News & Updates


Investors Recruit Terminally Ill To Outwit Insurers on Annuities


PROVIDENCE, R.I.—”Terminal Illness? $2,000 in CASH, Immediately Available.”

That was the promise of an advertisement that appeared regularly in 2007 and 2008 in the Rhode Island Catholic, the official newspaper of the local diocese. The money, the ad said, was coming from a “compassionate organization” that wanted to provide “financial assistance” for those near death.

In reality, the ad was a recruiting pitch for a plan hatched by a prominent Rhode Island estate-planning lawyer, who believed he had discovered a way to use an investment product sold by insurance companies to make no-risk bets on the stock market. He recruited dozens of terminally ill people to, in effect, serve as paid fronts for purchases of the product, variable annuities. The lawyer and other investors put tens of millions of dollars into the policies, hoping to reap a profit when the recruits died.

The arrangement, now under investigation by federal prosecutors and snarled in litigation, is the latest twist in a cat-and-mouse game between insurers and sophisticated investors. The investors comb through policies marketed to individuals and figure out ways to convert them into profit-making products for people with no emotional bond to the deceased.

For years, insurers have cried foul about “stranger-originated” life insurance, in which people are paid large sums by investors to take out life-insurance policies and sign over rights to collect on them. In the most controversial of such deals, some elderly people lied to get multimillion-dollar policies, using loans to pay their premiums until they sold the policies, court rulings indicate. The investors continued to pay the premiums, collecting when the insured person died.

Many in the business of buying policies say they’re providing a valuable secondary market for consumers. But insurers claim the practice violates laws requiring buyers of life insurance to have a legitimate interest in the insured person, such as a relative. Insurers have filed lawsuits and lobbied for regulatory changes. Last year, 11 states, including New York and California, passed industry-backed laws that tightly restrict the ability of customers to flip brand-new policies.

Now, there are signs that professional investors are moving into a different product, variable annuities. Though the trend is recent, regulators and insurers are on alert. Ohio’s insurance department put out a warning last summer, suggesting insurers install safeguards against stranger-originated variable annuities. ING Groep NV warned its brokers against facilitating such policies. The National Conference of Insurance Legislators, a group of state officials, has the topic on the agenda for a meeting next month.

“Never underestimate the creativity of people who want to take advantage of the system,” says Mary Beth Senkewicz, a Florida insurance regulator. Some cases, including the Rhode Island one, appear to involve untested areas of the law, experts on insurance law say.

Variable annuities are issued through insurance carriers, but function as retirement-savings vehicles akin to 401(k) plans. An individual puts in money upfront and can add more over time, which gets invested in stock or bond funds and grows tax-deferred.

At retirement, a holder can withdraw the money, convert the accumulated amount into a stream of lifetime annual payments—or leave it sitting there for heirs.

The twist that makes variable annuities attractive to professional investors is a money-back guarantee built into the plans, called a death benefit. In effect, insurers promise that a buyer’s beneficiaries will get back at least the amount that was originally invested, less withdrawals. So if a holder puts in $1 million, and the market subsequently tanks, the holder’s heirs will still receive $1 million.

Some insurers added enhancements to this basic death benefit, including a built-in interest rate that gradually increases the minimum money-back amount. Insurers figured they could recoup the cost of the guarantees over time, through the hefty fees usually associated with the products.

Joseph A. Caramadre, the Cranston, R.I., lawyer behind the ads recruiting the terminally ill, is an insurance expert with a high profile for his philanthropic activities. Last year, his family was honored by the Rhode Island United Way chapter with its highest annual award, and was lauded by the local Catholic Charity Fund for a $100,000 gift.

“Joe’s specialty is closely reading insurance contracts,” says his lawyer, Robert G. Flanders. About 15 years ago, he says, his client realized that variable annuities have two significant differences from regular life insurance. Because the products are sold primarily as investments, insurers generally don’t ask about the health of the “annuitant,” the person whose death triggers the death benefit. And some don’t seek information about the buyer’s relationship to this annuitant.

That leaves the door open for professionals to invest in somebody else’s policy, says Mr. Flanders.

Some observers find such tactics ghoulish, but say insurers are partly to blame. “The amazing thing to me is that the money comes in, and they just take it,” no questions asked, says Joseph Belth, professor emeritus of insurance at Indiana University.

The best way to take advantage of the death benefit, Mr. Caramadre decided, was to take out an annuity tied to somebody with a short time to live, his lawyer says. That transformed a long-term product with hefty fees into a short-term, no-lose way to play the stock market.

If stocks rose while the person was still alive, the investor did well. If they fell, the investor got a full refund, leaving the insurer on the hook for the loss. Meanwhile, a broker—in some cases a partner in Mr. Caramadre’s firm—would collect a share of a commission of as much as 7.5% of the invested amount, paid by the insurer.

Mr. Caramadre started off by teaming clients with terminally ill people found by word of mouth, his lawyer says, and also invested his own money. Profits could be small. But in one instance, an investor made a 30% profit in nine months on a $1 million annuity, according to one of eight lawsuits filed by insurers in federal court in Rhode Island seeking to rescind some of the annuity deals.

Among those who responded to Mr. Caramadre’s offer was Sandra Bulpitt of Johnston, R.I. She was dying of stomach cancer in 2008 when she saw a flier from what appeared to be a Catholic charity, says her husband, Dan. Mr. Bulpitt says the family of four was on food stamps after he quit his auto-dealership job to care for his wife.

One of Mr. Caramadre’s employees came to their house and gave them $1,000, Mr. Bulpitt recalls. In a second meeting, the man brought a client who paid them $5,000 “as philanthropy” for helping with what Mr. Bulpitt thought was a tax shelter. His wife, heavily medicated, signed a flurry of papers.

According to a lawsuit brought by Aegon NV, one of its units issued an annuity in Ms. Bulpitt’s name in October 2008, and a total of $1 million was soon put into it. Ms. Bulpitt died less than four months later, at age 49, as the stock market was approaching its low. When the Caramadre employee submitted a death-benefit claim in June 2009, the account was less than the original $1 million, according to a spokesman for Mr. Caramadre. But Aegon repaid the full $1 million, plus $13,000 from an interest rate built into the death benefit.

Mr. Bulpitt, who says he recently testified before a federal grand jury, says his wife wasn’t told about any annuity. He says “they took advantage of my wife. Don’t get me wrong, I was out of work. The money was definitely needed.” Still, “I think they’re scumbags for preying on the sick and suffering like that.”

Mr. Flanders says everyone who signed up for annuities was fully informed. “This was the opposite of Bernie Madoff,” he says. “Everybody who was touched by Mr. Caramadre made money.” He says Mr. Bulpitt got an additional $2,000 after requesting more help.

A January report by the U.S. Treasury Department’s Financial Crimes Enforcement Network noted reports of “death benefit annuity scams” in several regions of the U.S. in 2007 and early 2008, involving eight insurers. The transactions often involved “elderly or terminally ill persons,” the report said, and quick claims for payment.

In a case pending in federal court in Brooklyn, N.Y., an Illinois man claims that investors fraudulently took out or sought to buy annuities through at least six major insurers in the name of his late sister, Sherry Pratt, then a 38-year-old quadriplegic from a shooting who lived at a nursing home in Chicago.

The case involves a $975,000 variable annuity issued by MetLife Inc. in early 2008 to a family trust overseen by Daniel Zeidman, a doctor, 14 days before Ms. Pratt died. While reviewing the death claim, MetLife says it received a letter from Ms. Pratt’s estate, saying the quadriplegic woman couldn’t have “executed any signatures” because her dominant arm had been amputated.

The estate alleges that a Chicago-area woman worked to help identify patients whose names could be used by brokers around the country on annuity applications. The Pratt family isn’t out any money, but contends it is due compensation for misuse of Ms. Pratt’s name.

MetLife rescinded the deal and asked a judge to sort out whether the $975,000 should go to the Zeidman trust or Ms. Pratt’s family, court documents show. The Zeidman trust says Ms. Pratt consented to the annuity’s issuance, but it isn’t contesting the rescission.

In Rhode Island, Mr. Caramadre began ratcheting up his annuity business around October 2007, when he started running ads in the Catholic weekly. Local hospice workers and nurses also handed out the ad to patients.

His lawyer, Mr. Flanders, says his client genuinely wanted to help the terminally ill. More than 150 people responded to the offer, he says. Of those, 112 weren’t interested in having their names used for an investment plan and were paid $2,000 anyway, he says.

Mr. Caramadre offered extra money to those who let him use their names in connection with the annuity plan or a separate program involving corporate bonds, his lawyer says. In that program, an investor and the dying person would establish a joint brokerage account, used to buy “death put” corporate bonds trading below face value. When the person died, the instruments allowed the surviving owner—in this case Mr. Caramadre’s client—to demand the bonds’ original face value, potentially turning a quick profit.

Forty-four respondents agreed to have their names used in either the annuity or bond program, or both, according to Mr. Flanders. They received an additional sum, usually $5,000 to $7,000.

Anthony Pitocco, a 74-year-old man with lung cancer, is listed on a $2 million annuity taken out in January 2009. In a sworn statement filed in an Aegon lawsuit, he said the signature on the annuity application wasn’t his. His son, Jim, says: “Why should people be profiting from my dad dying? That’s just disgraceful.”

Mr. Flanders says there may be a few angry people, but many who received the money were happy to participate. “Far from being taken advantage of, they were being given an opportunity to make money.” He insists that Mr. Pitocco signed the documents, and notes that he was given an extra $3,000 in cash.

Mr. Flanders confirms the investigation by federal prosecutors, which he believes was stirred up by insurers’ “whining.” He says insurers were happy to take the money and fees, until forced to cover investment losses after the 2008 market slide. “They’ve got the resources to fight if somebody is clever enough to beat them at their own game,” he says, adding that Mr. Caramadre and his firm are “cooperating fully” with the probe. A spokesman for the U.S. attorney in Providence declined to comment.

Federal lawsuits filed by units of Aegon and Nationwide Mutual Insurance Co. variously name Mr. Caramadre, his associates, brokers or investors. According to court documents, the group bought at least $50 million of annuities from those insurers. Mr. Flanders says his client also arranged annuities through ING and other insurers.

Eric Henderson, a Nationwide senior vice president, says professional investors are “gaming the system,” and if such practices become common his firm will be forced to raise prices for ordinary customers.

Aegon, which filed seven of the lawsuits, maintains among other things that the annuities are void because they violated a state “insurable interest” law that requires anybody buying life insurance to have a legitimate interest in the life of the insured, and because the defendants failed to disclose the terminal illnesses.

Mr. Caramadre’s lawyers respond that the annuities are securities and don’t fall under those laws, and that insurers didn’t ask about health for fear of reducing the pool of buyers.

Legal experts say the Rhode Island cases may be the first to test the nuances of variable-annuity death benefits.