AC Brooks vs. The Lincoln National Life Insurance Company and Lincoln Financial Distributors, Inc.

The Situation

In 2003, an initial proposed class action was filed against Lincoln National Life Insurance and Lincoln Financial Distributors, Inc. on behalf of people who purchased either an individual variable deferred annuity contract or a certificate to a group variable deferred annuity. The lawsuit alleged that Lincoln violated Section 10(b), Section 20(a), and Section 29(b) of the Exchange Act by omitting material information when it sold variable annuities, an investment tool for accumulating tax-deferred savings that can come with various insurance benefits and that later may be used to purchase an immediate annuity. Plaintiffs argued that the main benefit of variable annuities, tax deferral, is unnecessary when annuities are purchased for investments in qualified retirement plans, such as 401(k) plans, and that variable annuities are sold with higher fees that are not justified by any additional benefits provided relative to investments such as mutual funds.

NERA's Role

Lincoln retained NERA Senior Vice President Dr. Robert Mackay to provide testimony on various issues, including whether variable annuities can be suitable investments in qualified plans; whether levels of disclosure relating to tax deferral affect fees; whether the variable annuity market is competitive, implying that Lincoln would not have the ability to charge excessive fees; and whether the insurance benefits offered by variable annuities justified any higher fees charged by annuity issuers.

Dr. Mackay testified on two sets of findings. First, variable annuities can be suitable investments for investors in qualified plans. Variable annuities offer unique and useful features that reduce the risks of investing for retirement and provide other benefits. These additional features, which expose the insurance companies issuing variable annuities to costs and risks not borne by mutual fund companies, and which are more complex to explain during the sales process, help to explain the additional costs of investing in variable annuities.

Second, Dr. Mackay testified that no support could be found for plaintiffs' theory that variable annuity fees are an implicit payment for tax deferral. A study of variable annuity fees and disclosures about tax redundancy in variable annuity prospectuses was conducted and the study finds that variations in the level of detail about tax redundancy in the disclosures have no impact on fees. In other words, the alleged omission regarding tax redundancy does not allow issuers to implicitly charge for tax deferral. Further, Dr. Mackay testified that the variable annuity marketplace is highly competitive and, given this, variable annuity fees reflect the costs of production, product or quality differences, investor demand, and competition among firms for market share and profit. That is, in a competitive market variable annuity issuers can charge for actual product features, not for tax deferral which is a free good created by the government, and this provides further support for the argument that any omission relating to tax deferral could not be material.

In additional testimony, Dr. Mackay also argued that the testimony of plaintiffs' expert, an actuary, should be excluded, on the grounds that it fails to meet the standards for acceptable expert testimony. Specifically, Dr. Mackay testified that the plaintiffs' expert failed to provide support for his assertions about how the variable annuity marketplace functioned and failed to provide any way to replicate the analysis that led to his conclusions. As an example, Dr. Mackay testified that, though the plaintiffs' expert testified that variable annuities include an implicit charge for tax deferral, he provided no estimate of the size of this implicit charge and provided no methodology for estimating the charge.

The Result

On 12 February 2008, Magistrate Judge Caroline Craven rejected testimony from the plaintiffs' expert witness and recommended denying class certification. She found that because the representatives who sold variable deferred annuities made suggestions based on individual investors' circumstances, not scripted sales pitches, individual claims in the case predominated over common ones. While finding the opposing expert qualified to testify, Judge Craven nevertheless threw out his expert report for lacking a sound basis for his conclusions, particularly in the light of NERA's empirical work and substantive arguments.