SEC Charges IAR with Defrauding Clients in Connection with FIA Sales

If you missed this past newsletter, you didn’t download/read the SEC’s complaint. If you want to (it’s quite troubling), click on the following:

LSW Sued for Fraud Over 412(e)3 Life & Annuity Sales in Pension Plans

This complaint should be MANDATORY reading for every insurance agent and securities licensed advisor. To download the complaint, click on the following:

I’ve been railing against 412(e)3 Defined Benefit (DB) plans for over 20 years. They have NEVER made any economic sense, but insurance companies and agents continue to push them.

To understand the math as to why 412(e)3 DB Plans are so bad, click on the following to read my past article titled: Why Buying Life Insurance in a Qualified Plan is a Terrible Idea!

Defined Benefit (DB) Plan vs. 412(e)3 DB Plan

What’s the difference? An (e)3 plan MUST be funded solely with life insurance or annuities.

(e)3 plans are “fully insured” plans because they are funded with products that have guarantees. Because the expected rate of return on these guaranteed products SUCK, actuaries can assume a lower rate of return which increases the contributions by the employer.

You can tax-deduct significantly more into a 412(e)3 plan. But the retirement benefit does NOT increase (which is why these plans make no financial sense).

Life Insurance (whole life) vs. Annuities—insurance companies/agents typically recommend a 50% mix of life insurance and 50% fixed annuities. They could be funded solely with annuities.

A traditional DB Plan can be funded with ANY investment (although, usually conservative investments are used since the business is guaranteeing the employees’ retirement benefit).

Why the lawsuit?

1) Someone figured out that the plan SUCKs from a financial point of view.

2) The plan in question required more funding than the company could afford after it was made clear from the outset that the company could only afford X amount as payments each year.

Who was sued? Bruce Reich, National Life Insurance Company, Life of the Southwest.

What were the claims?

1) Breach of Fiduciary Duty
2) Negligence
3) Fraudulent Misrepresentation

National Life and LSW are being sued through a principal-agent relationship theory.

Facts (as pled in the complaint)

-In 2019, the employer (Plaintiff) engaged agent Bruce Reich to assist with creating an employee benefit plan to “retain key employees.”

-Employer had budgeted $500,000 a year in annual contributions.

-Reich “continually assured” the employer that contributions would NOT substantially increase.

-Reich “imprudently invested” excessive pension funds into life insurance and low-yielding annuity policies.”

-The plan “required” them to buy inefficient, expensive, and low-yielding policies.

From a fiduciary standpoint, the Plaintiffs alleged that the advisor and company put their own commissions ahead of what’s best for the client (I 100% agree) (in the form of up-front and ongoing commissions).

The most damning allegation:

As an investment fiduciary to the plan, Reich knew or should have known that it would take many years before the cumulative cash surrender value of the individual life insurance policies he sold to the plan would equal the accumulated premiums paid, and many more years before it would achieve a modest 2-3% investment return. This massive financial loss to the plan assets dramatically increased the plan’s annual funding requirement above the level that would have been required to fund the plan without the purchase of life insurance policies.

It sounds so simple, but I’ve been railing against these plans for two decades, and agents/insurance companies who sell them don’t seem to care (about the client).

What should the plan investments have been to avoid this lawsuit?

If they used a mix of FIAs (Fixed Indexed Annuities) with a modestly conservative equity portfolio, the plan would NOT have required additional funding and it would have been able to meet the retirement distribution requirements.

But then the agent/insurance company wouldn’t have sold a bunch of life insurance!

Should You EVER Use a 412(e)3 DB Plan?

NO! Use a traditional DB plan which allows more prudent investments to be used.

But the deduction will be lower! So what, the retirement benefit is NOT higher. So, it makes NO financial sense to fund these plans.

What if you already sold one of these awful plans? Hope your clients don’t run into a law firm that is as savvy as the one who filed this lawsuit.

Roccy DeFrancesco, JD, CAPP, CMP
Founder, The Wealth Preservation Institute
Co-Founder, The Asset Protection Society