What Does Prudential Really Owe?

As much as $8.5 billion for alleged churning, some critics say

Is Prudential getting off too easy? Starting on Jan. 26, three judges in the Third Circuit Court in Philadelphia will consider overturning a major class-action settlement with the Prudential Insurance Co. of America.

The class action alleged that Pru harmed owners of 10.7 million of its policies. The settlement, which was approved by a New Jersey U.S. district court judge in March, 1997, could require Pru to pay a minimum of $410 million and as much as $1.7 billion, depending on the amount of claims paid to policyholders. Michael Malakoff, a Pittsburgh attorney for 21 clients who objected to the settlement, is leading the charge to overturn the deal. "The settlement is just totally inadequate and the attorneys' fees are excessive," he says, referring to the $90 million paid to the class's law firm, Milberg Weiss Bershad Hynes & Lerach. Melvyn Weiss, lead plaintiffs' counsel, denies the fees are excessive. The court is not expected to make a decision for months.

Even $1.7 billion pales in comparison to the actual dollars customers may have lost through allegedly deceptive sales practices. Estimates of total harm range from $5.6 billion, as calculated by the state of Florida, to $8.5 billion, according to a former Prudential audit director, John Cressman. Most comes from "churning"--agents selling existing customers new life insurance without explaining it is financed by stripping the value from their original policy.

Of course, it's not unusual for plaintiffs to get crumbs in class-action settlements, since their lawyers can cut deals that are far better for themselves than for the injured parties. But J. Robert Hunter, a former Texas insurance commissioner who is now director of insurance for the Consumer Federation, says: "The settlement is woefully inadequate."

There's an outside chance Malakoff's appeal will succeed, for the class-action game is getting harder to play. In 1996, the Supreme Court threw out an asbestos class-action settlement against AmChem Products Inc. on the grounds that it wasn't fair to thousands of alleged victims. But Weiss thinks the settlement is secure. "I'm highly confident we will succeed," he says.

STUNNING RESPONSE. Prudential, headed by Chief Executive Arthur F. Ryan, disputes the higher estimates of economic harm. And the company is offering restitution to every policyholder with a legitimate claim, says Pru spokesman Robert DeFillippo. In 1997, the insurer mailed out lengthy information packets to all customers who bought policies between 1982 and 1995, inviting them to apply for restitution. It ran ads and set up an 800 phone number to answer questions. Pru says that's the most it can do, since it is impossible to determine how many have been harmed. "No one can make an accurate estimate," insists DeFillippo. "The settlement is fair and equitable."

But there are grounds for skepticism. None of the court studies answered the basic question of how many policyholders were actually harmed by deceptive sales practices. Studies submitted to the court assumed that 3% of policyholders in the class would receive relief. As in most class-action cases, the people who responded to letters from Pru seeking restitution may represent only a small part of all the people who were harmed. DeFillippo says the 3% assumption is merely a "hypothetical" used only to "illustrate if the settlement would work."

In fact, though, 10%--1.1 million people--have responded so far. In Florida, the response rate was a stunning 29%. Of roughly 300,000 Pru policyholders there, some 87,000 have applied for relief, says Insurance Commissioner Bill Nelson.

The explanation is not that a larger proportion of Floridians were churned than elsewhere. Pru has far more customers in Pennsylvania, New York, and New Jersey, and the allegedly deceptive sales practices were fairly consistent nationwide, according to a study by the Multi-state Task Force, a group of 45 state regulators who hammered out the settlement. Rather, Florida was considerably more aggressive in helping its citizens get relief. It got an extra $15 million from Pru to pay for special staff to help Floridians fill out Pru's confusing, 20-page claim forms; Florida insisted on an independent review of claims, rather than one by Pru employees; and it advertised filing deadlines.

"I would try to replicate what we've done in Florida," says Nelson. "If you leave it up to Prudential, people won't get their money." Theoretically, if all 50 states had worked as hard as Florida, the response rate--and restitution--could have been triple the actual one.

But the main issue is what the actual damages were. In December, 1996, Florida conducted a detailed study of the amount of churning in the state based on customer data obtained from Pru on policies from 1990 to 1994. Florida looked at "disbursements from old policies in the exact amount [to the penny] of premiums on new policies issued to the policyholder." By extrapolating to the 14-year period covered by the class action, the state estimated that Floridians lost $205 million. Since Florida typically comprised 3% to 4% of Pru's national sales, it estimated that nationwide, the economic harm of Prudential's churning was about $5.6 billion.

"RIDICULOUS." However, an accountant hired by Prudential disputed Florida's calculations, saying the $5.6 billion estimate should only be $150 million. Weiss calls the Florida estimate "ridiculous." The New Jersey court rejected the Florida numbers as well.

Another estimate of harm is derived from calculations by Cressman, now assistant chief financial officer at the Housing & Urban Development Dept., using data from the 1996 state task force study, the most comprehensive report on Pru's deceptive sales practices. Cressman applied the task force's estimates of deceptive practices to the actual amount of premiums Pru collected. That analysis shows the insurer collected $100 billion in individual life insurance premiums between 1982 and 1995. Of this, $11.7 billion represents premiums for just the first year. The analysis assumes 20% of the $11.7 billion in new sales was made on the basis of churning, or $2.3 billion in the first year. But since churning typically lasts about four years, the assumption is that Pru churned an additional $7 billion for the subsequent three years. Using the data, an estimated 10% of sales was for "abbreviated pay," when an agent tells a client that premium payments will end in five years, then be covered by dividends. Some 5% was for selling insurance as an investment product.

This analysis concludes that policyholders were victimized to the tune of $17 billion. To be conservative, chop this in half, and the cost is still about $8.5 billion. "It's clear to me that the amount of harm done to the policyholders is substantially more than the company is expected to pay as a result of the recent settlement," says Cressman.

To be sure, the task force says that its estimates are very rough. And Prudential strongly disputes this calculation and says it is paying everything that policyholders are owed. Now it's up to the judges.

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