"maximize the investment return." (Tr. 712-13).
On three occasions, in 1977, 1979, and 1981, the Sperry Trust
withdrew funds — a total of approximately $12 million of Plan
assets — from the PAF's accumulated free funds, using the
rollover procedure. The SRC transferred these amounts to the
Plan's other money managers.
In 1982, the SRC attempted again to use the rollover procedure
to withdraw accumulated free funds, but Hancock refused to let
the SRC do so, citing its own cash-flow needs. (ASF ¶¶ 77-79; Tr.
1488-89, 1607-13, 1689-90). The SRC then attempted to withdraw
accumulated free funds to pay non-guaranteed benefits, but
Hancock provided notice that it would no longer pay
non-guaranteed benefits under the Retro-IPG-PDL (as it had been
doing through June 1982). (PX 662; ASF ¶¶ 83, 84; PX 675; Tr.
811-12, 894-96, 1325). As a consequence of Hancock's refusals to
permit such access to "free funds," the only mechanism available
for the SRC to withdraw "free funds" were the transfer
provisions of GAC 50. Again, however, that was not a viable
option because of the pricing scheme.
Hancock did not consider its obligations under ERISA to the
Plan when it decided to terminate the rollover procedure or the
payment of non-guaranteed benefits with excess funds. (Tr.
1352-54). Instead, it used Plan assets for its own benefit: to
help address its own cash flow problems, as "one more way of
limiting cash outflows." (Tr. 1612; see Tr. 736; see also PX
593). In addition, by refusing to permit the withdrawal of "free
funds," Hancock was able to continue collecting charges on the
investment income generated by these funds. (Tr. 313-14). There
was no question that the "free funds" belonged to the Trust; the
issues confronting the parties were how to compute the amount of
the excess funds, when Hancock had to give them back, and under
what circumstances. (See Tr. 752-54).
Throughout this period, Hancock assessed the Trust risk
charges. Hancock did not actually face any risk with respect to
the free funds during this time period, however, because it was
"sufficiently protected" by other provisions of GAC 50 so that
it was not at "material risk." (Tr. at 313-14, 343-44, 401-02).
Therefore, the excess risk charges collected by Hancock during
this time period constituted over-compensation.
For some years prior to 1981, Sperry had been questioning
Hancock on whether it was willing to revalue annuities to
reflect changes in interest rates. (PX 449). Hancock's response
was that its "policy" was to continue to value the annuities "on
the basis on which they were originally purchased." (Id.).
Hancock itself recognized, however, that there was a problem in
using the original rates:
Interest rates have risen dramatically over the last
several years and have risen gradually over a much
longer period. Over these periods the case earnings
rate of most of our retro IPG conversions and issue
IPG's has risen as well. However, most of these
contracts contain fixed interest, mortality, and
loading assumptions for a major portion of the LOF.
The rise in case rates has resulted in sizable
differences between the case rate and the various
interest assumptions of the LOF, especially for
canceled annuities. The difference approaches 5% in
some instances. The current size of such differences
has resulted in numerous customer complaints that LOF
amounts are absurdly conservative and should be
revalued using higher interest rates.
(PX 572). In an internal memorandum addressing the issue,
Hancock recognized that "[f]ar greater margins exist in LOF
amounts than were imagined when the fixed LOF basis was
established, and we should pass these prospective gains on
faster than we are doing now." (Id.). The
memorandum showed, however, that Hancock was motivated by
self-interest: "If we revalue and charge for it, John Hancock
has increased profit potential."
At a meeting in December 1981, Hancock presented to Sperry a
number of "possible contractual changes" that it was
considering, including a change in the interest rate assumptions
used to calculate reserves. (PX 593, at 4). In return, however,
Hancock indicated that it would want an "up-front charge" of 10%
of the difference between the reserves calculated on the new
basis and the old basis. (Id. at 5). Sperry's reaction to the
proposed 10% charge was that it was "[h]ighway robbery." (Tr.
750). Hancock confirmed at the meeting that its motivation was
self interest, as Hancock's senior representative at the meeting
began by stating that "Hancock was losing money in the
individual health line of business and, in essence, the group
pension or group annuity line of business was going to pay for
that." (Tr. at 736).
After a follow-up meeting on January 13, 1982, at which
Hancock confirmed its "recognition that the liabilities [had]
been overstated" (PX 611), Hancock made a formal revaluation
proposal on February 12, 1982, offering to revalue GAC 50's
liabilities, thereby reducing the amount necessary to pay
guaranteed benefits. (PX 626). The proposed new LOF assumptions
were "an improvement," but they were still "more conservative
than they needed to be." (Tr. at 543-44; see PX 1241).
Significantly, the proposal did not modify the transfer
provisions, and thus Sperry would not be able to transfer excess
funds out of the general account without terminating the
contract. (Tr. at 742, 801-02, 1513-14; see DX 1594, PX 611).
In addition, the proposal included a "special risk charge" to be
paid to Hancock "as consideration" for its increased risks. (PX
626) Principally for these reasons, Sperry rejected the
revaluation proposal. (Tr. 76467, 803). Sperry's rejection of
the revaluation proposal was reasonable. (Tr. 166-67 578-81).
In sum, the circumstances surrounding Hancock's revaluation
proposal demonstrated that it recognized that it was holding
reserves far in excess of the amount necessary to cover
liabilities, that it hac the discretion to revalue the
liabilities to reduce the amount necessary to be held in
reserve, and that it refused to do so on terms more favorable to
the Trust because of its own self-interest.
H. The 1988 Amendment
In 1988, after the filing of this action, the Plan was amended
again, to permit the Trustee to freely transfer "free funds" out
of Hancock's General Account without triggering the termination
of the PAF and Hancock's "repurchase" of the pre-1968 deferred
annuities (the "1988 Amendment"). Pursuant to the 1988
Amendment, the Trustee requested the transfer of more than $53
million in "free funds" out of the PAF.
I. Hancock's Investment and Allocation Decisions
1. Fixed and Frozen Assets
From at least as early as 1976, Hancock routinely invested
Plan Assets in its own home office properties, i.e., the
buildings, land, and physical plant maintained by Hancock for
"its own occupancy" for the operation of its business, as
opposed to properties acquired solely for investment purposes.
(Tr. 218). Hancock charged itself "rent" for the use of this
property, thereby generating investment income.*fn3 Hancock
determined the rate of return on
these "investments" in its own assets and it allocated income
and losses from these investments to its participating General
Account contracts, including GAC 50. Hancock invested a greater
proportion of its assets in home office properties than most
other comparable insurance companies. (PX 353). The resulting
rates of return were consistently lower in many years than the
return on other investments made by Hancock for its customers.
(Tr. 220-21, 232). Hancock recognized this problem itself as
early as May of 1977 when it observed in an internal memorandum:
Particular attention was given to the fixed and
frozen component of "scaling" which changed
significantly in 1976, primarily due to the adverse
effect of the investments in the Home Office complex.
This adverse effect on interest rates is expected to
continue and possibly worsen in 1977. . . . Notable
was the fact that John Hancock (of the 12 listed
insurance companies) has, except for Travelers, the
largest proportion of admitted assets in Home Office
properties (1.11% in 1976 versus Equitable's .30%)
and, except for Mutual of New York, the lowest rate
of return on such properties (-6.69% in 1976 versus
(PX 353; see Tr. 226; see also PXs 899 at 1, 900, 901, 914,
1042). Hancock also recognized itself that one of the reasons
for the low yield was that Hancock was "charging itself rental
rates below the market rates." (PX 351). In addition, two of the
buildings in question had low occupancy rates, and the
properties had high operating expenses. (Id.).
The manner in which Hancock allocated the investment income
for the fixed and frozen assets benefited other lines of
business within Hancock at the expense of the group pension
line. Group pensions is a line that accumulates a great deal of
assets but is comparatively inexpensive to operate, while group
insurance, for example, accumulates smaller levels of assets but
generates high expenses because it requires more personnel and
office space to handle the higher amounts of paperwork. (Tr.
In addition, Hancock chose not to allocate any portion of
Hancock's investment in fixed and frozen assets to the
Guaranteed Benefit Separate Account (the "GBSA"), the portion of
the general account from which virtually all new
nonparticipating group pension contracts were sold since 1980.
(Tr. 1547-48, 1624). In the participating group pension
contracts, the policyholders bore the investment risk; in
contrast, Hancock bore all the investment risk with respect to
GBSA contracts. As a consequence, the GBSA contracts were not
saddled with the lower rate of return. An August 7, 1985
internal Hancock memorandum noted that there was higher negative
scaling for participating contracts than for non-participating
contracts and observed: "It does not seem reasonable to have the
negative scaling for fixed and frozen assets vary even slightly
between the two segments." (PX 877, at 3; see also Tr. 251-52,
Hancock's own group pension actuary, Henry Winslow, and others
at Hancock repeatedly questioned the manner in which Hancock was
allocating fixed and frozen income to the group pension line. In
the early 1990's, Winslow repeatedly argued that the allocation
procedures resulted in unacceptable shortfalls of income for the
group pension line, and noted that this had the effect of
"confound[ing]" customer expectation that the general account
was primarily a fixed income investment. (PXs 899, 900, 901,
902, 907, 914; see also Tr. 1527-29 (Winslow acknowledging
that group pension should have gotten additional income), 1541
(Winslow acknowledging that from 1977 to time of trial Hancock's
investments in home office properties had driven down the rate
of return on GAC 50 assets)). The minutes of the November 30,
1992 meeting of the Hancock Group Pension Profit Center Board of
Directors read as follows:
The current corporate investment generation
methodology for Fixed and Frozen continues to be a
burden for Group Pensions. The shortfall of over 60
basis points implies a shift into equity investments;
whereas par [participating] clients expect the par
general account's investments to be primarily fixed
income. Group Pension should continue to work with
corporate to ameliorate this situation.
Hancock did not, however, significantly change its manner of
allocating fixed and frozen income after 1977 and the rate of
return on the home office properties was lower than the rate of
return on other investments in subsequent years as well. (Tr.
232, 244). By 1994, the shortfall for fixed and frozen assets
had reached 70 basis points; yet, Hancock failed to make any
change in its methodology. (PX 1042).
Hancock's investments in fixed and frozen assets also included
investments in its own subsidiaries, and likewise Hancock
realized returns on these investments, which were allocated
across its assets as with the other fixed and frozen
investments. This continued into the mid 1990's. (Tr. 23233).
These investments resulted in reduced investment income. (See
PX 583 ("One half of this drop reflects the decision to supply
$200 million to our Variable Life subsidiary."); PX 878 at 5
("[T]he fixed and frozen portion of this item includes our
subsidiary, John Hancock Property & Casualty, which experienced
a large reduction in market value in 1986.")).
In deciding to invest Plan Assets in its own properties and
subsidiaries and in determining how to allocate income and what
adjustments to make, Hancock was exercising its discretion. (Tr.
2. Third-Year Drop
From 1970 to 1977, to improve its "new money" rate, Hancock
adopted a policy of imputing to new common stock purchases the
yields it was earning on its bond and mortgage portfolios during
the first two years after the common stocks' purchases. In other
words, Hancock decided to assume that stocks would earn the same
yield as bonds in the first two years following their purchase,
even though common stocks actually yielded a lower rate of
return. Hancock knew, at the time, that this decision would
penalize contracts with largely pre-1970 contributions, such as
GAC 50, while permitting Hancock to improve artificially its
"new money rate" to help it attract new customers. (Tr. 27071,
275-76, 278-83; PX 122, 126). Because the yield on stocks did
not increase, Hancock made adjustments every third year to
reconcile. (Tr. 271-72; PX 1248).
The net effect of Hancock's policy was to reduce the rate of
return allocated to GAC 50 and other participating contracts, as
Hancock artificially increased the "new money rate" for new
investments by taking investment income properly allocable to
older contracts like GAC 50 and using it to improve the rate of
return on new business.
The actions with respect to the "third year drop" occurred
prior to July 20, 1977.
3. The Cost of Borrowing
During certain years Hancock borrowed money and allocated the
cost of the borrowing to different lines of business, including
group pension. The group pension line of business, however, was
always profitable and the cash flow associated with GAC 50 was
always positive. Hence, GAC 50 and other group pension contracts
were required to share the burden of the borrowing even though
the loans were necessitated not by group pension but by other
lines of business within Hancock. (Tr. 257-61; PX 1200A).
Hancock could have allocated this expense just to the lines of
business that required the loans, but it chose instead to
allocate the costs of borrowing funds to other lines as well,
including group pension.
4. Indirect Expenses
Hancock also allocated certain "indirect expenses" to GAC 50,
including (a) a portion of the litigation costs of the instant
case, (b) a portion of the expenses incurred by Hancock in
lobbying Congress to amend ERISA to relieve Hancock and other
insurers of the fiduciary duties that the courts in this case
have held ERISA imposes on them, and (c) a portion of expenses
relating to contracts other than GAC 50. (Tr. 296-97, 1397,
1440-41, 1552-54; 1567-68; PX 904; see also Tr. 1440-41).
These practices were inappropriate, and Hancock should have used
its own surplus to pay for these items. (Tr. 297).
5. Segmentation (Par v. Non-Par)
In 1982, Hancock segmented its General Account into
subaccounts, each with its own investment policy. One of the
segments was the Pension Participating Segment, which was
applicable to GAC 50, and another was the Pension
Non-Participating Account. For the 1982 investment year, Hancock
allocated higher yielding investments to its own
nonparticipating business than it allocated to participating
contracts such as GAC 50. (Tr. 305). Hancock benefitted from
this allocation, to the detriment of the participating segment,
including GAC 50. (Tr. 305-07).
6. Income Tax Allocations
Hancock allocated federal income tax to GAC 50 in such a
manner that GAC 50 was charged for taxes generated by other
contracts. Beginning in 1984, mutual life insurance companies
were taxed on their surplus, or what could loosely be called
"operating profit." The tax attributed to the participating
segment of the group pension line was based upon the total
allocated and unallocated surplus associated with that line,
while within the line the tax was allocated to each
participating contract not on the basis of the surplus but using
its investment contribution base. In the case of GAC 50, the
allocation was based on GAC 50's entire PAF, rather than the
much smaller Contingency Account. (Tr. 309-11). If Hancock had
allocated the tax on the basis of surplus within the line as
well, GAC 50 would have borne a lower share of the tax. As
McCarthy explained it:
[I]n effect, Hancock took the tax, split it into two
pieces, allocated one piece of it the way the tax was
actually borne and the other piece across the asset
bases of the contracts, without regard to whether
they had surplus or not or how much.
At trial, the Plan's expert witness in this respect
acknowledged that the Plan's damages would disappear in the
event Professor Ibbotson's damages calculations were accepted.
(See PX 1237.)*fn4
This action was commenced on July 20, 1983. The Trustee
alleged that Hancock was an ERISA fiduciary with respect to the
free funds and that Hancock had breached its fiduciary duties
by, inter alia, not permitting the Trustee to withdraw free
funds. Hancock responded principally by arguing that it was not
an ERISA fiduciary with respect to the free funds.
In 1988, the parties filed summary judgment motions. In 1989,
Judge Patterson, to whom the case was then assigned, granted
summary judgment dismissing the Trustee's ERISA fiduciary
claims, holding that Hancock was not an ERISA fiduciary with
respect to any assets of GAC 50. See Harris Trust & Sav. Bank
v. John Hancock Mut. Life Ins. Co., 722 F. Supp. 998 (S.D.N.Y.
1989). Judge Patterson later dismissed the Trustee's remaining
of contract and tort claims. See Harris Trust & Sav. Bank v.
John Hancock Mut. Life Ins. Co., 767 F. Supp. 1269 (S.D.N.Y.
On appeal, the Second Circuit reversed in part and affirmed in
part. It held that Hancock was an ERISA fiduciary with respect
to the "free funds" portion of GAC-50, as to which benefits were
not guaranteed, and that therefore Hancock was subject to
"fiduciary responsibility" under ERISA with respect to the free
funds, which were plan assets. See Harris Trust & Sav. Bank v.
John Hancock Mut. Life Ins. Co., 970 F.2d 1138, 1143-44 (2d
Hancock appealed to the Supreme Court. The Supreme Court
affirmed the Second Circuit's holding, concluding:
Hancock provided no real guarantee that benefits in
any amount would be payable from the free funds. We
therefore conclude, as did the Second Circuit, that
the free funds are "plan assets," and that Hancock's
actions in regard to their management and disposition
must be judged against ERISA's fiduciary standards.
John Hancock Mut. Life Ins. Co. v. Harris Trust & Sav. Bank,
510 U.S. 86, 106, 114 S.Ct. 517, 126 L.Ed.2d 524 (1993).