Filed Under:Your Practice, Regulatory

Under Siege

In just a few short months, what began as a probe by California and Florida into the claims-paying procedures of life insurance companies has turned into a nationwide effort to shake loose any and all unclaimed death benefits that have accumulated over the last several decades. An alliance between cash-strapped state governments and enterprising accounting firms, which both get to keep discovered unclaimed assets, is quickly turning to an endless assault on industry practice that could leave insurers reeling.

The examination of the policies of life insurance companies in turning over unclaimed property to state treasuries is apparently just the beginning of an effort that has no end in sight, and it is already creating a cottage industry for the purpose of generating revenue for state governments, as well as delivering handsome commissions to the

financial services firms running the unclaimed property investigations themselves.

The decision in July of the New York state insurance department to get involved in the probe has turned up evidence that the examinations are being expanded to cover perhaps as many as 22 large insurance companies, foreign and domestic, that do business in the state.

This was confirmed in securities filings last month by MetLife, Prudential and American International Group.

MetLife said in its filing that more than 30 U.S. jurisdictions are exmaining its policies, and that in addition to payments to states, the examinations may lead to more payments to beneficiaries, administrative penalties or changes in procedures.

"The company is not currently able to estimate the reasonably possible amount of any such additional payments or the reasonably possible cost of any such changes in procedures," MetLife said. "It is possible that such costs may be substantial."

Prudential said it was being probed by 33 states.

And, AIG said in its regulatory filing that it added $100 million to its reserves for death claims at its life insurance subsidiaries for the second quarter.

There is also evidence that examinations are also being conducted of companies in the Southeast. But a spokesman for the Florida Insurance Department, which is playing a key role in the probe, including holding a public hearing in July, would not elaborate on what is going on there.

"Florida continues to work with the other state regulators of insurance and unclaimed property departments to conclude examinations and require insurance companies to investigate claims and remit to unclaimed property units as required by law." said a Florida department of insurance official, adding that the exams are progressing, but findings are confidential until the exams are completed."

In May, John Hancock Life Insurance Company, Boston, agreed to an unclaimed life insurance settlement with 29 states. Separately, Hancock agreed to a $2.4 million settlement with Florida.

Such figures may amount to small change, as industry officials are privately growing alarmed that unclaimed property examinations could be expanded into their holding companies, which would expose to scrutiny general business practices with allied industries, such as broker-dealers, mutual funds and third-party administrators.

There is already a strong incentive for states to thus expand their unclaimed property probes. Delaware, the corporate home of many large U.S. businesses, generates $400 million in revenue annually from unclaimed property.

Officials at the Unclaimed Property Professional Organization, based in New York, as well as officials at a trade group which represents state treasurers, confirm that unclaimed property examinations are the third-largest generator of revenue to the state of Delaware annually.

Looking beyond insurance

Although National Underwriter was unable to determine specific instances where examinations of other financial firms are being conducted to determine their policies into turning over unclaimed accounts to states, the Securities and Exchange Commission issued a notice in August saying it is putting the process used to record efforts to locate missing security holders up for a routine paperwork review.

According to "Unclaimed Property Audits: No Laughing Matter," an alert issued in August by Miami-based law firm Greenberg Traurig, the success of the probe at life insurers is serving as incentive for states to expand their recovery efforts.

"In light of success with life insurers," Greenberg Traurig's lawyers wrote, "recent legislative changes and continued state budget crunches, it is reasonable to expect an expansion of audits to other industries."

The Greenberg Traurig lawyers said that a significant percentage of companies are likely not in full compliance with unclaimed property laws. Moreover, in most jurisdictions, there is no statute of limitations when it comes to unclaimed property. As a result, the look-back period can be fairly lengthy and cover periods for which the company no longer has adequate records.

"The auditor may estimate the unclaimed property liability for such periods, which can lead to a company paying more than it would have otherwise owed," the lawyers noted. This is significant because interest and penalties on such payments could be severe. In California, for example, where a substantial unclaimed property effort is already underway, interest is calculated by state statute at 12% per annum from the date the property should have been reported.

As to the original probe, started by the California state Treasurer's Office several years ago, industry officials say regulators are demanding copious data on their handling of unclaimed property for annuities, life insurance, group life and other products.

"An incredible amount of resources are being required to determine what the audit companies retained by insurance regulators and state Treasurers do to conduct these examinations," said one lawyer involved with the probe.

And, in a bulletin to clients Aug. 18, lawyers at Sutherland, Asbill & Brennan noted, "The inconsistency between unclaimed property law and insurance law is resulting in turmoil in the context of unclaimed property audits."

The bulletin added that, "Insurers know state insurance laws and how they are enforced through market conduct exams. The exams are regulated and relatively uniform in application."

"By contrast, unclaimed property audits are producing non-uniform application of state statutes and inconsistent enforcement efforts via third-party contingent fee auditors," the alert said.

Birth of an Industry

These industry officials are also concerned that the basis for the probe is misuse of the death master file provided regularly by the Social Security Administration.

The current investigation began several years ago, when the California state Treasurers' office accepted an offer from a Waterbury, Conn.-based audit firm to use a software program it had developed to determine whether life insurance companies were far more diligent in using the Social Security death master file to terminate annuity benefits immediately when the owners had died than they were in searching to determine when the owners of life insurance policies had died.

Indeed, the New York Insurance Department recently issued a bulletin ordering life insurers to use the Social Security Death Master File to locate insureds who may have died and report on the effectiveness of the search.

And, in its August regulatory filing, AIG said it had also started using the Social Security death master file in its claims process system.

But, these officials point out, a recent article by the Scripps Howard News Service said that every year, thousands of Americans are entered into this computer system in error and recorded as deceased, when in fact they are alive.

The article prompted Sen. Richard Durbin, D-Ill., Aug. 8 to write a letter to ask the Social Security Administration about the problem of living people mistakenly being placed on the SSA Death Master File.

There is also growing evidence that the inquiries could also extend into the holding companies of insurance companies, that is, their practices dealing, for example, with turning over to the states funds from uncashed payroll checks.

"There is a lot going on in insurance, but this is much broader than that," warns Tony Marchetta, a partner in the New Jersey office of Day Pitney LLP. "Any company incorporated into the state of Delaware is subject to these audits. It is a big money generator."

And, he said, a number of audit firms are involved in this. "On both sides, outside firms are being hired to deal with this issue," he said. "It's becoming its own cottage industry at this point."

Marchetta, who is working with a client on a corporate unclaimed property audit at this time, said these audits can involve intangible property, debts, credit obligations, unclaimed property, "anything that might have been paid out, that couldn't be paid out and stayed with the company for which an escheat tax was not declared or paid."

He said that a substantial amount of discovery takes place, and that the auditors ask for a great deal of information.

A key issue is a firm's document retention policy. "They can have you in a whipsaw with your document retention policies," Marchetta said.

One critical problem is that unless an insurer can document every item that might be subject to escheat, then the audit company makes an estimation based on revenue, sales, accounts payable, payroll, employees, average sales, customers, tax returns.

"They ask for everything imaginable to help them with their audit. And, if you can't document precisely the amount of escheat property that might be subject to the tax, then they can estimate," Marchetta said. "Then you are forced to challenge the estimation."

The bottom line? As a sluggish economy and budget crises force states to raise revenue however they can, audits into unclaimed property seem likely to grow in both scope and aggression. What started as a forensic auditing situation in a single state has now become a nationwide problem for the entire industry, with no easy end in sight.

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