Death Benefits for Servicemembers: a Case Study on The

Death Benefits for Servicemembers: A Case Study on the

Department of Veterans Affairs and its Life Insurance Contract

By

Philip S. Hadji[*]

Table of Contents[A1]

I.Introduction

II.Background

A.Overview of the Servicemen’s Group Life Insurance Act (SGLIA) and Prudential’s 1965 Contract (the 1965 Contract) with the Department of Veteran Affairs (VA)

B.Prudential’s Benefit Payment Responsibilities under the 1965 Contract and the Establishment of a Retained Asset Account Program

C.How Prudential Benefits from its Current Contract with the VA

D.Changes to Prudential’s Retained Asset Account Program Initiated by the VA

III.Legal Authority Issues Raised by the VA’s Contract with Prudential

IV.Competition Issues Raised by the VA’s Contract with Prudential

A.Competition Rules Prior to Enactment of the Competition in Contracting Act (CICA)

B.Rationale of the CICA......

C.The VA Never Used Competition for its Contract with Prudential

D.Changes within the Scope of the Original Procurement...

E.The 1999 Modification Did Not Meet Any of the Seven Exceptions to the CICA

F.The VA was Ultimately Hurt by Failing to Use Competition

V.Transparency Issues Raised by the VA’s Contract with Prudential

A.The VA’s Dealings with Prudential Illustrate a Need for Better Transparency Rules

B.New Transparency Proposals......

C.The Limitations of the New Transparency Proposals......

VI.Best Value Issues Raised by the VA’s Contract with Prudential

A.Best Value and the 1965 Contract......

B.The VA Decision Not to Make Multiple Awards for the 1965 Contract

C.The 1999 Modification and the Opportunity to Negotiate.

VII.Policy Implications of the VA’s Contract with Prudential

A.Policy to Contract with Private Insurance Companies Created by Congress

B. The Necessity of Private Companies for Insurance that is Guaranteed by the Government

C. The Consequences of Involving Private Companies for Uninsured

D. Contracting with For-Profit or Non-Profit Insurance Companies

VIII.Conclusion

I.Introduction

For more than a decade, a major insurance company hasprofited from the beneficiaries of soldiers who have died while serving in the armed forces – with the colorable authorization of the Department of Veterans Affairs (VA) but without providing the VA with a commensurate benefit.[1] In 1999, the VA orally modified a 1965 contract with Prudential Insurance Company of America (Prudential)requiringthe company to pay death benefits by lump-sum payment or in 36 equal installments,[2] as required by statute.[3] The modification, however, allowed Prudential to pay beneficiaries by sending them checkbooks, instead of by one of the statutorily authorized methods.[4] By sending the checkbooks, Prudential not only retained control of the funds until a beneficiary wrote a check, but it also invested these funds and kept most of the profit for itself.[5] This payment practice is generally known as a retained asset account.[6] Specifically, in the past ten years, $7 billion in military death benefits has passed through Prudential’s retained asset accounts, also known as Alliance Accounts.[7] Prudential has held the survivors’ money in its general corporate account, where it has earned eight times what the company currently pays in interest to beneficiaries.[8] In 2010, for example, Prudential’s general corporate account earned 4.2%, mostly from investment in bonds.[9] Conversely, the company paid survivors holding Alliance Accounts 0.5% in interest during that same period.[10]

Prudential’s practice of profiting from the Alliance Accounts has raised concerns among beneficiaries,[11] regulators,[12] and Congress,[13] and generally raises several government procurement issues worth examining in detail. The purpose of this Article is to examine closely some of the federal contracting issues arising from Prudential’s contract with the VA.

Part IIof this article provides background information on survivorship benefits to fallen soldiers, examines the VA’s 1965 contract with Prudential (the 1965 Contract) and its modifications, and explains how Prudential has benefited from its contact with the VA. Part III considers the VA’s 1999 oral modification to the 1965 Contract (the 1999 Modification) that authorized Prudential to use retained asset accounts in lieu of issuing lump-sum payments. Part IVthen evaluates whether the VA properly used competition in its dealings with Prudential as required by the Competition in Contracting Act (CICA) and the Comptroller General.[14] Part V of this Article examines transparency issues raised by the manner in which the parties reached agreement on the 1999 Modification. Part VIthen looks into whether the VA negotiated the best value for the taxpayers that it could given the circumstances. Part VII considers public policy issues raised by Prudential’s contract with the VA. In particular, it questions whether a private life insurance company can provide the Government enough of a benefit to justify the cost of a contract. Finally, thisArticle concludes by identifying the VA’s contract with Prudential as a prime candidate for insourcing, which President Obama has championed as part of a larger government procurement reform effort.

II.Background

The Government has been involved in providing life insurance to soldiers since World War I.[15] The rationale behind this is simple. Private life insurance companies have been unwilling to underwrite the coverage for soldiers due to the great difficulty of accurately predicting deaths during wartime.[16] To avoid taking on this type of high-risk insurance, companies have traditionally added “war clauses” to their contracts to cover wartime periods.[17] A war clause voids payment of life insurance claims for soldiers who are killed in combat.[18] Because the market had failed to provide soldiers with life insurance coverage, the Government set up individual plans for soldiers– specifically during World War I, World War II, and the Korean War[19] –which the Government ran and administered directly.[20]

A.Overview of the Servicemen’s Group Life Insurance Act (SGLIA) and Prudential’s 1965 Contract (the 1965 Contract) with the Department of Veteran Affairs (VA)

Beginning with the Vietnam War, Congress directed the VA to contract with the private insurance industry to provide life insurance for servicemembers by passing the Servicemen’s Group Life Insurance Act (SGLIA) in 1965.[21] The SGLIA was modeled after the group life insurance system for non-military federal employees that was signed into law in 1954[22]and that is administered by MetLife.[23] The SGLIA authorizes the VA to work with a private insurance company or multiple insurance companies to provide life insurance for servicemembers.[24] In 1965, nine days after President B. Lyndon Johnson signed the SGLIA into law, the VA awarded a contract to Prudential without competition.[25] Even though the SGLIA authorized the VA to make multiple awards,[26]the agency decided only to award a single contract to Prudential.[27]

The program established by the 1965 Contract between the VA and Prudential insures all servicemembers unless a servicemember specifically chooses to waive all or a portion of the coverage.[28] Under the SGLIA’s statutory scheme, the VA is responsible for collecting premiums and administering the program.[29] The premium rates are established by mutual agreement between the VA and Prudential.[30] Prudential is responsible for managing an insurance fund created from the premium payments and for paying out any claims.[31] Prudential covers the full cost of benefits from non-war related deaths through the insurance fund.[32] For war related deaths, the Government is responsible for covering the full expense of benefits.[33] The Government accomplishes this by paying higher premium payments covering the costs of the extra hazards attributable to the dangers posed by going to war.[34] The VA determines the extra amount of premium payments by analyzing the extra hazard of deployment to a war zone over the last three years.[35] If the Government overpays, Prudential is responsible for returning the amount overpaid, and if the Government underpays, it must pay more into the insurance fund.[36]

The provision in the SGLIA that ensures that the Government pays any additional costs due to war was endorsed by the Life Insurance Association of America to protect private insurance companies from bearing the risk of war casualties.[37] The result of this provision is that Prudential does not actually provide insurance for servicemembers killed in war because the Government pays those costs.[38] Prudential merely pays beneficiaries from the money that the Government pays Prudential in hazard payments, with the guarantee that the hazard payments will always cover the costs of the payments to the beneficiaries.[39]

B.Prudential’s Benefit Payment Responsibilities under the 1965 Contract and the Establishment of a Retained Asset Account Program

Under the 1965 Contract, Prudential is responsible for paying benefits to the beneficiaries of soldiers who have died in combat.[40] Based on its statutory authority, the contract specifies that the payments should be made either in a lump-sum or in 36 monthly installments.[41][A2] Until 1999, Prudential sent lump-sum checks to beneficiaries who requested lump-sum payments.[42] However, a 1999 oral agreement between Prudential and the VA’s director for insurance, Thomas Lastowka, modified the contract.[43] The VA has since admittedthat it would have been best to put the 1999 Modification in writing.[44] Nonetheless, the VA has maintained that the 1999 Modificationis valid, even thoughit was not in writing,since the parties to the modification agreement had the authority to enter into it.[45]

The 1999 Modification allowed Prudential to send checkbooks and set-up retained asset accounts instead of making lump-sum payments.[46] Consequently, Prudential began sending checkbooks and establishing Alliance Accounts for beneficiaries who requested lump-sum payments.[47] This practiceeffectively replaced the lump-sum payment method – which is specifically authorized in the SGLIA as a valid means of discharging Prudential’s obligation – with a payment method of Alliance Accounts, which is not specifically authorized by the statute.[48]

On January 1, 2007, the VA and Prudential replaced the 1965 Contract with a new contract (the 2007 Contract).[49] This new contract did not initially make any references to the 1999 Modification, and did not provide that Prudential could use retained asset accounts.[50] The 2007 Contract initially specified that policyholders could elect to receive insurance payments in lump-sum or in 36 monthly installments, in accordance with the SGLIA.[51] But the 2007 Contract was modified in writing on September 24, 2009 (the 2009 Modification),[52]andthis modification specifically authorized Prudential to use retained asset accounts as a means to satisfy the lump-sum payment requirement.[53] Therefore, the 2009 Modification in effect memorialized the 1999 Modification.[54]

C.How Prudential Benefits from its Current Contract with the VA

Under the current contract, when anAmerican soldier dies in combat, the VA is ultimately responsible for insuring that servicemember up to the statutory maximum set at $400,000.[55][IM3] From 1999 to 2010, if beneficiaries requested lump-sum payments of the death benefit, Prudential opened anAllianceAccount that allowed beneficiaries to draw money when they wanted to spend it.[56] Until the money was used, it remained in Prudential’s corporate account, where the company could invest it.[57] Since it started using Alliance Accounts, Prudential has invested and profited fromdeath benefits owed to the families of fallen soldiers and paid for by the Federal Government.[58] Since the Iraq War began in 2003, the Government has paid Prudential $1.7 billion for war hazard payments.[59] In addition, servicemembers have paid premiums that go into the Alliance Accounts.[60] In total, $7 billion in military death benefits have passed through Prudential’s Alliance Accounts during the last ten years.[61]

While the VA does not pay Prudential for benefits owed to families of soldiers who do not die in combat,[62] Prudential still benefits from managing the money soldiers pay as premiums for life insurance.[63] Soldier premium payments, which are set by the VA, have been high enough for Prudential to build a contingency fund that the company manages.[64] According to the VA, the contingency fund held about $835 million as of June 30, 2009.[65] VA actuaries have determined that the fund is too large, and that it should hold about $230 million less.[66] To reduce the size of the contingency fund, the VA lowered soldiers’ premium payments by 7% to $26 a month, effective July 1, 2008.[67] Despite the reduction in premium payments, the VA maintains that Prudential has a larger cushion than it needs.[68] In fact, throughout “the 45-year history of the VA insurance program with Prudential, the money in the contingency fund has always been sufficient to cover all of the claims the company had to pay out.”[69]

D.Changes to Prudential’s Retained Asset Account Program Initiated by the VA

In reaction to media stories and Congressional inquiries, on September 14, 2010, the VA announced several reforms to the Alliance Account program.[70] As a result of these changes, the VA began using new paperwork that allows beneficiaries to choose among three options for payment: (1) a lump-sum check; (2) an Alliance Account, which is described as a “lump-sum Alliance Account”; and (3) 36 monthly installments.[71] This ended Prudential’s policy of automatically enrolling beneficiaries who requested a lump-sum payment in an Alliance Account and sending them checkbooks to use the account.[72] In addition, the VA announced it “will require Prudential to conduct a followup contact with beneficiaries whose accounts remains open after six months to confirm the beneficiary understands the terms of the account.”[73] Finally, the VA announced that it will “clearly designate the source of correspondence by removing the [Servicemembers’ Group Life Insurance][74] seal from all checks, forms, and correspondence and replacing it to show that it is from Prudential, with the subtitle of ‘Office of Servicemembers’ Group Life Insurance.’”[75][O4] Even though Prudential has stopped sending beneficiaries Alliance Account checkbooks as the default option in September 2010, the VA and Prudential still continue to operate the Alliance Accounts today.[76]

III.Legal Authority Issues Raised by the VA’s Contract with Prudential

The 1999 Modification authorizing the use of retained asset accounts, which was subsequently reduced to writing in 2009, likely violates the SGLIA and is not enforceablebecause it is outside the scope of the power granted by Congress. The 1999 Modification in effect creates a third payment option, whereas the SGLIA only allows for two.[77] A fundamental rule in government contract law is that the Government cannot be bound by unauthorized acts of its officers or agents.[78] Unlike in private agency law, actual authority is required to bind the Government.[79] The U.S. Supreme Court has explained the rationale for only enforcing agreements where government representatives had actual authority to act:

Whatever the form in which the Government functions, anyone entering into an arrangement with the Government takes the risk of having accurately ascertained that he who purports to act for the Government stays within the bounds of his authority. The scope of this authority may be explicitly defined by Congress or be limited by delegated legislation, properly exercised through the rule-making power.[80]

When Congress has explicitly defined the scope of an agency’s authority in a statute, government officials do not have the power to waive statutory requirements.[81]

The VA orally modified its contract with Prudential to allow the company to use retained asset[IM5] accounts in 1999 underat the direction of Thomas Lastowka, the agency’s director for insurance.[82] The VA claims that the modification was valid because Lastowka was authorized to act on behalf of the Government.[83] However, as an agent of the Government, Lastowka’s power is constrained by the statutory authority granted to the agency.[84] Therefore, any modification that Lastowka authorized that is not within the scope of the VA’s statutory authority is not valid. Congress specifically defined the scope of the VA’s authority regarding life insurance of soldiers in the SGLIA.[85] The SGLIA provides:

The member may elect settlement of insurance under this subchapter either in a lump sum or in thirty-six equal monthly installments. If no such election is made by the member the beneficiary or beneficiaries may elect settlement either in a lump sum or in thirty-six equal monthly installments. If the member has elected settlement in a lump sum, the beneficiary or beneficiaries may elect settlement in thirty-six equal monthly installments.[86]

This statute states explicitly that insurance settlements must be made either in lump-sum or in monthly installments.[87] There is no provision for retained asset accounts.[88] Moreover, no other statute appears to waive the statutory requirements of the SGLIA.

Insurance companies have argued that retained asset accounts constitute lump-sum payments under the SGLIA, but both the First Circuit and the Seventh Circuit have rejected this reasoning. In Mogel v. Unum Life Insurance Company of America,[89] the First Circuit held that an insurance company had not discharged its payment obligation under a life insurance policy by sending a checkbook instead of sending a check.[90] According to the court, “the euphemistically named ‘Security Account’ [at issue in the case], accompanied with a checkbook, was no more than an IOU which did not transfer the funds to which the beneficiaries were entitled. . . .”[91] The First Circuit determined that the key distinction between sending a checkbook and sending a check is that a checkbook fails to transfer funds.[92]

The Seventh Circuit went even further in determining when an insurance company divests possession of funds in Commonwealth Edison Company v. Vega.[93] In that case, the State of Illinois sought to apply the Uniform Disposition of Unclaimed Property Act (UDUPA) to funds payable under Commonwealth Edison Company’s pension plan that were not yet claimed by a beneficiary.[94] The plan issued several checks to beneficiaries that often were not cashed or deposited.[95] In holding that federal law preempted the UDUPA, the Seventh Circuit found that “until the check to the beneficiary is actually presented to the plan for payment through the banking system, and paid, the money to the beneficiary is an asset of the plan.”[96] Under this rationale then, the retained asset accounts that Prudential has used would not constitute a lump-sum payment, since the companyhas never divested possession of the life insurance funds. In fact, payment of Prudential’s life insurance obligation would not occur until the beneficiary transferred all of the funds into his or her personal account via a lump-sum check or through an Alliance Account check.[97]