating and notifying owners, insureds and beneficiaries of matured policies

16. Where Are We Now? • New York Attorney General Subpoenas: • All documents and communications on insurers’ policies and procedures for: • Identification of policies without an address for any owner, insured, annuitant or beneficiary • Tracking and monitoring returned mail • Payment of death benefits • Allowing term policies to lapse • Wide range of documents on these topics, as well as unclaimed property filings and set asides/reserves to cover shortfalls in unclaimed property filings • Documents identifying senior and middle management • Documents on media coverage of shortfalls in unclaimed property payments in any state

17. Where Are We Now? • New York 308 Letter • Following week, on July 5, NY DOI issued “308” Letter to 172 companies • Ordered life companies to cross-check all life insurance, annuity contracts and retained asset accounts on their administrative files against the DMF • Look-back 25 years to 1986 • NYS issued four sets of guidance on use of DMF • Two-stage reports • First stage report. Due October 31, 2011. Must complete the cross-check, categorize and report results electronically on spreadsheet using the Department’s portal

18. Where Are We Now? • New York 308 Letter • Methodology required to do cross-match • If SSN: one-point check of SSN against DMF • Exact match only – no “fuzzy match” • If no SSN: match first and last name and date of birth against the DMF • Must verify the death • Second-stage progress updates on the last day of each month • From November 2011 through March 2012 • Progress updates must be cumulative • Show matches eliminated because previously paid or not in-force at death, where locating beneficiary or still investigating • Very labor intensive

19. Where Are We Now? • Proliferation of uncoordinated state market conduct exams, surveys, audits and subpoenas since May 2011 • Inquiries from DOI in at least ten states, such as CT, CO, IA, IL, KS, LA, MI, MA, MN and OH • Market conduct single state exams by at least nine states: CA, FL, NE, ND, MA, MD, MN, NY and PA • FL and CA appointed Verus as market conduct examiner • Multi-state market conduct exams from seven states on NAIC EX Task Force signed by FL, plus 23 others • Materials provided to Verus in unclaimed property audit are working papers in market conduct exam

20. Where Are We Now? • Ongoing Escalation of Unclaimed Property Probes • On October 28, 2011, the MN AG and State Commissioner of Commerce issued a letter requiring insurers to perform a comprehensive review of internal records and policies on unclaimed property • Certify compliance with unclaimed property laws by November 30 • On October 31, 2011, MN DOC issued subpoenas – like NY AG – but going back 20 years • On November 4, 2011, the NY AG and Comptroller jointly vowed “to undertake the largest and most comprehensive investigation of life insurance practices in the country” • To make sure life insurance companies “make good on their promises to beneficiaries and their obligations to the state of New York” • In February 2012, MA AG issued subpoenas, even though MA is a Verus state for unclaimed property and market conduct exam purposes

21. Where Are We Now? • Class Actions • Four class actions filed in Ohio state court; all removed to federal court under CAFA • One state remanded to state court • Plaintiffs’ Theory • Insurer duty to affirmatively determine whether any insured with greater than 70% (or 60%) chance of having died has in fact died and to pay benefits without proof of claim • Seek classes of all insureds for past 15 years with > 70% (or 60%) chance of death – including those who have died • Defenses including lack of legal support for alleged duty and absence of injury/standing for living plaintiff where no benefits are due • One motion to dismiss granted by state court on basis of these defenses; on appeal • One case voluntarily dismissed; motions pending in two cases

22. Where Are We Now? • Illinois False Claim Act Lawsuits – Sealed Lawsuits • alleged insurers’ failure to transfer policy proceeds to state • Alleged 4,766 policies valued at $524.3 million • More than $1 billion counting alleged penalties • Whistleblower plaintiff receives 15%-30% of proceeds recovered •  New York Securities Derivative Suit  • Asymmetrical use of DMF  • Alleged breach of directors’ fiduciary duties to insurer • Alleged breach purportedly caused devaluing of stock; increased regulatory exposure to insurer

23. Where Are We Now? • Regulation by Settlement • Industry standards developed from company-specific settlements • Huge regulatory fees; no clear authority     • Inherent uncertainty after settlement • No finality

24. Where Are We Now? • Settlements: Unclaimed Property and MCE • Date of death is dormancy trigger on unclaimed property audit settlements (no basis in law) • Possible conflicts of law issues on “beneficiary presumption” • “Settlement” is a misnomer: Verus will present “fuzzy matches” to insurer at a rate of 10,000 or more per month for a year or so, for validation or proof that match is invalid, which must be provided to Verus within 30 days • ERISA annuity contracts are carved out of UP settlement, but not market conduct settlement • Insurer agrees to conduct quarterly searches of DMF using unproven “fuzzy match” algorithm to obtain “notice” of death • Once insurer receives “notice” of valid death, must conduct a “thorough search” for beneficiaries – or escheat • Market Conduct Exam Settlement continues for an additional 8 years, with payments to Verus and the states for administering the exam throughout that period.

25. TWO WORLDS COLLIDE – INSURANCE LAW VS. UNCLAIMED PROPERTY LAW

26. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Conflicting demands and tensions resulting from different approaches of • Insurance regulation and traditional insurance practices • Unclaimed property law and positions staked out by auditors and unclaimed property administrators • Conflicting objectives of regulatory schemes • Insurance regulation – insurer solvency and protection of insureds and beneficiaries • Unclaimed property – earliest possible escheatment of funds to state

27. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Insurance regulation • Unfair Claims Practices Act • What constitutes a claim • Unclaimed property laws • General concept – if property is unclaimed for full dormancy period, report it and escheat it to state • Outside of insurance, generally based on loss of contact with property owner • Different dormancy period triggers for insurance • Typically when (i) proceeds became due and payable or (ii) insured reaches or would have reached limiting age • Some states have knowledge of death trigger

28. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Proof of death vs. knowledge of death • What constitutes knowledge of death • What constitutes a claim • What triggers statutory interest

29. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Time limits • Insurance – often no time limit for submission of death benefit claim • Unclaimed property • In some states, escheatment is required at the end of a dormancy period triggered by knowledge of death, without regard to submission of any claim for benefits • Verus contends that the dormancy period is triggered by date of death, without regard to any claim for benefits or even any knowledge of death

30. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Impact of knowledge of death • In less than half of states, knowledge of death an express dormancy trigger • In more than half of states, not an express dormancy trigger • Arguably no dormancy period triggered until limiting age reached if merely knowledge of death without proof of death and no claim • Not necessarily a good position for insurers to be in • Consider impact in states where statutory interest runs from date of death • What position will insurance regulators take?

31. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Date of death as dormancy trigger • Verus position, citing Connecticut Mutual v. Moore, apparently for all states • Not supported by Moore • Not supported by language of most statutes • Implies duty to search affirmatively for deaths to avoid unclaimed property penalties • Duty – Insurance regulators may attempt to impose and/or adopt new statutes

32. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Duty to maintain contact with insureds and beneficiaries • Insurance law generally does not appear to impose duties to seek out new addresses (although referenced in NAIC Market Conduct Examination Handbook) • Relevance of loss of contact under unclaimed property laws • Relevant to limiting age triggers • Some duties imposed by 1981 Act • Loss of contact after submission of a claim

33. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Time period to verify deaths and attempt to pay claims • Where claim submitted, Unfair Claims Practices statutes typically set time frames • Verus audit process seeks to impose short period to verify deaths and determine whether policy proceeds may be due and owing • Insurance regulators may attempt to impose new requirements and/or sponsor new statutes

34. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Protection against liability for early and/or improper escheatment • Unclaimed property administrators and auditors are urging procedures that may involve escheating early or to the wrong state • Not clear whether liability relief provisions in unclaimed property statutes apply in such circumstances • Insurance regulators should be concerned about exposure to insurers possibly created by questionable escheatment procedures • Unclaimed property administrators and auditors not taking into account federal securities laws

35. Two Worlds Collide – Insurance Law vs. Unclaimed Property Law • Insurance regulators’ lack of authority • Contractual obligations • Unfair Claims Practices Act • Market regulation handbook • New York • Historical perspective

36. POINTERS TO KEEP IN MIND: UNCLAIMED PROPERTY AND MARKET CONDUCT EXAMS

37. Unclaimed Property Exams • How unclaimed property exams differ from state market conduct exams • No statute of limitations • Utilizing third-party contingent fee auditors • Aggressive definitions of unclaimed property types • Burden of proof is immediately shifted to the company • Very few administrative remedies • Preparing for the unclaimed property exam • Be proactive – determine your potential liability • Consider running DMF using “fuzzy matches” • Voluntary Disclosure Agreements • Process and procedure review

38. Market Conduct Exam Considerations • Exams will focus on policies and procedures for and results of • Claims process • Missing policyholders • Limiting age and maturity dates • Steps to consider • Form your team (compliance, legal, unclaimed property) to do internal compliance review under attorney-client privilege • Know whether you have used the DMF in your business and evaluate your processes for paying death benefits • Evaluate how you identify and locate beneficiaries • Evaluate what you do to find missing policyholders, see if insured on lapsed policy died, determine if the missing person is deceased, treat maturity date • Examine your processes around escheatment

39. Market Conduct Exam Considerations • Confidentiality of market conduct exam papers • In 2004, the NAIC adopted Model 693, which has been adopted or is consistent with a majority of state laws • Strong confidentiality protections in the Model. Section 7.A. of Model 693 requires that “all documents, including but not limited to working papers” be kept confidential • But confidentiality provisions of Model 693 are not uniformly adopted. Not all state laws treat market conduct materials as confidential or prohibit states from disclosing those market conduct materials • Some states make disclosure of market conduct materials permissible at the discretion of the commissioner • Get legal advice because litigation may be a real possibility

40. WHERE ARE WE HEADED?

41. Where Are We Headed? • State Comptrollers and Treasurers • Reducing budget deficits • Unclaimed property is a proven revenue raiser • States are holding more than $6 billion in unclaimed property • Companies remit hundreds of millions a year • States return only a fraction of the amount collected • States benefit from poorly documented beneficiary information • Third-party unclaimed property audits are a win-win for the state

42. Where Are We Headed? • Unclaimed Property Administrators • Continue to utilize unclaimed property as a revenue generator • Creative theories of what is unclaimed property • Changes in state laws regarding dormancy trigger • Uniformity? • Lack of knowledge of insurance law • Willingness to enter into voluntary disclosure agreements • Improved procedures for returning escheated property to beneficiaries

43. Where Are We Headed? • NAIC/State Insurance Regulators • Likely require a DMF match at regular intervals across the business • Require investigation of matches under the Unfair Claims Practices statutes • What level of “match” will be required? • Single point match of SSN like New York 308 guidance? • “Fuzzy matches” under the Verus algorithm? • Model Law and/or 50 state variations? • What level of proof of death will be required to pay and/or escheat a “claim” and trigger “interest” on death proceeds? • Model Law and/or 50 state variations? • Existing contract language? • Variable contracts? • What types of duties will be imposed?

44. Where Are We Headed? • NAIC/State Insurance Regulators • Multi-state exams are likely • Multi-state MCE for top 40 life insurers • Coordinate with multi-state unclaimed property audit so data from audit becomes market conduct work papers • Prepare • Remediate • Legal defenses

45. Where Are We Headed? • Potential Challenges with Unclaimed Property/Market Conduct Exams/Settlements • Lack of authority • Violates existing authority • Conflict of interest • Confidentiality of records • Examiner qualifications • Insurer privileges • Sampling • Credible match criteria

46. Where Are We Headed? • State Attorneys General • More subpoenas or inquiries possible • Unclear whether AGs are coordinating with each other or with • Unclaimed property administrators • Insurance regulators • Can be very onerous in scope

47. Where Are We Headed? • Possible Further State False Claims Act Litigation • Cited in Minnesota Attorney General Letter • 32 states and DC have False Claims Acts • Six apply only to Medicaid • Most modeled after federal statute • Most have qui tam provisions • Most apply to reverse false claims

48. Where Are We Headed? • Unclaimed Property Claims Litigation – Beyond Ohio • Duty to search • Beneficiary as plaintiff • Negligent escheatment • Consequential damages • Improper calculations of benefits

49. Where Are We Headed? • NCOIL Legislation • Will an alternative to the Verus Settlement emerge? • Current draft legislation uses 308 Model and may be opposed by the Verus states

50. Where Are We Headed? • Considerations • Review policies and procedures • Consider VDAs • Conduct remediation in advance of audit • Fuzzy matches – test credibility; determine exposure