2012 0910 - DOC 245 - DECLARATION OF DR. PATRICK L. BROCKETT - 73p

  • the policy as represented (“PR”)
  • with the policy as it actually functions (“PA”).
  • present discounted value (“PDV”)
  • premium expense charge (PEC),
  • “lapse acceleration” features

(p6)

Assignment
6. I have been retained by counsel for Plaintiffs to analyze issues in this matter as they pertain to the use of common evidence to determine the claims in this case as a class action, rather than as many individual actions.

  • Among other  things, I have been asked to describe the functioning of the SecurePlus Provider (“Provider”) and SecurePlus Paragon (“Paragon”) policies issued by Life Insurance Company of the Southwest (“LSW”).
  • Furthermore, I have been asked to determine whether damages based on the liability theories asserted by Plaintiffs could be calculated using a common formulaic approach.1

(p33)

54. Next, for each scenario, the actual policy dynamics (basic and index strategies, accumulated value, cash value, expenses taken out as per the illustration and premiums put in as per the illustration, etc.) were computed using the detailed outline of how the policy cash flow operated taken from the letter65 from James Lux to Brian Brosnahan dated September 13, 2011.66

(p41-42)

C. LSW’s Failure To Disclose The Policy Fees And Its Use Of The Term “One Policy Fee” In The Illustrations

69. Plaintiffs claim that LSW failed to disclose to policyholders various fees in the policy illustrations: the costs of the policies (including cost of insurance charges, the monthly Percent of Accumulated Value charge (for the SecurePlus Paragon policy), and the monthly policy fee).

(p42)

70. Plaintiffs further claim that LSW’s placement of the phrase “One Policy Fee,” in oversized, bolded type, at the beginning of the illustration is likely to cause policyholders to believe that there is only one fee that is applicable to the policy. Because the only fee that a policyholder must pay that is identified in the policy is the Monthly Administrative Charge, Plaintiffs contend that a reasonable consumer would understand the “One Policy Fee” to be a reference to the Monthly administrative Charge and would believe that the stated amount of the Monthly Administrative Charge would cover all policy fees that the policyholder must pay.

(p42) - Optional Report - ?

71. I have been informed that the subclass that asserts this claim has been defined to include only people who received a sales illustration but did not receive “Detailed Extra Columns” showing the additional fees.

  • I understand that this claim is common to the subclass as a whole because the sales illustrations do not show the allegedly undisclosed fees unless the “Detailed Extra Columns” are provided.

(p43)

D. LSW’s Failure To Disclose That The Guaranteed Minimum Values Are Not Annual Guarantees

The difference between two approaches is illustrated by the following hypothetical:

  • Assume that the policy was in effect for five years and that the S&P 500 had no gains in the first four years but had a gain of 10% in the fifth year.
  • Because the guaranteed minimum interest rate is 2% annually for the Provider policy, Plaintiffs contend that a reasonable policyholder would believe that he or she would be credited with 2% in each of the first four years plus 10% in the fifth year, for a total of 18%. In fact, LSW would calculate the guaranteed minimum interest retrospectively at the conclusion of the five-year period and would average the 10% gain in the fifth year with the 0% gains in the earlier years and credit only a 10% gain for the entire five year period, which yields an “average” gain of 2% per year.77

(p43)

  • Moreover, each of the illustrations contains a statement about how long the policy will endure on a guaranteed basis before it lapses.81

(p46)

  • These items significantly inflate Policy values and make the Policy appear far more attractive than it is.

(p49)

87. It is my understanding that each of Plaintiffs’ theories of liability permits damages to be calculated using the so-called “actual value” approach, which is a market-based approach that compares the price that the consumer paid for the product with the “actual value” of the product, i.e., the price that the product would have commanded in an open market under conditions of full disclosure.

  • If the actual value of the product is lower than the price the consumer paid for the product, then the consumer has been damaged.

(p49)

  • I further understand that the “actual” or “market” value of the product under conditions of full disclosure can be determined based on the willingness of consumers to pay for the product under conditions of full disclosure as compared with their willingness to pay under the original condition without full disclosure.

(p49) 

88. I have been asked to compare the expected value of the policy under different conditions.

  • In general, my approach has been to compare the expected value of:
    • the policy as represented (“PR”)
    • with the policy as it actually functions (“PA”).

(p51)

90. Moreover, it is my opinion as an expert on insurance that the value of the policies is far less as they actually function than was their apparent value as they were represented to policyholders and, further, that the reduction in the expected value of the policies as they actually function, as compared to the expected value of the polices as represented is a good approximation of the needed adjustment to calculate the value of the policies.

  • My methodology for making this adjustment -- principally by multiplying the fees paid (less the cost of insurance charge) by the ratio of the expected PDV of the policy as presented to the PDV of the expected PDV of the policy as it actually functions – is described below for each of Plaintiffs’ six theories of deception.

(p51)

I then apply that ratio .5 in my example to the prices that the consumers paid for the policies in the form of certain policy fees (the premium expense charge, Monthly Administrative Charges, policy fees, Percent of  Accumulated Value Charges, and surrender charges) because these fees represent prices paid by the consumer.87

  • In cases where a policy has not lapsed, the amount of premiums paid will in most cases be larger 
    than the amount of fees that have been deducted from the policy and there remains Accumulated Value in the policy; therefore, it would be incorrect to calculate damages based upon the total amount of premiums paid rather than the amount of fees paid. For that reason, I apply the reduced expected value ratio to the fees paid, not the premiums paid.
  • Thus, in the case of Ms. Walker, if the ratio representing the reduced expected value of the policy were .50 and she paid a total of $97,451 in fees, her damages would be $48,725.50.88

(p56-57)

This calculation can give an improved valuation of consumers’ willingness to pay if they were informed about the lapse risk induced by the volatility in the S&P 500 (and consequent damages since they were not so informed).

  • This adjustment would be common to all class members and may be appropriate to make in the merits phase of the case.

(p56)

When the policyholders bought LSW’s policies originally, they knew nothing about lapse risk induced volatility in value because it was not discussed in the illustrations.

  • If presented with the information, they would value the policy below the original sales price because they would want a product without lapse risk, and if they realized there was lapse risk they would demand a lower price to compensate them for the increased risk.

(p56)

Willingness to pay in the Actual World is related to the volatility around the present value of the future cash flow stream and not just the expected value.

  • Fortunately, the theory of modern finance offers an approach to this problem of calculating the dollar value of volatility risk by using the Capital Market Line (see Brigham and Daves, 2007, 85-87).
  • This gives a conversion rate at which changes in volatility risk can be transformed into changes in return. Because this model comes from traded markets, it represents a market price of risk, which is appropriate for this case since LSWsets rates according to the market environment common to all insurance buyers.

(p62)

  • 95 By “undisclosed fees” I refer to the premium expense charge (PEC), the cost of insurance charge (COI), the policy fee (PF), and (for Paragon policies) the percentage of accumulated value fee (%AV).
  • 96 For the Undisclosed Fees claim, the No Guaranteed MAC Reduction Claim, and the Current Basis Claim, the expected PDV of the policy is the same as its PDV because these are deterministic cases without any volatility.

(p64)

(ii) Refund Approach
105. As an alternative method based upon a refund approach, I simply calculated the amounts of undisclosed fees paid by the policyholder.97 For the named Plaintiffs, those amounts are as follows:

AMOUNT OF UNDISCLOSED FEES PAID
Walker Howlett Spooner
PEC COI PF %AV PEC COI PF %AV PEC COI PF %AV
11,200 3,930 145 N/A 6,345 21,415 195 1,110 3,570 8,181 155
574
Total: $15,275 Total: $29,065 Total: $12,481