A fiery short seller, a soft-spoken actuary, whistleblowers, and government
intervention are the makings of chaos in the Great White North.
intervention are the makings of chaos in the Great White North.
Michael Hawkins was working his first job as an actuary in Regina, the capital of Saskatchewan, when he discovered the loopholes that could bring down the Canadian insurance industry. His boss at Crown Life, a former astrophysicist, told him that if people took advantage of the options that were in plain sight — at least to an actuary — in a broad range of insurance contracts, the companies would all be bankrupt....MUCH MORE
Hawkins, a baby-faced farmer with 30-odd cows and a bull on his cow-calf farm who now lives near the uniquely named town of Flesherton in southern Ontario, 50 miles from where he grew up, says, as an example, that insurers sell what’s called term-to-100 life insurance. This type of insurance guarantees that premiums stay the same for the life of the policyholder. As he explains this, it’s December, a week before Christmas, and Hawkins has driven down from his farm to meet me in Toronto at the offices of large Canadian law firm Aird & Berlis.
“Think about it,” says Hawkins. “When consumers stop paying — whether it’s one year or 50 years after they bought the policy — they get nothing and the insurance company is freed from having to pay a death benefit.”
“I bought one when I lived in Regina when I was 25,” he explains. “The premiums I pay today, at 48, are the same as when I bought it. But the policy has no cash value, so people let them lapse all the time, even though when they are 85 or 90, that contract has a lot of value,” says Hawkins. “Insurance companies take advantage of that.”
In the 1990s at Crown Life, Hawkins worked on then-popular universal life insurance products, which also offered holders a range of investments, including short-term accounts that offered guaranteed minimum interest rates between 3 and 5 percent. Crucially, a few had no limits on the amount of money that could be deposited. Insurance companies were aggressively competing with one another to attract customers watching rising stock markets with life policies that included an investment component. Within these products hid Hawkins’ Trojan horse.
By 1997, Hawkins had moved to Toronto to take a job at insurance specialist Buck Consultants. Still working on universal life, valuing the products and helping brokers design them, he was loving his job of analyzing old contracts, some of which were issued by insurance companies long ago acquired by competitors.
In 2000, he started his own firm. One of his consulting clients, an investment banker, asked about hedging the exposure to minimum interest rate guarantees and whether there were limits on the amount of contributions the policyholder could make. “Maybe, maybe not,” Hawkins says he told the client. “If not, that would be an interesting option to hold,” mused the banker, echoing the words of Hawkins’ astrophysicist boss at Crown Life.
Hawkins took the bankers’ words to heart and by the end of 2007 he started a business called Dominion-West Finance to find contracts that didn’t have limits.
Hawkins began researching contracts and found one with no contribution limits that an AIG subsidiary in Canada was still issuing (the subsidiary was later bought by the Bank of Montreal when AIG was bailed out by the U.S. government in 2008). He bought it in 2008. Now he had a contract that he could someday use to earn extra interest on short-term money. If market rates fell below the insurance companies’ guarantee, Hawkins could offer outside clients a higher-than-market rate. He would then pocket the difference between that and what the insurance company was paying.
Hawkins established three limited partnerships for the contracts, named for stops on a Saskatchewan rail line: Mosten, Ituna, and Atwater. He also hired a law firm in Saskatoon to make sure — he rightly anticipated a fight — he was doing everything right.
Hawkins, who played on his high school and college curling teams, knew there were more contracts out there, both from the details of those he remembered over the years and from sifting through readily available public information. But he needed to find owners who wanted to sell and buy the ones with the most lucrative options. That wouldn’t be easy, as only four of Canada’s provinces, one being Saskatchewan, allowed what’s called trafficking — buying and selling insurance contracts. “Sounds bad, doesn’t it?” says Hawkins.
Between 2008 and 2010, after pestering insurance agents for leads on people who no longer wanted policies they bought in the ’90s, Hawkins acquired eight universal life insurance contracts, which are now owned by Manulife Financial Corp., Canada’s largest insurance company; Industrial Alliance Insurance and Financial Services; and Bank of Montreal’s insurance arm. According to Hawkins, all of them offer guaranteed interest rates of at least 3 percent on an unlimited amount of money, bonuses, and other perks. Some allow beneficiaries to be added over time, making the contract last in perpetuity. Hawkins wanted contracts with guarantees that couldn’t be withdrawn, meaning the contracts didn’t have language like “subject to administrative rules” (a phrase that would later become contentious in the court battle).
Hawkins raised money from external clients in 2011.
In 2012, an insurance broker introduced Hawkins to Gary Selke, a former partner in Front Street Capital, which manages hedge funds and other investments. Selke’s family has a long history in hockey: His grandfather, Frank J. Selke, was an executive with the Toronto Maple Leafs and the general manager of the Montreal Canadiens. Hawkins teamed up with Selke, who bought shares in the three partnerships, three years later. Selke became president and CEO of Mosten, Ituna, and Atwater.
“When I first saw the contracts, I was surprised, puzzled, intrigued, curious about the terms,” said Selke in Toronto. “The guys who wrote them clearly didn’t understand them. But the courts interpret insurance contracts in a generally predictable way. If that happened here, then there was an opportunity in front of us.”
Mosten, Ituna, and Atwater are now holders of some of the most valuable universal life contracts in the world. Not surprisingly, the three insurers don’t agree....
