Michael Hawkins was working his first job as an actuary in Regina, the capital of Saskatchewan, when he discovered the loopholes that could bring down the Canadian insurance industry. His boss at Crown Life, a former astrophysicist, told him that if people took advantage of the options that were in plain sight â€” at least to an actuary â€” in a broad range of insurance contracts, the companies would all be bankrupt.Â
Hawkins, a baby-faced farmer with 30-odd cows and a bull on his cow-calf farm who now lives near the uniquely named town of Flesherton in southern Ontario, 50 miles from where he grew up, says, as an example, that insurers sell whatâ€™s called term-to-100 life insurance. This type of insurance guarantees that premiums stay the same for the life of the policyholder. As he explains this, itâ€™s December, a week before Christmas, and Hawkins has driven down from his farm to meet me in Toronto at the offices of large Canadian law firm Aird & Berlis.Â
â€śThink about it,â€ť says Hawkins. â€śWhen consumers stop paying â€” whether itâ€™s one year or 50 years after they bought the policy â€” they get nothing and the insurance company is freed from having to pay a death benefit.â€ť
â€śI bought one when I lived in Regina when I was 25,â€ť he explains. â€śThe premiums I pay today, at 48, are the same as when I bought it. But the policy has no cash value, so people let them lapse all the time, even though when they are 85 or 90, that contract has a lot of value,â€ť says Hawkins. â€śInsurance companies take advantage of that.â€ť
In the 1990s at Crown Life, Hawkins worked on then-popular universal life insurance products, which also offered holders a range of investments, including short-term accounts that offered guaranteed minimum interest rates between 3 and 5 percent. Crucially, a few had no limits on the amount of money that could be deposited. Insurance companies were aggressively competing with one another to attract customers watching rising stock markets with life policies that included an investment component. Within these products hid Hawkinsâ€™ Trojan horse.
By 1997, Hawkins had moved to Toronto to take a job at insurance specialist Buck Consultants. Still working on universal life, valuing the products and helping brokers design them, he was loving his job of analyzing old contracts, some of which were issued by insurance companies long ago acquired by competitors.Â
trial began in September 2018. The insurers have argued that the court shouldnâ€™t analyze the language of the contracts, explaining that the policies need to be looked at in terms of their purpose and intent and the context in which they were issued. They say the â€śspiritâ€ť of the insurance contracts was just that: insurance; they were not to be used as investments, as the plaintiffs claim. The insurers have filed multiple briefs on â€ścontextâ€ť that include the history of the Insurance Companies Act, tax policies, and other regulations, including how to calculate reserve requirements. Context, if itâ€™s relevant, though, has to be entirely obvious to the consumer, say legal experts.Â
Manulife, for one, has pulled out the bankruptcy card. Its expert witness claimed in court that the insurance company will go out of business if Hawkins and Selke are allowed to put an unlimited amount of money into the contracts.
announced on October 4 a short position in the insurer and issued a report on Manulifeâ€™s potential liabilities, sending the stock down 14 percent. â€śIf the judge rules in Mostenâ€™s favor, they could turn this into the worldâ€™s highest-yielding money market. This would be an attractive alternative for fund managers to stash cash and they could stuff Manulife with billions,â€ť Block told Real Vision, a financial news show, in December.
(In a written statement, Manulife asserted that it â€śtakes its disclosure obligations seriously and has complied with applicable disclosure requirements. The Company carefully reviews litigation before making a determination whether to disclose it. The likelihood of a significant loss in this case is remote and therefore the Mosten matter is not material. As stated in our third-quarter 2018 analyst call, we anticipate that Mosten and others who have an interest in undermining confidence in Manulife will continue to resist our position and may have an interest in spreading misinformation.â€ť)
Block stressed that he isnâ€™t making a bet on which way the litigation will go, but instead was shorting the stock because the market wasnâ€™t aware of the risks at the time. Manulife disclosed information about the trial for the first time in a press release on October 4th, after the Muddy Waters report.Â
changed its insurance regulations to limit the amount of premiums a life insurer may receive or accept for deposit in certain life insurance policies. Manulife then issued a press release saying the regulation changes resolved the case. â€śManulife and the other life insurers involved in similar matters plan to make submissions to the court, asking it to dismiss the claims that life insurers can be compelled to accept unlimited premium payments,â€ť the firm said. Industrial Alliance issued a similar statement. Manulifeâ€™s stock rose, at least temporarily.Â
The regulation, which was retroactive, came only a few weeks after the end of the trial and didnâ€™t follow normal procedural processes, such as public comment and discussion. Many rules can take 18 months to be implemented. Other provinces donâ€™t have similar rules on limits. â€śItâ€™s very unusual for the government to intervene in an ongoing trial,â€ť says Selke. The Canadian Life and Health Insurance Association intervened in the case, saying Mostenâ€™s and the other partnershipsâ€™ position is contrary to the intended purpose of the product and the regulatory system in Canada.Â
Block agreed that the timing of the regulation was odd. â€śThis is suspicious in timing. The regulation was promulgated two or three weeks after we made it public. So they get media attention and suddenly thereâ€™s a new Saskatchewan regulation. Interesting insight into our friends to the north,â€ť he told Real Vision.Â
Itâ€™s not the first time insurance companies have struggled after mistakes from bad underwriting, particularly after 2008, when the market downturn and fall in interest rates highlighted the financial impact. Manulife had to issue more shares and borrow billions during the financial crisis after failing to hedge the risk of variable-annuity guarantees. Hartford Financial, Voya Financial, and other insurers sold off billions of variable life or annuity liabilities for a fraction of their costs in the last ten years because the contracts had been a drag on their stock prices.Â
No one would be fighting about these contracts if it werenâ€™t for low interest rates. The insurers never imagined that long-term interest rates around the world would drop far below 5 percent.Â
After the Saskatchewan regulation, the judge in the case said he would consider the rule and delayed his decision. Manulife filed a new brief in late December; Hawkins and Selke will file a response at the end of January. The trial will be reopened for three days in February.
Until Justice Brian Scherman comes to a conclusion, what we have is a war of words.Â
Manulife says that itâ€™s all, well, absurd.Â
â€śMostenâ€™s proposed interpretation of the contract is commercially absurd. It suggests that Manulife (through its predecessor, Aetna) entered into a contract that provides a guaranteed interest rate on unlimited deposits,â€ť Manulife said in its brief of law submitted in August.
Itâ€™s absurd, the insurer claims, because it could take down the Canadian life insurance industry. As its lawyers write in the brief:
â€śNot only is this interpretation unsupported by the language of the contract and prohibited by statute â€” it would also have significant and severe financial implications for Manulife and a destabilizing effect on the entire Canadian life insurance industry. This cannot be what the parties to the original insurance contract intended.â€ťÂ
â€śMischiefâ€ť is what Terry Dietrich, vice president and appointed actuary at BMO Life, wrote in an affidavit in April 2017 about Hawkinsâ€™ interpretation of the contract.Â
â€śThe potential for mischief if Atwater is successful in its application is that hundreds of millions, if not billions or more, of dollars available to hedge funds and pension funds seeking a highly rated investment opportunity with complete liquidity and an advantageous rate of return, could be deposited into the contracts or into similar UL policies.â€ť Dietrich went on to say that there will be â€śfurther specific mischiefâ€ť if the partnership earns fees to do all that.Â
It might not be what the insurers intended, but Hawkins and Selke maintain that the contracts are black and white. They say Manulife and the other insurers can solve the problem by offering a new policy in exchange for the old one â€” for a price, of course. Manulife did something similar for some annuity holders late last year. (Hawkins and Selke, however, do not want to sell their policies.)
â€śThe insurance companies need to get the product back and clean up the mess,â€ť Selke says. â€śBut Iâ€™m not aware of a financial product recall. Itâ€™s similar to the Tylenol problem, but here the product is bad for the company â€” and good for the consumer.â€ťÂ