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IN RE THE NORTHWESTERN MUT. LIFE INS. CO. SALES

October 14, 1999

IN RE THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY SALES PRACTICES LITIGATION.


The opinion of the court was delivered by: Debevoise, Senior District Judge.

        OPINION

In this multi-district litigation concerning the sale of so-called "vanishing premium" life insurance policies by defendant The Northwestern Mutual Life Insurance Company ("NWM") in the 1980's, NWM moves for summary judgment on the claims of plaintiffs Scott Hartmann, Merrill Hess and Wallace B. McGahan. Plaintiffs move for a continuance of NWM's motion in order to permit them to conduct discovery pursuant to Fed.R.Civ.P. 56(f) and plaintiff Hartmann moves to strike the declaration of Keith F. Koppen dated August 13, 1999 (the "Koppen Declaration"). For the following reasons, NWM's motions for summary judgment will be granted, plaintiffs' motions for a continuance will be denied and Hartmann's motion to strike the Koppen Declaration will be granted.

BACKGROUND AND PROCEDURAL HISTORY

The plaintiffs in this action allege that they were defrauded by NWM because they were induced to purchase life insurance policies on representations from its sales agents that premium payments would have to be made for only a limited number of years in order to obtain fully paid up policies, yet the policies they received required them to pay premiums for many more years. The factual background of each plaintiff's case will be discussed in turn.

I. Scott Hartmann

Hartmann, a 49-year-old former vice president of a lumber company with a Master's Degree in Business Administration, purchased a $150,000 life insurance policy titled "Whole Life Paid Up at 90" from NWM in 1984 (the "Hartmann Policy").*fn1 As specified in the Hartmann Policy, the annual premiums of $2,424.50 were payable for 56 years, until Hartmann reached age 90. Under the terms of the Hartmann Policy, as long as those scheduled premiums were paid, NWM would pay at least $150,000 on Hartmann's death.

Each premium was required to be "paid on or before its due date." If Hartmann failed to pay the premiums, the Hartmann Policy provided that "a loan will be made to pay an overdue premium." However, the Hartmann Policy specified that a policyholder could not borrow more than the cash value of the policy to pay premiums: "If the policy debt equals or exceeds the cash value, this policy will terminate."

Instead of borrowing against the cash value to pay premiums, Hartmann could stop paying premiums altogether and convert his policy into a "paid up insurance" policy that provided a reduced death benefit but required no further premium payments. The guaranteed cash values and amount of paid up insurance provided under the contract at any given policy year were set forth in a chart on page 4 of the Hartmann Policy called a "Table of Guaranteed Values." For example, if Hartmann paid premiums for three years, according to the Table of Guaranteed Values the cash value of his policy would be $3,255 which he could convert into $11,250 of paid up insurance.

Hartmann's policy required him to make annual cash premium payments until he reached age 90. If Hartmann had paid his premiums in cash each year and used dividends to purchase Additions, there would have come a point when he could have paid the annual premiums by using a combination of current dividends and the accrued cash value of accumulated Additions rather than paying the premiums in cash. This concept is known as "Short Pay."*fn2

In 1984, Hartmann met with NWM agent Keith Koppen to discuss life insurance. According to his Complaint, Hartmann wanted to purchase a life insurance policy that would "assure him a death benefit for at least the next twenty years." Koppen proposed that Hartmann purchase a $150,000 90-Life whole life policy. According to Hartmann, Koppen orally promised that if Hartmann paid premiums for three years he would have a $150,000 paid up insurance policy for life. Hartmann understood "paid-up" policy to mean "a policy that doesn't need any more premiums."

Koppen's alleged oral promise is inconsistent with the written materials from NWM that Koppen gave to Hartmann and reviewed with him. These materials consisted of two "illustrations" demonstrating how the policy would perform under certain circumstances. The first illustration showed Hartmann how his policy would perform if the dividend scale remained constant at the 1984 level and Hartmann made all of his premium payments in cash.*fn3 The illustration showed that, if the policy continued to earn dividends at the 1984 dividend scale, Hartmann would have to pay premiums for 15 years before he would have paid up insurance equal to the $150,000 face value of the policy. When Koppen reviewed this illustration with Hartmann, Koppen circled "1984" in the phrase "Based on current dividend scale — 1984 scale." Koppen also underlined the number "15" in the phrase "Years to pay up 15" and circled the 15th year of the column titled "paid up insur.," emphasizing that, if dividends remained at 1984 levels, it would take fifteen years to obtain $150,000 of paid up insurance. The illustration also showed that Hartmann would be entitled to only $13,888 in paid up insurance if he stopped paying premiums after three years.

The second illustration was a Short Pay illustration showing how Hartmann's policy would perform, based on the 1984 dividend scale, if he made eight premium payments in cash. This illustration showed that after making eight cash payments Hartmann could elect in the ninth year to pay his premiums out of a combination of dividends on the policy and the cash value of the accumulated Additions, and maintain a death benefit of between $150,000 and $180,000 for the first 20 years of the policy.*fn4 The two core assumptions underlying both these illustrations — that the dividend scale would remain at the 1984 rate and that there would be no loans on the policy — are disclosed in the illustrations as follows:

  DIVIDENDS ASSUME NO LOANS; LOANS WILL REDUCE
  DIVIDENDS. BASED ON CURRENT DIVIDEND SCALE — 1984
  ISSUE. NOT AN ESTIMATE OR GUARANTEE OF FUTURE
  RESULTS.

On July 11, 1984, Hartmann applied for the 90-Life policy recommended by Koppen. In his application, Hartmann requested that dividends be used to purchase paid-up additions. The application stated, above Hartmann's signature, that "[n]o agent is authorized to make or alter contracts or to waive any of the Company's rights or requirements." Hartmann admitted in his deposition that nothing in the policy application indicated that he would have to make only three premium payments.

Hartmann received a copy of his insurance contract on or about August 10, 1984.*fn5 The cover states that NWM "agrees to pay the benefits provided in this policy, subject to its terms and conditions." The policy states that the policyholder should read it carefully, and that the policyholder can return the policy "for any reason within ten days after it was received" for a full refund. It also states that "This policy with the attached application is the entire contract . . . A change in the policy is valid only if it is approved by an officer of the Company . . . No agent has the authority to change the policy or to waive any of its terms."

In 1986, while Hartmann's policy was in force, Koppen provided Hartmann with an "in-force ledger" describing how his policy would perform under the 1986 dividend scale.*fn6 According to the ledger, Hartmann would have only $14,104 of paid up insurance after making premium payments for three years. Under the 1986 dividend scale it would have taken 13 more years of cash premium payments, until 1999, before Hartmann would have $150,000 of paid up insurance.

At his deposition, Hartmann stated that he understood from Koppen's oral representations that he was required to pay premiums for three years, and that he would be "stupid" if he failed to live up to "what [he] viewed as being a three-year commitment, a three-year contract." Hartmann conceded that if he did not pay the premiums for three years, he expected that the policy would not perform as he claims he was promised it would. Yet Hartmann paid premiums for two years and eleven months, not three full years. Hartmann's premium payment for the 36th month was not honored by his bank, and NWM sent him a notice informing him of this fact and reminding him to send a replacement payment. Hartmann made no replacement payment and, indeed, made no further payments for the next nine years, until his policy lapsed in 1996.

During those nine years, NWM sent Hartmann approximately 70 premium due notices: one Premium Due notice and one notice entitled "Premium Charged as Automatic Premium Loan" (the "Premium Charged" notice) every quarter. The Premium Due notices stated that the "Amount Due is the policy premium . . . plus premium loan interest," and that this premium payment would keep the policy in force for three months. These notices requested that Hartmann "return this notice with your payment," and stated:

  [I]f any premium is not paid to the Company or its
  authorized agent on or before the due date or within
  the grace period, the policy and all payments on it
  will be forfeited and void except for nonforfeiture
  benefits of the policy.

The Premium Charged notices explained that "[t]he overdue premium was charged as an Automatic Premium Loan. If instead you wish to pay the amount due, please return this notice with your payment in the enclosed envelope."

These notices also informed Hartmann that the accrued interest due on his loans was increasing substantially. The quarterly notices sent to Hartmann around July of each year, the anniversary date of his policy, advised him of both the quarterly premium and the interest due on the outstanding loan balance. Hartmann kept six of the July Premium Due notices and produced them during discovery. They show the "Amount Due" increasing steadily over the years. For example, in 1987 the July notice showed that Hartmann owed $641.87. By 1989, that figure had grown to $1,000.81. In 1991 it was $1,487.11, and in 1995 it had grown to $2,715.93. At his deposition Hartmann acknowledged that he knew that "it would be a problem if the loan amount became greater than the cash value," and that he was "surprised" to see that some premium notices were substantially higher than the regular quarterly premiums. However, during the nine years that Hartmann received approximately 70 of these notices, he failed to make the required premium payments and failed to inquire with Koppen, NWM or anyone else why he was being charged a premium beyond the three-year period allegedly promised by Koppen at the time of the sale or why the accrued interest on his policy loans was increasing so rapidly.

Hartmann also received Annual Policy Statements each year which informed him, among other things, of his policy's share of the dividends. For the first two years that the Hartmann Policy was in effect the dividends actually paid on the policy equaled or exceeded the dividends illustrated at the time of sale because the dividend interest rate had increased. After 1987, however, the dividends were lower than had been illustrated to Hartmann at the time of sale. According to NWM, the reason for this decline in dividends was twofold: Hartmann had stopped making his cash premium payments, contrary to the assumptions in the original illustration, and NWM was therefore required to take out loans against the policy to pay the premiums; and NWM's dividend interest rates declined during this time, as did interest rates generally in the economy.

The Annual Policy Statements show that beginning in 1988, the dividends actually paid on the Hartmann Policy were substantially lower than those illustrated in 1984. For example, the 1988 dividend that had been illustrated to Hartmann in 1984 was $649, while the actual dividend paid in 1988 was $571.72. The illustrated dividend for 1991 and 1994 were respectively $1,373 and $2,336, and the actual dividends paid in those years were $982.84 and $1,367.92. Although Hartmann was in possession of these Annual Policy Statements over those nine years he made no inquiries as to why his policy was performing so poorly. At his deposition, Hartmann acknowledged that "clearly after the fact, if anyone had closer analysis and strung together all of the policy statements, they may say, `Hey, we're moving down a path here that may put us in trouble.'"

By March 1996, the loans on Hartmann's policy exceeded its cash value. Pursuant to the terms of the policy, NWM sent Hartmann a notice informing him that the policy "no longer provides the protection you originally wanted," and that he could request to have his policy reinstated if he paid the past due quarterly premium in cash. At oral argument on August 23, 1999 Hartmann's attorney stated that Hartmann didn't think that anything was wrong with his policy until he received this notice, which he referred to as the "bomb."

In April 1996, Hartmann requested to have his policy reinstated and paid the premiums for two quarters in cash. NWM then sent Hartmann a quarterly premium notice and an automatic premium loan notice, as before. Hartmann did not pay the next premium due. Instead, on August 28, 1996, he sent NWM a request to surrender his policy for its cash value. NWM surrendered his policy and sent him a check for $2,427.15.

On January 26, 1999 Hartmann filed his Complaint against NWM in the Circuit Court of Cook County, Illinois. The Complaint is styled as a class action complaint representing a national class of plaintiffs. Hartmann asserts claims for fraud, violation of the Illinois Consumer Fraud Act and breach of fiduciary duty. In his Complaint, Hartmann alleges that he was promised that "the 90 Life policy would require him to pay only three annual premiums . . . to maintain the face value of the policy death benefit." Hartmann claims that he surrendered his policy because NWM sent him a notice in September 1996 demanding either an immediate pay-off of the outstanding loans on his policy or a commitment to make payments three times the amount of the premium.*fn7

On February 26, 1999 NWM removed this action to the United States District Court for the Northern District of Illinois. On March 17, 1999 the Judicial Panel on Multidistrict Litigation transferred the action to this Court for pretrial proceedings.

II. Merrill Hess

Hess owned at least four life insurance policies in July 1988. Hess felt that one of his policies, a single premium life insurance policy from New Jersey Life, provided insufficient coverage, and he set out to procure additional insurance. Howard Fisher, a friend of Hess's who worked at a brokerage firm, recommended that Hess purchase a single premium policy from Kemper Investor's Life. Under Fisher's proposal, Hess would surrender his New Jersey Life policy and use its approximately $146,000 cash value to purchase the Kemper policy. Based on non-smoker rates, this one-time, up-front payment would purchase $308,593 in guaranteed death benefits for the rest of Hess's life. Tom Alvarez, Hess's financial adviser, introduced Hess to NWM agent Bruce Himelman who recommended that instead of purchasing the Kemper policy favored by Fisher, Hess should apply to NWM for a "whole life" policy.

The policy that Himelman recommended, and that Hess ultimately purchased from NWM on June 16, 1988, was a "Whole Life Paid Up at Age 100" policy providing a basic death benefit of $500,000 (the "Hess Policy"). The basic features of Hartmann's whole life policy discussed above also existed in Hess's whole life policy, such as the accrual of cash value with every premium payment that the policyholder can use by borrowing on the policy or surrendering the policy for cash; the eligibility to receive any dividends in cash or apply the dividends to reduce premiums or purchase Additions; and the ability to, under certain assumptions, use the policy's dividends and accrued cash value to pay the annual premiums under the "short pay" concept.

According to NWM, to convince Hess to purchase the NWM policy rather than the Kemper policy, Himelman prepared a three-page analysis explaining that Hess could deposit the cash from the surrender of his New Jersey Life policy into an "advanced premium deposit account," an interest bearing account maintained by NWM. This cash, together with interest, would pay the first ten annual premiums as they came due for a whole life policy paid up at age 100 with a basic death benefit of $500,000, based on premium rates for a non-smoker. Himelman explained the short pay concept and showed that, assuming dividends were paid every year at the 1988 dividend interest rate, the annual premiums after ten years could be paid by using the cash values of the annual dividends and the accrued cash value of some of the accumulated Additions. Himelman illustrated how changes in the economy could cause dividend interest rates to drop and showed Hess how the cash values in the policy would decrease if NWM's dividend interest rate declined below the 1988 dividend interest rate of 10.25 percent.

While Hess denied in his deposition that he had ever seen this three-page analysis he admitted that Himelman provided him with an illustration of the short pay concept they had discussed. Under this illustration, all dividends credited during the first ten years of the policy would be used to purchase Additions. The Additions would increase the death benefit above the basic $500,000 and increase the policy's cash value. The illustration stated the non-guaranteed assumption that dividend interest rates would remain constant at the 1988 level, and showed how Hess could elect at the end of ten years to make his annual premium payments by using dividends and surrendering some of the accumulated Additions for their cash value. This short pay illustration stated: "Illustrated dividends (1988 scale) reflect claim, expense and investment experience and are not estimates or guarantees of future results. They may be larger or smaller than those illustrated."

According to Hess's deposition testimony, he understood that under Himelman's proposal, he would deposit the cash from the surrender of his New Jersey Life policy into an interest bearing account maintained by NWM, that the funds in this deposit account would earn interest, and that the funds would be used to pay the first ten annual premiums on the policy as they came due, beginning in 1988. Hess also understood that under Himelman's proposal dividends would be used to purchase additional insurance to increase the death benefit and that after ten years, assuming no declines in the dividend scale, the policy would increase in value to the point where the dividends and cash value of the accumulated Additions would be sufficient to pay premiums thereafter. According to Hess, Himelman explained that the 1988 dividend interest rate was 10.25 percent and that dividend interest rates could change over time, but he also "indicated that the interest rates might go down a little bit, but I was not to worry at all."

On June 16, 1988 Hess applied for the policy. Hess's application disclosed that he was a smoker. Because Himelman's proposal was based on a non-smoker annual premium rate of $20,117, he wrote to Hess on June 20, 1988 and explained that $500,000 of coverage at smoker rates required a higher annual premium of $21,080 and an initial deposit of $146,000 in NWM's interest bearing account would not pay ten years of annual premiums for the $500,000 policy at premium rates for smokers. Himelman explained that Hess would have to deposit more money to cover the first ten premium payments at the higher rates for smokers. Alternatively, Hess could use the originally planned deposit of $146,000 to pay for the first ten premium payments on a policy with a lower death benefit of $477,000. Hess neither deposited additional funds to cover the premiums nor requested a reduction of the death benefit to $477,000. Hess acknowledged his receipt of the policy on September 29, 1988.

On July 8, 1988, after the application was completed, Hess received and signed and acknowledgment form entitled "Important Notice Regarding Replacement of Life Insurance" (the "Replacement Notice"). The Replacement Notice notified Hess of the possible consequences of surrendering his New Jersey Life policy and replacing it with the proposed NWM policy, such as possibly higher premiums due to Hess's increased age from the time he applied for the New Jersey Life policy; a new period of exclusion of coverage for material misstatements on the application or because of death by suicide; and a slower increase in cash value and dividends for the new policy because of NWM's costs of issuing the new policy. The Replacement Notice recommended that Hess seek the advice of New Jersey Life and other advisors before completing the transaction. The Replacement Notice also included a chart comparing side by side the key terms of the New Jersey Life policy and the proposed NWM policy. The chart showed that the New Jersey Life policy required only a "single premium" of $100,000, while the NWM policy required annual premiums of $21,080 for the life of the policy. The notice also stated that although "dividends may materially reduce the cost of insurance and are an important factor to consider" they "are not guaranteed." Hess does not dispute that he signed the Replacement Notice; he does, however, contend that no Replacement Notice was provided to him at the point of sale, despite the fact that Himelman had already received Hess's check, and that Himelman did not meet with Hess to review the Replacement Notice. Hess asserts that Himelman concealed the fact that the sale was a replacement when Himelman completed the application.

Early in July 1997 Hess received a premium billing notice from NWM requesting payment for the $21,080 annual premium on his policy. Hess contacted Himelman and asked for an explanation. In a letter dated August 5, 1997 Himelman explained that the billing notice was the result of two factors. First, Himelman reminded Hess that he had failed to deposit the additional funds in the deposit account necessary to pay ten years of premiums for $500,000 of coverage at smoker rates. Second, Himelman explained that after Hess purchased his policy, NWM's dividend interest rates had declined from the 1988 dividend scale that formed the basis for the original sales illustration. According to Himelman, this decline caused a corresponding delay in reaching the point at which the policy could short pay by using dividends and Additions to pay the annual premiums. In his letter Himelman also explained that although the policy had not performed as they had hoped, Hess had acted wisely to replace the New Jersey Life policy because the NWM policy provided more than twice the death benefit of the replaced policy and New Jersey Life had since gone into receivership.

Hess paid the 1997 premium to continue the policy in force, as well as the premium for the following year, by surrendering Additions. The only cash payment Hess has made was the initial deposit of $146,000 and today, Hess has $519,516 in insurance coverage under this policy.

On October 22, 1997 Hess filed his Complaint against NWM in this Court. Hess instituted his action on behalf of himself and a putative national class of NWM policyholders. Hess asserts causes of action in Counts I through IX, respectively, of fraud, fraudulent inducement, negligent misrepresentation, negligence, breach of fiduciary duty, constructive fraud, unjust enrichment/constructive trust, breach of contract, reformation and violation of New Jersey's Consumer Fraud Act. In his Complaint Hess alleges that under Himelman's illustrations only one initial out of pocket payment was required after which all remaining premiums were to be paid from dividends, with no further out of pocket premium payments due for the life of the policy. Hess also accuses NWM of "churning," or improperly inducing him to unnecessarily replace his existing paid up $146,000 New Jersey Life policy with the new NWM policy. In August 1998 this action was consolidated for pretrial purposes with Wallace B. McGahan's Alabama lawsuit against NWM.

III. Wallace B. McGahan

In 1987, McGahan, a physician, purchased from NMW a $150,000 "90-life" policy on his life. Under the contract annual premiums for the policy are payable until McGahan reaches age 90. In 1988 McGahan purchased from NWM two $100,000 policies on the lives of his daughters, Mindy and Autumn. Annual premiums under the policies are payable until each daughter reaches age 65.

All three policies were "whole life" policies, having the attributes described above. Page 4 of McGahan's 90-life policy sets forth guaranteed cash value and paid-up insurance for each year that premiums are paid. For example, at the end of policy year eight the cash value was $11,869 and paid-up insurance was $45,300. The Table of Guaranteed Values states that "Values are increased by paid up additions and dividend accumulations and decreased by policy debt."

The policies which McGahan purchased stated that each year NWM distributed surplus, if any, in the form of dividends. However, "[t]he dividend will reflect the mortality, expense and investment experience of the Company and will be affected by any policy debt during the policy year." The policy specified that McGahan could elect to use dividends i) in the form of cash payments, ii) to reduce annual premium payments iii) or to purchase additional insurance "Additions." Additions increase the policy's cash value and death benefit.

As in the case of the other policies discussed in this opinion, the policies which McGahan purchased include the Short Pay option. As described above, the option requires that the policyholder continue to pay the scheduled annual premiums until the point is reached when a combination of dividends and accumulated Additions is sufficient to pay the premiums.

McGahan purchased his policies through NWM agent Tommy Lewis. In his complaint and in his deposition McGahan alleged that he purchased policies that would be "paid up" after eight to ten years. In his brief in opposition to the summary judgment motion he alleges not that he was promised a paid up policy but, rather, "if he paid an inflated amount of premiums by 1995, approximately eight years after the proposal issue date of the policy, then he would no longer be required to make premium payments to Northwestern in order to maintain the $150,000 death benefit agreed upon." (McGahan's Brief at 4).

  DIVIDENDS ASSUME NO LOANS; LOANS WILL REDUCE
  DIVIDENDS. ILLUSTRATED DIVIDENDS (1987 SCALE) REFLECT
  CLAIM, EXPENSE AND INVESTMENT EXPERIENCE AND ARE NOT
  ESTIMATES OR GUARANTEES OF FUTURE RESULTS. THEY MAY
  BE LARGER OR SMALLER THAT THOSE ILLUSTRATED.

McGahan testified in deposition:

  Q. Did Tommy Lewis show you an illustration in
  connection with the hundred fifty thousand dollar
  life insurance policy you bought from Northwestern?

A. Yes, sir, he did.

Q. What do you recall of those illustrations?

  A. I recall that actually he had highlighted, and he
  said he even wrote stop pay in his own handwriting.
  He said this is where you stop pay. You can stop pay
  this year. It was after the eighth year. He said you
  ...

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