Life of the Southwest (LSW) has been on a bad roll lately and has now been sued for deceptive IUL sales with a RICO (racketeering) count which comes on the heels of two other lawsuits:
-LSW Sued in IUL Pyramid Sales Scheme (Class Action Certified)
-LSW Sued for Fraud Over 412(e)3 Life & Annuity Sales in Pension Plans
Download All Three Complaints
If you want to download a copy of LSW’s NEW Class Action lawsuit, and also its other two recent lawsuits, click on the following link:
https://advisorshare.com/lsw-class-action-rico
VCIs are at the Center of This Lawsuit
The allegations in this new lawsuit are ones I’ve not seen before and revolve around how VCIs (Volatility Control Indexes) are illustrated and credited.
Many advisors selling FIAs and IULs with VCIs don’t really understand how they work and can’t explain their mechanics to clients. In 2018 I drafted a 16-page VCI white paper explaining how VCIs work. To read this white paper, click on the following link:
https://advisorshare.com/vci-white-paper
At the heart of the matter is how LSW illustrates the historical/back-tested/hypothetical rates of return in the IUL policy.
The plaintiff is alleging that LSW is being deceptive in how they illustrate two different VCIs.
There are a few issues at play…
1) Why did LSW use hypothetical back-tested returns in years when they had the actual rates of returns in those same indexes?
2) Why were the hypothetical returns so much better than the actual returns?
It’s alleged that the illustrated performance has a 1 in 1,000 chance of coming true.
The complaint harps on how the use of back-tested VCIs (and specifically ones that have only been in existence for a handful of years) is misleading (the company created the VCIs with hindsight to make them look good knowing that the back-tests are not likely to come true).
FYI, the illustrated rate of return in the policy alluded to in the complaint was 6.42%.
3) Excess return indexes
Most advisors (most internal marketers at IMOs) do NOT know how excess return indexes work (how the caps move, what the fees are, etc.).
Most FIA indexes (VCI, S&P 500, etc.), use “forward” option contracts. When doing so, the cap/par rates are highly susceptible to changes in interest rates. If interest rates go down, so do the cap rates. The cost of options affected by volatility also affects the cap/par rate.
Having caps go down after a client purchases it causes the client to get upset and in turn, that can blow back on the advisor who sold it.
Excess return indexes—when a measuring stock index uses an excess return model vs. a forward model, the caps/par rates are NOT interest rate sensitive. If interest rates go in the tank, the company can still keep the rate where it was at issue.
However, with an excess return crediting method, there is an internal load that can change every year and, in turn, will affect the return credited inside the FIA.
For example, say a product used a VCI with a 100% par rate.
If the index goes up 10%, the client you’d think would get credited with 10%. But no, with an excess return product, there is a borrowing cost (risk-free rate) that’s say 4%. This 4% cost is subtracted from the return netting the FIA a 6% rate of return. As the risk-free rate (interest rate) goes up, the return in the FIA will go down.
Back to the lawsuit
The complaint alleges that the illustration did not disclose that the return index couldn’t possibly return the advertised par rate (because the load on the index will reduce the return to be below the advertised 50% rate).
Changing cap/par rates and the load on an excess return VCI
The complaint alleges that when illustrating “today’s” cap/par rates and load on an excess return VCI is essentially total nonsense because the company knows that the actual results historically would have been much different. The complaint went on to state that the returns were “artificially constructed” and a “fraudulent sham.”
Also, the illustration shows a VCI crediting 6.67% over 5 years. However, the 5-year return of the index itself was only 0.6% for that same time period.
I could go on and on about what’s in the complaint, but there is too much to cover and I highly recommend anyone selling an IUL or thinking of selling one to read this complaint.
Bottom line…
This lawsuit could end up being much to do about nothing. Will LSW prevail because they were illustrating in accordance with AG-49 guidelines?
Will the case force new regulations about how IUL policies are illustrated (especially when it comes to using hypothetical back-tested returns in years when actual returns are available)?
I personally think it’s stupid not to be able to show a variable rate of return in an IUL illustration vs. showing a level positive return every year based on an average rate of return over time.
Finally, one thing that might come out of this lawsuit is the industry’s ignorance of what they are selling. Most advisors don’t understand excess return crediting strategies. I recommend if you are selling FIAs or IULs you get up to speed on excess return crediting strategies so you can explain them to clients and check the box on your full disclosure discussion.
Roccy DeFrancesco, JD, CAPP, CMP
Founder, The Wealth Preservation Institute
Co-Founder, The Asset Protection Society
269-216-9978
https://wealthpreservationinstitute.net
