November 2010 (Bloomberg Markets) -- After a U.S. soldier dies in combat -- including the more than 4,000 service members who have been killed in Iraq and Afghanistan -- the Department of Veterans Affairs sends Prudential the full amount of each family’s life insurance coverage, usually $400,000.
The government has paid Prudential $1.7 billion for these benefits since 2003, when the war in Iraq began, according to information provided by the VA, Bloomberg Markets magazine reports in its November issue.
Prudential holds that taxpayer money, invests it and reaps the gains.
Here’s how it works: If survivors request a lump-sum payment of the death benefit, Prudential opens a so-called retained-asset account, a quasi-checking account that allows families to draw money when they’re ready to spend it.
Until the money is used, it stays in Prudential’s corporate account. There, the insurer invests the funds, mostly in bonds, making returns as much as eight times higher than what it is paying out to holders of the retained-asset account.
What this means is that Prudential is investing -- and profiting from -- death benefits owed to the families of slain soldiers, using money provided by the U.S. government.
“They have what appears to be a nice sweetheart deal with the federal government,” says Michael Powers, professor of risk management and insurance at Temple University in Philadelphia. “This strikes me as the same sort of thing as those classic stories of the government paying hundreds of dollars for a wrench or a toilet seat.”
Ninety-five percent of survivors paid by Prudential ask for lump-sum payments, the VA says. Since 1999, Prudential has sent out more than 60,000 Alliance Account checkbooks, instead of checks, covering more than $7 billion in death benefits when families asked for full payouts.
On average, Prudential holds about 16 percent of survivors’ money for at least a year, according to Prudential. As of June 30, the company had $662 million belonging to military families in its general account, the VA says.
Prudential’s general account earned 4.2 percent in the first half of 2010, regulatory filings show. The company paid survivors holding Alliance Accounts 0.5 percent in the same period.
“It sure looks like the VA provided an ill-conceived giveaway, or that Prudential played the VA like a fool,” says Steven Schooner, co-director of the Government Procurement Law Program at George Washington University Law School in Washington. “It’s a lose-lose proposition for everyone but Prudential.”
Prudential spokesman Bob DeFillippo says the professor is wrong.
“Prudential assumes the vast majority of mortality risk for the participants,” he says. “We also assume all of the investment risk.” He declined to elaborate on what Prudential’s insurance and investment risks are.
The VA says it is taking steps to better help survivors.
“The VA is working to ensure that all aspects of the Alliance Account and all choices to the beneficiary are made absolutely clear and that all facts concerning the administration of the accounts continue to be fully transparent and disclosed,” says Thomas Lastowka, the VA director for insurance.
Since July 28, when Bloomberg News first reported that Prudential sent checkbooks instead of checks to survivors requesting lump-sum payouts, state and federal officials have demanded the retained-asset system be investigated and reformed. The VA itself launched a probe of its life insurance program the day the first story was published.
The next day, New York Attorney General Andrew Cuomo launched what he called a “major fraud investigation” of Prudential and other life insurers over their use of retained- asset accounts. Since then, Cuomo’s office has issued subpoenas to Prudential and at least 12 more insurance companies.
The insurance departments in Georgia and New York have also opened probes. The U.S. House Oversight and Reform Committee plans to hold hearings into Prudential’s use of retained-asset accounts to pay money owed to fallen soldiers’ survivors.
New VA Policy
The VA announced on Sept. 14 that Prudential had agreed to halt its practice of automatically sending checkbooks to survivors who ask to be paid with a lump sum. Instead, the insurer will offer families the option of receiving the full amount by check.
Prudential also said it would no longer include any official agency seal on Alliance Account checks, forms and correspondence -- to avoid the appearance that they have been endorsed by the federal government. Prudential will also make clear that its account isn’t protected by the Federal Deposit Insurance Corp.
The reason why taxpayers pick up the tab for all life insurance benefits owed to the families of soldiers killed in combat goes back 45 years.
Before the Vietnam War, the U.S. government ran its own life insurance programs, with separate plans specifically created for World War I, World War II and the Korean War. By 1956, the military had closed to new enrollments all of the programs insuring combat soldiers.
To provide coverage for troops being sent into harm’s way in Vietnam, Congress adopted a law in September 1965 -- proposed by the life insurance industry -- creating the Servicemen’s Group Life Insurance program.
The 1965 law required that, for the first time, the federal government would work with a life insurance company to cover war deaths. Congress also put into the law another mandate endorsed by the industry, which was concerned about the casualty rate among soldiers in Vietnam.
The Life Insurance Association of America endorsed a provision guaranteeing that the government pay the full costs to the insurance company for death benefit payments due to families of soldiers killed in battle. The private company would not be on the hook for payouts owed to any soldiers slain in combat.
Nine days after President Lyndon Johnson signed the bill into law on Sept. 29, 1965, the VA awarded a no-bid contract to Prudential. The program is set up so that the government deducts premiums from soldiers’ pay. The government holds the money for a short while and then sends it to Prudential.
The insurer uses that money to pay benefits for deceased military members who didn’t die in combat. Prudential puts cash not immediately needed to pay claims into a reserve fund. The company invests that money and puts all the gains back into the reserve.
Today, the VA’s contract with Prudential covers 6 million active service members, their families and veterans. Lastowka says his agency isn’t considering putting the contract up for bid. Since 1965, the VA has paid Prudential annually to cover administrative expenses, most recently $4 million in 2009.
Before Prudential started using the Alliance Account in 1999, the insurer’s government contract wasn’t a moneymaker, VA Chief of Staff John Gingrich says.
“Where Prudential has the option to make money is the Alliance Account,” Gingrich says. Alliance Accounts hold survivor money for families of both soldiers killed in war and those who died in other circumstances.
The first taxpayer money made its way into Alliance Accounts in 2003, as soldiers died in Iraq and Afghanistan, according to VA documents.
After taxpayers covered $18 million that year, annual payments to Prudential peaked at $460.9 million in 2007. Taxpayers sent Prudential $213.2 million in 2009. The seven-year total of public funds going to the company was $1.7 billion, 95 percent of which went into Alliance Accounts.
The VA doesn’t reimburse Prudential for benefits owed to families of soldiers who died noncombat deaths, but it does help the insurer in another way. The agency provides a financial cushion.
To do that, it has set soldier premium payments at levels high enough to build up a so-called contingency fund, which Prudential manages. The VA says that fund held about $835 million as of June 30, 2009.
The contingency fund is too large, Lastowka says. VA actuaries have determined it should hold about $230 million less, he says. As a result, the VA lowered soldiers’ premium payments by 7 percent to $26 a month starting on July 1, 2008.
Even with that change, the contingency fund provides Prudential more backup than VA actuaries recommend.
“It’s a very low-risk situation,” Lastowka says. In the 45-year history of the VA insurance program with Prudential, the money in the contingency fund has always been sufficient to cover all of the claims the company had to pay out.
In 1965, before Congress created the new insurance program, the American Legion tried to convince lawmakers not to contract with an insurance company.
The nation’s largest veterans’ service organization, chartered by Congress in 1919, expressed concern that the government would set and collect premiums, do record keeping and pay for war deaths -- so there would be no need for an insurance company.
‘Widows and Orphans’
“Nothing remains, really, for the commercial companies to do except realize a profit,” American Legion executive John Corcoran said at a hearing on Sept. 9, 1965. “Indemnifying the lives of our servicemen and providing a degree of protection to their parents, widows and orphans is not a business transaction; it is the responsibility of the government.”
Peter Gaytan, executive director of the American Legion in Washington, says the organization’s position hasn’t changed: “We have to overhaul the system so nobody can make profits off soldiers who died in action.” David Evans is a senior writer for Bloomberg Markets in Los Angeles at firstname.lastname@example.org.
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