Canadian insurers fight cattle farmer’s investment strategy
Battle to determine if limitless sums can be fed into accounts with high-interest payouts
Michael Hawkins, an Ontario consultant and farmer who owns about 50 head of cattle, was looking for extra income when he started buying Canadian lifeinsurance policies a decade ago. What he got was an unexpected legal battle that could lead to huge losses for some of Canada’s largest financial institutions.
Mr. Hawkins argues the eight insurance policies, into which he has pumped 14 million Canadian dollars (US$11 million), should continue to pay above-market interest rates for as long as he likes.
Now, three publicly traded insurers dispute the terms of those policies in Canadian court, arguing that the feature of the plans on which Mr. Hawkins has capitalized wasn’t designed for large-scale investing. If Mr. Hawkins prevails, it could allow much bigger investors to take advantage of the same loophole, funneling endless amounts of money into accounts with high-interest payouts.
“It poses a significant risk of financial harm to the insurance industry,” one of the insurers wrote in a court filing. For every C$100 million in deposits, the companies estimate they would take up to C$45 million in losses. The policies, known as universal life insurance, include both a death benefit and investment accounts. The quirk in the disputed Canadian policies allowed owners to prepay insurance premiums and house the extra money in a side account that guaranteed interests rates up to 5%, without explicitly limiting how much could be invested.
While American companies offer similar universal life plans with guaranteed minimum interest rates, U.S. tax policy strictly limits how much money can go in, experts say.
Mr. Hawkins said he and a group of friends and family collectively earned about C$500,000 in interest after depositing as much as C$5 million over six years in four separate policy accounts operated by Industrial Alliance Insurance and Financial Services Inc. He sold one of the policies to Targeted Strategies Ltd, a Saskatchewan wealthmanagement firm, which deposited over C$13 million into the account for the interest.
Mr. Hawkins, 47, who juggles his consulting practice with a 160-acre farm near the southern Ontario village of Flesherton, said the contracts for such plans were clear.
“They have tried to drown me in legal arguments,” he said. “Any normal person would walk away from this, but my position is they have no respect for the contract.”
Spokespersons for the insurers, Industrial Alliance, Manulife Financial Corp. and the insurance arm of Bank of Montreal, declined to comment.
A provincial court judge in Saskatchewan is weighing the issues after three weeks of trial and could rule within a few months. So far, the insurers and Mr. Hawkins haven’t been able to agree on a settlement.
Lawyers for the insurers told the court the policies were designed to encourage customers to set aside money for premiums, not for investment opportunities.
“This contract does not give… an opportunity to throw a walloping amount of risk at the insurers,” Trisha Jackson, an Industrial Alliance lawyer, told Saskatchewan judge Brian Scherman.
In response, Judge Scherman of the Saskatoon Court of
Queen’s Bench said, “The insurance industry itself has kind of created this problem by introducing an investment element to these policies.”
Though the insurers no longer sell the policies, thousands of similar contracts were sold in the 1990s. At the time, even 5% promised returns would have allowed insurers to profit by getting higher rates themselves. Today, with global rates still well below 5% even after recent gains, those promises would generate a stream of losses for the financial institutions, highlighting how unusual the current environment remains even a decade after the financial crisis.
Industrial Alliance was so unprepared for the potential policy risks of the accounts that Mr. Hawkins’s multimilliondollar investments didn’t trigger alarms until six years after his first investment in 2009. The insurer suspended the accounts in 2015 and returned the deposits, citing an “unwritten maximum permissible” investment limit. Industrial Alliance and Manulife dominate the Canadian life-insurance sector, which collected about C$21 billion in premiums last year, according to an industry association.
Contract-interpretation battles are common, but Mr. Hawkins’s case isn’t clear-cut. Contract law does allow for restrictions based on the “spirit” of an account, and some experts said Mr. Hawkins could lose there. “This is an attempt to essentially exploit a loophole,” said Daniel Schwarcz of the University of Minnesota Law School.
But insurance experts expressed surprise the companies didn’t explicitly limit the side accounts.
Cobbling together the eight life policies over the years wasn’t easy for Mr. Hawkins; he had to buy them from others, and only four of Canada’s 10 provinces allowed such deals.
Mr. Hawkins began his hunt in 2007 in Saskatchewan. After frequent trips to the prairie province to prod financial planners and insurance agents for leads, he bought a few policies that gave him at least 3% returns. His most lucrative find was the policy acquired from a Saskatchewan lawyer. It offered what amounted to 5% on the side account—when the 10-year Canadian Treasury was roughly half that.
“When I saw the 5% I thought, ‘Wow, this is great,’” he said.
Mr. Hawkins placed the policies in a trio of private partnerships, each named after old Saskatchewan railway stops: Ituna, Mosten and Atwater. Investors in the partnerships, including Mr. Hawkins’s mother along with other family and friends, earned a share of interest income on the policies.
Lawyers for some of the insurers portrayed Mr. Hawkins and his group of investors as “rogues” seeking to convert lifeinsurance policies into piggy banks for unnamed foreign investors.
“They want to turn this into a syndicated vehicle for U.S. hedge funds,” David Outerbridge, a lawyer for Industrial Alliance, told the court in September.
A group of investors has meanwhile taken on most of Mr. Hawkins’s legal costs in exchange for the potential opportunity to earn above-market rates in the side accounts. The lead investor, a former Toronto hedge-fund operator named Gary Selke, has already begun discussing the idea with several U.S. and Canadian hedge funds.
“They see an opportunity to earn higher rates of return on one the safest investments available,” Mr. Selke said. “Money will flow to these premiums if we prevail in court.”