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A confidential witness

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EDITOR'S NOTE: This report was among documents regarding an investigation of Prudential Insurance Co. of America that were released in December 1997 by the Florida Department of Insurance.

This particular document is the first part of testimony by a "confidential witness," a former Prudential employee, to Florida officials investigating the insurance company. The testimony was taken Oct. 18, 1996.




IN RE THE MATTER OF: Prudential Insurance Company of America.
CASE NO.: 16463-96


THE SWORN STATEMENT OF A CONFIDENTIAL WITNESS was taken on behalf of the State of Florida at the Regional Office of the Insurance Department, Jacksonville, Florida, Suite 101, Taylor Building, Koger Center, 1965 Beachway Road, Jacksonville, Florida, on Friday, October 18, 1996, at 12:00 noon, before Jayne Foreman, a Notary Public in and for the State of Florida at Large.

(Pages 1 - 113)

Daytona Beach, Florida 32114-5644
(904) 252-9774



Senior Assistant Attorney General
Bureau Chief, RICO Section
Tallahassee Bureau
The State of Florida
Office of the Attorney General
The Capitol
Tallahassee, Florida 32399-1050

Appearing on behalf of the State of Florida.

Division of Legal Services
612 Larson Building
Tallahassee, Florida 32399-0333

Appearing on behalf of the State of Florida.

Office of the Attorney General
Department of Legal Affairs
Economic Crimes Division
The Capitol, PL-01
Tallahassee, Florida 32399-1050

Appearing on behalf of the State of Florida.





Examination by Mr. Vanden Dooren, Mr. Shropshire and Mr. Camil




A CONFIDENTIAL WITNESS, having been produced and first duly sworn as a witness on behalf of the State of Florida, testified as follows: EXAMINATION

Q (By Mr. Vanden Dooren) How do you want to approach it?

A Let's start with the audit report. Evidently, the company knew about this as early as the early 80's. I think you'll see from this that they knew about it before the early 80's.

Q (By Mr. Shropshire) Referring to financed insurance?

A Wrongful sales practices including financed insurance.

Q (By Mr. Vanden Dooren) I guess an easy way to do this, assuming you are talking about the APP, the financing and the pension plan stuff, unless you tell us -

A And insurance sold as an investment. The kind of problems in the 1982 audit report they noted that -financing of new business using insurance surrenders, without the full knowledge of the policyholder in one district office. They also indicated that they were intensifying audit activity of the district office referring to Cedar Rapids, Iowa.

Q Who are they?

A The auditors. When I refer to audit reports, it is the auditors that are testing. They found no problems in ordinary agencies, which is odd because ordinary agencies was using what they call the variable outlay plan, VOP, at that time which was a significant number of their sales. In the 1983 audit, they uncovered more irregularities with regard to financed insurance without the knowledge or consent of policyholders, and they communicated their concerns, and this is in the report to the executive office and launched a company-wide review. They also said that they implemented new audit software. One of the phrases in the report says, "To avoid disrupting the marketing effort and properly marketed financed sales, we adopted a systematic measured response in all offices." That essentially means that they slowed their investigation so that they would not interfere with sales.

Q Which audit is this?

A The 1983 audit.

Q (By Mr. Shropshire) Cedar Rapids?

A No, for district agencies as a whole.

Q Coming out of Newark?

A Yes, sir, they are all Newark audit reports to the Board.

Q What would those documents have been called technically?

A They would be the 1983 audit reports.

Q How would it be identified?

A Report to the auditing committee of the Board of Directors, 1983.

Q Does it give a specific entity audited?

A Within the report, and yet you have to keep in mind that that report has a body which is signed by the senior vice president and comptroller and vice president associate comptroller, typically the chief auditor. Eugene O'Hara and Milan Johnson would have been the two people that signed it. It was presented to the audit committee of the Board. There are appendices to the audit reports. You have to have the appendices. Without the appendices you have nothing.

Q Again, this was an audit of the district agencies nationwide?

A Yes.

Q Was it a special audit?

A No. These were normal audits conducted in the normal course of business.

Q (Mr. Vanden Dooren) annual one?

A For instance, ordinary agencies, here it says they audited 31 percent of the field offices, so each year they do a certain percentage. Each report tells about how many they did.

Q (Mr. Shropshire) This would have been an audit for the year 1983?

A Yes.

Q So it would have been presented in '84?

A '84, correct.

Q So this would have addressed, would have included the Cedar Rapids result?

A The Cedar Rapids result from the '82 audit -- '83.

Q Certainly would have been in the audit report if not in the -

A Keep in mind also specialized audit reports address different subjects and are prepared for senior management.

Q Does it indicate who the specific audit staff were, who worked it?

A No. But you could, after you got these, ask questions which lead to who prepared.

Q Do you know what retention policies were?

A They are permanent.

Q (Mr. Vanden Dooren) Is that pursuant to general retention policies?

A We have no general retention policies in the company.

Q So what makes this permanent?

A The audit department makes it permanent.

Q Pursuant to written?

A I'm not sure if there are any written -- keep in mind record retention policies were kept by the record -- I think it was called record retention office or record management office up until 1986. In 1986, that office was disbanded and each of the business units then began to set their own retention policies.

In 1984 audit report district agencies they -

Q (By Mr. Shropshire) The audit report for calendar year 1984?

A Whenever I say a year it is for that calendar year. It has continued to support the marketing practices program established by corporate district agencies department and has encouraged its expansion recently to further the program. The corporate district agencies department issued to the field sales force a restatement of their commitment to sound sales practices and interest in an interest sensitive environment. This was the precise year where the sales began to boom and you began to see a great increase in financed insurance sales. The auditors did not pick it up.

Q (Mr. Vanden Dooren) was there some reason for that?

A The only reason I can think of is they didn't want it picked up or the system was so ineffective that they didn't pick it up.

Q Yet in the prior one you said they developed a system?

A Correct.

Q Let me go back to that for a second. They developed a system. What kind of system, do you know?

A I don't know. I think it was the core report system which essentially has a number of different elements in it, and I can discuss that later.

Q (By Mr. Shropshire) What was that slow down that you mentioned earlier today, where they slowed down the dropping marketing?

A That was in 1983.

Q (By Mr. Camil) Who directed that?

A I assume it was the auditor.

Q (By Mr. Shropshire) Can you show me that again?

A Yes, "to avoid disruption of the year's marketing effort ... financed systematic measured response in all offices," okay. Well, let's keep going. I'm sorry. That is Prudential speaking.

1985 audit report, no major problems found. 1985 was the year in which financing and APP were not the predominant methods of sale. They were certainly very significant methods of sale, but they found no problems. In 1985, again, they reported no significant problems.

Q 1986?

A 1986, again, reported no significant problems. In 1987, they reported that management controls have been administered in a satisfactory manner. Just as a background in what year are we on?

Q (By Mr. Vanden Dooren) '87.

A '87 audited 34 percent of district agencies offices, and 31 percent of the ordinary agencies offices should have been a significant enough sample to discover problems.

Q 34 percent of the -

A District agency and 31 percent of ordinary agency offices.

Q (By Mr. Camil) Do we know why it didn't uncover anything?

A No. I can't figure it out because it was common knowledge. In the 1988 audit, the report states management controls were generally satisfactory. Support functions were performed in accord with company guidelines, but they also indicate that another area of concern is the need to strengthen field management's supervision of agents' activity. '88 is where they began to talk about supervision of agent activity in a significant fashion.

1989 -- this is 1992. Did I skip one?

Q (By Mr. Camil) You left off at '88. '89 would be the next.

A '88 -- I don't have the next one, I have '92. In '92 they talked about the implementation of a new system for district agencies. The full effect would not be realized until 1993.

Q (By Mr. Shropshire) System referring to what?

A Call it the business quality process. It was implemented under the direction of Don Southwell. It is a flawed process that was not designed to catch much of anything simply because the maximum financed period was 120 days.

In other words, if you did the financing on the second policy 120 days apart from taking the money out of the other policy, you would never be caught. Well, anybody can beat the system even if it meant putting your own money in. You would still make money because it is the first year of the commission rate.

Again, they talk about recommendations to strengthen supervisory controls.

Q Let me ask you about that last comment. So you are saying that the agent might have the sale initially recorded as a quarterly premium payment, and the agent might pay the first quarterly premium to get by the 120 days?

A No, there are a couple of ways you could do it. What they could say is you pay us a quarterly premium on the new policy and pay one more quarterly premium on the older policy, and after that you won't need to pay any more, or they might say we are going to terminate the coverage under the older policy and wait months to terminate the older policy. Or you might say we're going to leave -- we're going to terminate coverage on the older policy immediately and we're not going to collect the premium and make up the premium themselves. I mean, there is a whole range of ways to do it. They are very obvious to the sales people and sales management.

And then '93 is just more of the same and '94 -that is '93. '94 is when it really began to hit, and they do talk about it in those. They are not going to be very useful.

Q (By Mr. Camil) Was it considered common knowledge by Don Southwell, and the others who implemented the business quality process to supposedly catch -- monitor these activities; that they knew it wasn't efficient and would not do what it was intended to do?

A In the first design meeting of this which occurred in, I believe, 1991, that very matter was discussed along with the thought that you should include dividends on -- not include dividends in financed. And after that meeting, it was decided to not include dividends. And then it was also decided to go with the short period.

Q Can you tell us if you were at that meeting and who was at that meeting?

A I don't know who was at the second meeting. The first meeting in '91, it was Don Southwell, Ed Beard, Ren Nelson and some of the vice presidents of district agencies from the field. And I think there were some staff people in there too, but I can't remember.

Q (By Mr. Vanden Dooren) Do they normally record those meetings or have minutes of those meetings?

A No.

Q (By Mr. Shropshire) You said earlier that you couldn't figure out why the audit reports from the 80's didn't pick up the financed sales because it was common knowledge. What do you mean by that remark?

A Well, it was common knowledge that the financed sales technique was being used. I don't think it was common knowledge that it was being used inappropriately to the length it was being used inappropriately.

Q Among who was that common knowledge?

A It was common knowledge by the sales people, by attorneys, by a great number of the people.

Q Was it common knowledge among Prudential's top management?

A I think you'll see some records to show that people at the executive vice president level and even in president level knew.

Q And if -- do I understand you correctly to say that what was known was that it was being done -financed was being done improperly, but perhaps the amount of it wasn't appreciated?

A Correct, and probably even not the amount of the financed was appreciated.

Q But they do know back then that improper financed sales were going on; is that right?

A Yes, I think it is. I think that they knew that from at least 1981 and probably as early as 1976.

Q Okay, go ahead.

A Now, with regard to sales practices in the 80's, the people who you would probably want to talk to would be David Dukehart, D-U-K-E-H-A-R-T, Dave Fastenberg, Joe Gebbia, G-E-B-B-I-A, I think it is. I think those people would give you fairly straight forward answers about how things were done and how things were actually sold in the 80's, all in the field in the 80's, and they were all in field management in the 80's also.

Q (By Mr. Vanden Dooren) What do you mean how things were sold? How would they describe it?

A They would be able to describe how sales were made, how people might get around systems, how they were directed, and how they directed people.

You will probably see that in Prudential all the documents that you see or the bulk of the documents you see will be very good on their face, they'll say you shall not do this. The problem was there was nothing behind "you shall not do this." There was no enforcement mechanism, and there was no mechanism to punish. In fact, I don't believe you'll find a single termination of an agent or member of management for financing insurance outside of Cedar Rapids and a couple of other districts in the 80's.

Q (By Mr. Shropshire) Who is David Dukehart?

A Dave Dukehart is retired from Prudential. He was formerly vice president with Prudential. He worked in Western Region and worked in the Southwestern Region.

Q Do you know where he lives?

A Yes, he -- well, he is a consultant with Prudential right now and he works in Newark in New Jersey. I don't know where he lives.

Q (By Mr. Camil) The 1991 meeting that you talked about where different people were present, can you give us any additional details of that discussion, what took place as far as what to use or not to use or whether it was effective or noneffective to go forward with -- anyway, what took place?

A I think that what occurred at the meeting you should talk to the people that were there. The people that I mentioned.

Q Ed Beard who you named, what was his position?

A Ed Beard was the administrative head of District Agencies at that time.

Q (By Mr. Shropshire) in Newark?

A Yes. He is currently working in the group department in Roseland, New Jersey.

Now, in 1973, September 13, 1973, there is a memorandum which essentially is an outline of the history with respect to replacements, financed insurance and Prudential's positions on those matters. I refer that to you simply because I think that that will be an important document for you to understand what the public position of Prudential was; that they were against financed insurance; that they were against replacements at that time.

Q (By Mr. Camil) Do you know who this is from, this memorandum?

A It was written by Bill Porraro who was the vice president of marketing in Ordinary Agencies. Wait, maybe it wasn't. No, I don't know who, but what you would want to do is ask for any memorandums outlining the company's position with respect to financed insurance replacement and replacements published in 1973 or earlier, and you'll get it. And if you don't get it, that is a different problem.

Q (By Mr. Vanden Dooren) Is there anything else identified in that thing? A rifle shot is a lot better.

Q (By Mr. Camil) Who is cc'ed, or signed possibly at the end?

A No signature on it. I'm trying to fold these pages back. These are attachments, but it appears to be unsigned.

Q (By Mr. Vanden Dooren) Why is that thing so bland? That is what I don't understand.

A So what?

Q Bland. It doesn't say to, from, or -

A It may have been a memorandum just for historical purposes, and that would be the value to you.

Q (By Mr. Camil) Does this say underwriting file and a signature below?

A It may have been written in underwriting. I don't know.

Q Agents life underwriting?

A But you can't rifle shot these documents or my identification will be known.

Q Okay.

A You have to be very general, go from the general to the specific. On February 7, 1974, Lynch, Kvernland, and Nash, who at that time were the heads of the District Agencies and Ordinary Agencies, did a memo to everybody involved in sales on financing insurance in the lower and middle income brackets. Basically what it says is, don't do it. And again, it outlines why not to do it and a brief history of the company's position, which, again, is don't do it. And it outlines the danger in doing it. Now, oddly enough these are the very people that Prudential did it most to later on.

Now, in 1974 this would indicate, this memo would indicate, that they were already aware that this was a problem and Lynch was senior vice president of District Agencies. Kvernland was chief actuary, and Nash was the Senior Vice President of Ordinary Agencies. So essentially they were the senior people within distribution channels actually.

Q What is this guys Kvern -

A Kvernland. I believe all three of them are still alive.

Q Are they all present employees?

A No, they are all retired. In fact, Nash lives in Jacksonville, William Nash.

Q (By Mr. Camil) And that was written to corporate regional home office?

A Written to regional home office vice presidents of sales, regional home office actuary director, or regional home office director of agencies.

Q And reflective on their work on a national scale.

A Right.

Q (By Mr. Shropshire) Up at the top it refers to attachment A-1?

A That was written in by somebody else.

Q Do you know what it was an attachment to?

A No, I don't believe this was an attachment to anything.

Q ( By Mr. Vanden Dooren) Originally?

A I believe this was written-in later on.

Q (By Mr. Shropshire) What level was that?

A This is national. This applied to everybody.

Q (By Mr. Vanden Dooren) Where were these people when they wrote this?

A Newark, New Jersey.

Q (By Mr. Shropshire) The previous document that you showed us, does that also -- does that have reference to some incident that has come up?

A No.

Q No cause whatsoever?

A Of the cause, no. July 26, 1976, Dewayne Murner, M-U-R-N-E-R, recommended an -

Q (By Mr. Shropshire) "Underwriting change with respect to financing and insurance; one, to forbid financed insurance for individuals making less than $25,000 a year." The current that is indicated in this was $20,000 a year. He was recommending increasing that threshold?

A From $20,000 to $25,000. This was in 1976. And they were for financed insurance underwriting changes. The question this memorandum brings up is on the face it looks very positive, very good, because you are protecting lower income people. In fact $25,000 in 1976 was -- went pretty high.

The question you ask is what were the underwriting procedures? That is to be certain that we didn't write under $20,000. And the persons you would ask that of are two people. One is Ernie Testa, T-E-S-T-A, who is currently in charge of underwriting for a company, and the other would be John Snore, S-N-O-R-E, who was formerly in charge of underwriting and is now retired. I believe he still lives in New Jersey and you will find the procedures were lacking almost in their entirety. Again, although we said things publicly that were proper, what was behind them was very little.

Q (By Mr. Camil) And the memorandum is written to -

A It was written to Robert Scales who was then in the District Agencies department. He was the vice president.

Q (By Mr. Camil) Is he still with Prudential?

A He is retired also. I think he is still alive.

Q (By Mr. Shropshire) This reference to being regularly attacked by the actuarial department, do you have any background on that kind of a statement?

A There are some documents that will give you background on that and some people you can talk to, but basically what is known about financed insurance is if it is done properly, at best you are putting them in a very precarious position where they may have to pay premiums on the two policies when they are expected to pay premiums on one. At worse, they have no knowledge of what is going on in the transaction. And when the one policy is depleted and lapses, they essentially stop paying on the other policy and both policies lapse.

So whenever I have two policies in a household that have lapsed, you can almost be certain that there was a misrepresentation in the sale, almost certain. I have never seen a case where it wasn't true.

Q That statement is toward financed insurance in general?

A Yes.

Q (By Mr. Vanden Dooren) Some of these prior documents, did Prudential acknowledge that -- in other words, that financing is generally just bad?

A Yes. That has always been Prudential's public statement, financing and replacement is bad; not generally in the best interest of the policyholder.

Q Only to be used in rare circumstances; is that right?

A Correct. At the peak, it was used in at least 30 percent of the cases and probably higher. And if you ask them to explain when it was, in what factual situation it is proper, very few people can explain it.

Q That was going to be my next question.

A I can give you one example: When a net expected cost of the insurance on the new policy is less than on the old, and the people are aware that the old policy may lapse. Now, there are very few situations where that can occur.

Q (By Mr. Shropshire) Because in the older, net cost is going to be higher by definition?

A The time it may occur is where you have a policy with a high cash value front-end loaded. A change in the mortality assumptions on a new series of policies is the only time I can think of where it occurs.

Q Was it rare?

A I have never seen it.

Q So rare you have never seen it?

A Yes. But when people ask me for a factual situation where I can say absolutely it is a good buy, that is the only time I can think of.

Another factual situation for instance was when interest was tax deductible and where your income tax bracket was 70 percent, it may make a lot of sense to borrow and to get the tax deduction and to buy more coverage if you need the coverage. That is not true any longer, not true since 1989 when it was completely done away with, and when it started to be done away with in '88 or '87.

Q Well, looking at this memo then it seems that this establishes that whatever safeguards Prudential intended to be used in the sale of financed insurance weren't washing because Prudential knew the lapse rates were extra high on financed insurance?

A Absolutely. Keep in mind this recommendation as far as I know was never adopted.

Q Mr. Scales to whom this is to, is he in Newark?

A He is retired now, but he was the VP in Newark.

Q (By Mr. Vanden Dooren) So national VP?

A Yes.

Q (By Mr. Shropshire) Something has always puzzled me in that the company has said publicly, and you have indicated, in the insurance, financed insurance is only appropriate in very unusual circumstances, and then they explain the circumstances.

A No they don't -- correct, I'm sorry. But they do say that generally financed insurance is not appropriate in official publications.

Q They say that?

A Correct.

Q And then the company says currently that you can't make the assumption that the people who were sold this financed insurance that it wasn't appropriate for them, because maybe the agents did apply proper procedures to those for all we know?

A Correct.

Q But this memo indicates that they do know because the lapse on business actually sold was high on financing insurance, correct?

A No, not missing anything.

Q So that then this document would indicate that the company knew way back in '76 that financed insurance was regularly producing unacceptable results?

A Correct. And the next question is why was it producing unacceptable results. Did you look into it? Did you ascertain what occurred in the sale that produced these unacceptable results? The answer is nothing. The reason that Prudential didn't care was they were sales driven. Everything was measured off new sales. Persistency was a very small percentage of anybody's compensation and still is today.

Q (By Mr. Camil) Do you know what system or records may have been in play in 1976 to be able to produce this kind of memorandum, these kind of reports; that they new that they were looking at lapsed rates, that sort of thing, to tell them that this was probably in the computer system in place earlier on?

A No, but the person you would want to talk to who could tell you is the person by the name of Jay Dings, D-I-N-G-S. He is retired from Prudential, and I understand he is still living in New Jersey also. He is probably familiar with the systems monitoring persistency in financed and you'll see some memorandums, memos from him in here.

Q (By Mr. Vanden Dooren) Do you know if these people that we have been mentioning who are familiar with this stuff that are retired, do you know if they are receptive to telling us about this stuff or -

A I don't know.

Q Any idea?

A I don't know. Keep in mind that many people who are involved in the industry got involved because they really thought the industry had the capacity to do good. If you are in this industry for 30 years, it is hard for you to say, 30 years I have been wrong. It is very difficult to say you have wasted your adult life and now you have discovered that what you have done is you have participated in helping a company rip off policyholders. It is a hard conclusion to come to. It is gut wrenching, especially when you know that the company has to survive, because no matter how many people were misrepresented, there are many more people who have policies who want to be paid if the company doesn't survive. So that you have to balance this. You have to protect not only those who were misrepresented, but those who remain who we made a promise to that we would pay them when they die. You cannot -that is a large number of people. You cannot hurt those people. The people you have to hurt are the people who were in management who were responsible. You have to get them out of the industry. And unfortunately Prudential is not the only bad place.

Q (By Mr. Camil) For the company to suggest that financing is bad because it did not benefit them and in fact cost them to insure higher risks of people, that sort of thing, and as far as it really didn't promote, encourage, or allow it because it hurt the company, in fact, financially, what would you say to that?

A I would say that is an appropriate stance for a company that is a mutual company owned by the policyholders. Keep in mind that what it really means is when a policyholder owns a company, that is their claim to be able to be paid when they die. So the company owes a responsibility to its current policyholders, I owe a responsibility to. I don't owe it to Art Ryan, Jim Gillen, people like that. The management should not be managing this company to deplete the assets to be able to pay the claims of the policyholder.

Q What were the things benefiting the company the most about allowing this to take place?

A I can't think of benefits that enabled us to get bigger. There was a benefit to the agents, to management, to individuals working for the company, because their bonuses got dramatically larger.

If you look at the pay scale of management in 1976, a senior vice president in 1976 probably made a $100,000 a year, a lot of money. A senior vice president in the company today probably in the same position might make a million dollars a year. Now inflation has been eating away a lot since 1976, but I don't think it ate ten times.

Q (By Mr. Vanden Dooren) Not that much.

A So there was a financial incentive for the employees, all of the employees, not just the senior people. If you look at mid-level people, their compensation has gone up dramatically.

Q (By Mr. Shropshire) Looking at this July 1976 memo, if I understand you correctly you are saying this establishes that management knew that financed insurance was producing unacceptably high lapse rates and was not working, but that management then turned a blind eye?

A As to why?

Q Management affirmatively chose not to -- why?

A Reckless disregard. It was described as -- I don't think you are going to find anything criminal. I have to say that right up front. What I think you are going to find is gross mismanagement, reckless disregard for the steps they should have taken; that a reasonable person would have taken.

Q This person to whom it was addressed came up through the sales force; can we assume that?

A He did.

Q Wouldn't that person know exactly why financed wasn't working, why the high lapse rates were there?

A He should. I can't speak to what was in his mind. I do know other people who I could speak to, what was in their mind because they have talked to me.

Q Is it fair to say misrepresentations were going on but they affirmatively chose not to pursue it, management?

A It would probably be fair to assume that they knew something was wrong in the sale, but they may not have known what, this is in 1976, but instead of finding out, they said wait, I don't want to find out, or they actually did know and said shut it down -- we don't want any more record, one of the two. I don't know the answer.

Q (By Mr. Vanden Dooren) Well, let me follow up on that. I don't know if it was in '76, but at some point in time they -- now, I think the figure you gave was 30 percent or so of this business?

A That was not until the mid 80's that it reached that level.

Q At some point they find out through their monitoring systems or reports or whatever that financing is a very large portion of what is going on out there, right?

A Yes. Keep in mind no report is ever going to show 30 percent. The reports are always going to show 8 - 10 percent. They never showed 30 percent.

Q (By Mr. Camil) Why?

A The 90 days.

Q (By Mr. Shropshire) Why did they used to show 8 or 9 percent and never show the real 30 percent that you refer to?

A Because the time period that you look at it is so short that it never picks it up.

Q 20 days?

A 30 days before, 90 days after. That is the maximum period. As long as you are only looking at the short time frame, you never pick it up.

Q Did anyone ever know that it was running at 30 percent or whatever it really was running at? Did anybody ever know that at Prudential?

A I'm sure you could not -- you could not talk to the field and not know.

Q (By Mr. Vanden Dooren) Okay. Do you remember anybody ever asking that or suggesting that 120 days be the standard and management rebuffing that kind of suggestion?

A I was not present where that occurred, but I have heard rumors that it occurred, and I heard the person that rebuffed it was Don Southwell.

Q (By Mr. Camil) The reports that indicate the new business disbursement, reports that supposedly were to show matches and showed they exclude PUA's and dividends, do those reports exclude PUA's and dividends?

A But this report, that will show dividends also. That includes dividends. This figure, that gives you the dividends.

Q Are PUA's normally always left off the reports shown?

A Yes. Keep in mind that any sale, the argument is the dividends do not deplete the face value shown, so therefore, it is not an improper sale. There is a legitimacy to that argument on its face. But underneath I have never seen a dividend sale that didn't turn into borrowing.

Q If a customer was using dividends to pay current recommended premiums and you then went out to pay on a new policy or PUA, then they could end up having to pay premiums?

A Absolutely. But all I'm saying is you can make the argument, but once you look behind the argument, it falls apart, and once you look behind the facts -

Q (By Mr. Vanden Dooren) Right. Well, I guess just to take this a step farther, we say that that is true that on its surface you wouldn't see it, but someone at Prudential knew in the mid 80's or whenever it happened that there was something underneath there; is that not true?

A Yes, absolutely.

Q Okay. How high did it go?

A I don't know, but if the heads of the organization didn't know, it would shock me. The heads of the organization I'm talking about are Bob Beck who was involved in sales all of his life and Bob Winters who was an actuary all his life. They had to know, and both of them are very, very smart people. For them to say I didn't know, would be

Q It is ridiculous?

A Preposterous. At least, I think it would be.

Q (By Mr. Shropshire) Looking again at this July '76 document, do you have any information on why they were lapsing? Were they lapsing because people were becoming aware, the customers were becoming aware of the fact that the deal wasn't what they had been led to believe it was, or lapsing because they drained the old policy and the deals were collapsing financially?

A I don't know.

Q (By Mr. Camil) Was the purpose of leaving out PUA's and dividends being used to fund new policies from old ones to lower the supposed percentage of matches, was that its intent?

A Yes, because you could do a dividend, what they call a dividend sale, and sell a very high face value with very small dividends, get past the period and then go into borrowing; and that the policyholder may never know this was borrowing.

November 4, 1981, Don Garvey who was an investigator in the Fort Washington office wrote a memorandum to Hal Barney who was an assistant actuary, outlining what he thought were problems with the concept of financed insurance and misrepresentation.

Q Is Don Garvey still -

A Don Garvey is retired but does contract work for the company. Hal Barney has left the company, but he has a wife who currently is vice president with the company. Her name is Bev Barney, so you could -- whatever address they have on her would be his.

Now, this memo was then the subject of a memo by Mr. Barney to Julius Vogel who is the chief actuary for the company. "... clients seeing an increasing number of insurance sales which involve some sort of financing insurance or variable outlay plan. What is most troublesome about this trend is we have become aware of this trend not as a result of sales information, but as a result of complaints or questions raised by the policyholder after the sale."

Keep in mind this is 1981, and I think this memo was written in March of '82. And then it goes through the policy statement put out by Bob Beck, and he says one step that could eliminate many post sale problems would be to insure that the policyholder is given a clear and complete illustration, and then it tells what the illustration should include.

And then it makes two changes with it, recommends two changes with regard to financial. The first change is to put a question on the back of the new business application which would ask about financial. The second change would be require a copy of the illustration used in the sale be submitted with the application.

Neither of these things would have been particularly effective, and we ultimately did put a question on the back, because basically, I don't know if you have seen a policy illustration, but the idea that a common person can understand a policy illustration is preposterous.

I venture to say -- how long have you been in the insurance department?

Q (By Mr. Shropshire) 10 years.

A I venture to say that after 8 to 10 years even you couldn't understand it. I know people who have been in the business 20, 30 years that don't understand it.

Q Turn back to that last memo again.

A Now, this goes to the Julius Vogel in charge of the actuarial function for the whole corporation.

Q Was Fort Washington, Pennsylvania, a regional -

A Home office.

Q What region or territory was that called back


A Central Atlantic.

Q Vogel was in the national office?

A Yes. Now, Barney believes he was -- after writing this memo -- that his career was short circuited, and he ultimately left the company. I would guess that now Barney would be very cooperative.

Q Is this how Barney's memo, the March 25, '81 memo, is this -

A This is '82.

Q Which one indicates you were becoming aware of this through complaints?

A I think both of them.

Q Can you point that out?

A Right here (indicating). "What is most troublesome about this is becoming aware of the trend not as a result of sale information, but as a result of complaints or questions by policyholders after the sale."

Q Now, if this was coming out of Fort Washington, Pennsylvania, could this have had anything to do with the Cedar Rapids' problems?

A No, entirely separate.

Q It could indicate that the Fort Washington region and the Atlantic region were having the same problems?

A Correct. It would indicate rather than Cedar Rapids being an isolated case, that the company was becoming aware that inappropriate financed sales was a nationwide problem, not a problem isolated to one agency or one district office.

Q This was a Cedar Rapids' problem in any event, I believe?

A Yes.

Q (By Mr. Vanden Dooren) What is the date of this March 25 -

A 1982, I believe it is.

Q (By Mr. Shropshire) And this follows up the original memo?

A Right.

Q So the first memo is from Barney to Garvey?

A From Garvey to Barney.

Q And Garvey again is -

A I think he was marketing. He was manager of consumers affairs function in Central Atlantic.

Q So he writes to his boss?

A Boss.

Q Well, the assistant actuary?

A His boss was vice president assistant actuary.

Q Would consumer affairs have been in the actuary department? Barney thinks enough to send it on to Newark?

A Correct.

Q I have got you, okay, thank you. Well, was Vogel the chief actuary nationally?

A Yes.

Q Was he the predecessor to Milan Johnson?

A No, Johnson was chief of auditing.

Q Johnson was chief auditor?

A Yes.

Q And Vogel is chief actuary?

A Actuary.

Q Thank you.

A All right, now, in June of 1982, we announced a liberalization in payment of the commissions: "Under this liberalization, the representative who writes or submits the request for change for the new policy will receive a first year commission credit equal to the lesser of 12 percent or one half of the first year commission rate of the new policy applied to the lesser of the premium amount of the old or the new policy."

But what that means essentially is that prior to this time we didn't pay commissions on replacements. After this time we began to pay commissions on replacements.

Q (By Mr. Camil) Even if the existing policy stays in existence and is not totally replaced or surrendered?

A That is why it talks about the lesser or greater amount of the premiums. For commission purposes it is a replacement.

Q And so the last, partial last sentence that says that in no way is this change intended to encourage replacements -

A It is crap. How -- when you say that -- your replacements are seldom in the best interest of the insured. And then you change your commissions so that you pay commissions on replacements and you're telling this to people whose survival depends on commissions.

Q (By Mr. Shropshire) Well, prior to this change in policy you say that Prudential was not paying any commission at all on a replacement transaction?

A Correct.

Q Is that true as to both external and internal replacement?

A No, only internal replacements. External replacements we always pay commissions on.

Q But after this memorandum, you pay full commission even on internal replacements?

A Partial commissions.

Q Prior to this memorandum, though, if it was a replacement but, for example, through manipulating the 120-day feature, the agent was able to avoid detection. He would get a full commission?

A Correct.

Q But within the 120 days, if detected, it's called a replacement and get no -

A Correct.

Q So that would be a tremendous inducement to agents to manipulate the system and avoid 120-day detection because you get a full commission to avoid it?

Q (By Mr. Camil) Start looking for internal replacement, not just external?

A In fact, what you satisfy is you satisfy whole offices that hire new agents. And what they do with new agents is they give them the OPSR cards -- call on these people. The only OPSR cards they give them are the OPSR cards with cash value on them.

And a person who could testify as to that, and she can only testify as to that with regard to Cleveland, Ohio, one district in Cleveland, Ohio, is Brenda Nelson.

Q And who is she?

A She is a former agent. She worked for the company for about three months, and she is the wife of Ren Nelson, and she lives in Ponte Vedra, Florida, and she left there very dissatisfied with what she was being told to do.

Now, this doesn't talk about the office in Florida, but keep in mind that the vice president in charge of that region is now a manager of a Florida office.

Q Who is that?

A I can't recall his name, but he is down state some place.

Q (By Mr. Shropshire) Jamele?

A No, Jamele was actually vice president of the whole region.

Q Robert Schlip?

A Schlip has gone to Ohio. He had a position in Ohio. I just can't remember his name right at this moment. If I had a list of VPRM's in 1992, I could tell you who it was.

Q (By Mr. Shropshire) Well, I guess what I am having I'm having trouble putting together. Summarize for me the reasons that you saw that the financed insurance detection system undercounted financed insurance transactions?

A Okay. The system only counts, and if the disbursement in the old policy occurs within about 120 day period of the placement of the new policy -

Q Didn't you also indicate that doesn't look at dividend transactions?

A Correct.

Q (By Mr. Camil) Or PUA's?

Q (By Mr. Shropshire) Although the dividend transferred out of the old policy within 120 days?

A It wouldn't matter.

Q Even though the disbursement showed the payment of premiums on a new policy XYZ, are you telling me that the system would not catch that as a financed transaction back then?

A Right. There is now a report that shows that, but that is not the report that you manage by. The report you manage by is only borrowings.

Q And when is that report that at least noted or showed you dividends?

A I believe it was 1992.

Q And are you telling me also that the old style of report did not likewise -- likewise, it did not count or catch instances where they were using dividends or paid up addition riders to finance the new premiums?

A Correct.

Q So even though within 120 days the agent used the disbursement form that said take the cash value from this rider, this paid up additions rider, in the old policy, apply the new premiums within 120 days, the Prudential system would not have to include that and count it as a financed sale?

A (No audible response.)

Q (By Mr. Vanden Dooren) Does that report have a name?

A It is Core Reports, and the name of the report is Life Financial Report. Keep in mind that there are a number of reports in the Core Reports, Life Financed -not taken and the return of initial premium, FIU rejections, complaints, agent responsibility cases, interest reports, replacements, one month lapses, automatic premiums, loans, underwriting.

Q Now, that is the report you say they manage by -the Core Report?

A Yes.

Q Is there some other report that actually reflected -- well, I understand what you are saying. I understand what you are saying.

A Core Reports is a whole series of reports that are produced monthly, I believe.

Q (By Mr. Shropshire) When did these Core Reports first start being produced, do you know?

A I don't know the date.

Q Can you give me a time frame? Were they being produced throughout the 80's?

A Early to mid 80's, I guess.

Q Were they being produced at the time the Cedar Rapids story broke?

A I don't believe so.

Q The Core Reports and the other reports contained such as new life, business disbursements, associations, and so forth, those were created and intended to be used by sales managers and general managers to monitor their agents; would that be correct?

A And the regional officer to manage the agencies.

Q And above that, did corporate in New Jersey receive some sort of version or variation to identify for them the amount of matching and not matching financial variable outlays, APP's, sort of like a summary of the details of those reports for their region?

A Yes.

Q Do those reports that they receive that were taken from the Core Reports, did they have a title or a name?

A Jay Dings could give you that, D-I-N-G-S. Jay Dings will know more about the reporting system than anybody I can think of.

Q What you are saying, I guess, is the actual financing, APP, that was going on?

A Well, no, only the reported. Keep in mind that there were no reports of what I think is the actual because we didn't track it. Now, if they had chosen to track it, there would be reports of it. What if we expanded the looking back period and the looking forward period to a total of 15 months, a very different report than what has been produced.

Q I mean there is some notion that there was a system of some sort put together right about the Cedar Rapids era, okay, to identify exactly any kind of transfer of money out of an old policy into a new policy, whether it be a dividend or PUA or whatever, anything. Do you know anything about that?

A That may be what the audit system referred to in the '82 audit report.

Q So you are not aware if that happened?

A I'm not aware.

Q Taken through

A Not aware.

Q All right.

A And quite frankly the person you would ask about the audit reports is Priscilla Myers.

Q And who is she?

A She is the senior vice president of audit, compliance and investigations now, and she has been around a long time in the audit function.

Q Is she a current employee?

A Yes.

Q And where, is it in Newark?

A In Newark, yes. And on April 15, 1983, Bill Porraro sent a memo to, it appears, all the senior people in the various regional home offices. On page 26 he indicates another area of concern which involves our own variable practices: "We are experiencing increased replacement activity, increased use of financing insurance (4-pay, VOP, minimum deposit) in inappropriate situations, and significant increases in loan and cash surrender transactions and reversals, etc."

And then it goes on to say, "in the area of four to six month replacements alone, there were 2000 in 1981, and we are projecting 36,000 in 1982."

Q (By Mr. Vanden Dooren) What dates are we talking about here?

A April of 1983, and Bill Porraro, let me see what it has. He was senior vice president of District Agencies and he copied Sherwood, Malon, Pease, Marcus, Johnson, Paul Nolle, senior lawyers, senior presidents, all of them senior people within the corporation were copied.

Q Who is the senior lawyer here?

A Nolle.

Q (By Mr. Shropshire) Does the document indicate what the impetus was for sending the document? Is there a particular episode or event?

A It appears that the federal trade commission activity in the early 80's may have been -- where they talked about taking over regulation of the insurance industry.

Q And is it a fair interpretation that the memo is referring to an overall national increase in financed sales and replacement?

A Absolutely, and it refers to District Agencies only, not Ordinary Agencies.

Q What does the reference to 4-pay mean?

A That was an abbreviation pay where you showed them you were able to pay the premium out of pocket for four out of six years, four out of seven years and the rest paid from other values in the policy, other policies.

Q So you -

A Tax Law. In effect at the time pay four out of seven out of pocket in order to be able to deduct the interest on loans.

Q So that is not a reference to some abbreviation scheme or system?

A Well, it is in fact that abbreviation system because you pay four out of pocket and the rest comes from values within the policy or from other policies.

Q It is based on the concept that customers have a significant drop-in to the policy or just have been paying?

A Four annual payments, the amount of four annual premium payments is what 4-pay refers to.

Q So they are saying hold the product back then that apparently would begin to pay for itself after just four annual premium payments?

A Sure, that is just interest rates.

Q (By Mr. Vanden Dooren) Could that have happened?

A Well, when the prime rate was 17 1/2 percent, yes. The prime rate was 17 1/2 percent for what, a month and a half?

Q Do you think they were reasonably marketing this thing or this was something that, you know, pie in the sky, I mean?

A There is nobody that ever believed that this could work. I'm not aware even of people that sold it that I talked to believe it would work. They said how could you believe that interest rates are going to be 18 percent forever. Keep in mind that people selling grew up when interest rates were 5 and 6, and you probably remember the spike in interest rates and then they came back down like crazy, and there are some documents that really exhibit this which you want to get a hold of.

Q That exhibit what now?

A Prudential's raising the interest rate assumption and creating dividends while the economic interest rates were dropping radically, occurring at this time.

Q Crediting high when it is going low?

A Yes.

Q And what kind of document?

A This is what they called a SPRT (Spurt) team S-P-R-T, and what it refers to is sales practices review team in Ordinary Agencies. Dave Dukehart headed the team. It reviewed the practices that were going on in the economy, what was going on in the industry, and what was going on within Prudential beginning in about 1980 through 1995 or 1996. What you want are all of the reports, documents, charts prepared by the SPRT team, and you want those before you would talk to Dukeheart. You also -

Q What does SPRT stand for, sales practices?

A Review team.

Q You were going to say something. I cut you off there.

A The other thing you want is Dave Dukehart presented lessons to lawyers and things to explain the history. You would want him to present that to you.

Q (By Mr. Shropshire) This memo of April 15th of '83 provides a list of apparent measures to reverse the problem. Is that a fair reading?

A Yes.

Q Are the measures meaningful in your opinion?

A No.

Q Why is that?

A They are -- nothing was ever done about it. This is another case where a memo was published that said the right things, but nothing was put in place to make sure the right things were done.

Q These proposed measures were, to your knowledge, never instituted?

A Right, instituted. Right, and if they claim institution, look at what they mean by institution of the measures, and you will see that nothing was there.

Q I see that it refers to a third statement that you will be seeing a monitoring system for use in the regional office?

A That is the Core Reports, I think.

Q And those would be the reports you described today as being fairly ineffective for the reasons you have indicated, right?

A Correct.

Q 2000, 4 to 6 months replacements in '81; that is national?

A Yes, rising to 36,000 in '82. That is what we knew about.

Q What do they mean, 4 to 6 months replacement alone, 2000?

A This is where you looked back and found out there was a replacement of a policy 4 to 6 months after we wrote a new policy, and I don't know how we got the figure, but J. Dings can tell you how we got it.

Q (By Mr. Vanden Dooren) That is what they knew, but we don't know how they even knew it?

Q (By Mr. Shropshire) I'm not clear how they knew. Explain to me again.

A They are policies where a policy lapsed 4 to 6 months after a new policy was written on the same insured, maybe even in the same household. I'm not sure.

Q That would be just actual lapses, though?

A Yes.

Q Would they factor in anywhere -- they are saying they are replacement; do they include financed sales there?

A I don't know what he included in that. That is why you would -- J. Dings is the person that can help you with that. And August 1983, is a memorandum to J. Dings from Bill Porraro indicating that they devised, and I'm not quite sure what it did or what it was, but it looks like it was -- it had to do with replacements of policies.

Q You mean that Dings had designed something?

A Dings had designed it. Keep in mind that any designs would have been done by Dings or somebody by the name of George Knorr K-N-O-R-R.

Q What is this reference to, "But bears on one of our proposals for bargaining regarding the replacement period"? What does bargaining refer to?

A The union. The agents are represented by a union, and it refers to the union bargaining, which occurs in September of odd number of years.

Q And how would the replacement have been a bargaining? Do you know anything about -

A If you are going to change compensation or the rules with regard to compensation, you have to bargain it with the agent.

Q Would the majority of the replacements that they are talking about in these documents, would those be replacements of the financed insurance in your opinion?

A I don't know. But I have a view of financing being a subset of replacements, and it is almost concurrent.

Q Apparently Porraro and others in the company -

Q (By Mr. Shropshire) When you say almost concurrent

A Almost the same magnitude, overlaps one another to a great degree.

Q If I am following you correctly, you are saying essentially the number of the financed insurance is the same as the number of the replacements?

A Yes, I would think so.

Q The only other form of the replacement would be that literal extermination or termination in the initial transaction of the initial original policy, correct?

A Yes.

Q And -

A There is no state law that allows that interpretation that I am aware of.

Q Explain that.

A Well, State requires that if you use or intended to use, what is it, 25, 50 percent of the vals (values), that is a replacement. So for us to take the position that it requires 100 percent use of the values of the old policy would have no basis.

Q Well, okay, let me ask it a different way: Back in the time frame of these documents, to your knowledge was there much incidence of agents literally doing transactions that call for terminating existing Prudential policies and issuing a new policy?

A I don't know. I do know that there are certain things that precipitated significant replacement activity. The introduction of the family policy precipitated replacement of individual policies. The introduction of VLI was the predecessor to VAL policies, precipitated replacements of traditional and life policies.

Q Why the family policies?

A What the agent was able to do is go in and say I'll give you a family policy which not only protects you as you were protected on an individual policy, but protects your whole family. Why don't you buy this and then quit paying on the other one.

In the VAL policy what they are saying is this is really a good deal. You can benefit from the investment of the fund and take that benefit away from the Prudential if you buy this VAL policy and let your old outdated whole life policy lapse. But insurance and investments go up and down. If you need insurance you need to have some certainty of payment. A VAL policy doesn't do that. Universal life is even worse.

This is a memorandum written by Bob Hill in 1983 on replacements. Bob Hill, I think, at the time was the chief actuary. I'm not sure. Again, it notes that replacement activity is on the rise in the industry and in Prudential.

Q (By Mr. Camil) And a memorandum written to -

A It was written to Murch, Pease and Porraro, who were heads of O-A-D-A. Murch may have been -- Murch may have been head actuary at that time, and Bob may have been reporting to him outlines of what an agent wants to do -what an agent may do to avoid detection after replacement, and then makes a recommendation of what we might be able to do.

Q (By Mr. Vanden Dooren) What was that recommendation?

A Lengthen the replacement period to 6 months before and after, treat new issues as replacements if issued within 3 or 6 months of the policy loan on an in-force policy under certain circumstances. In other words, have a longer period and have it more black and white with no exceptions.

Q (Mr. Camil) Do you know what led to this being issued, agents getting around the current system and therefore it needed to be changed?

A The only thing I can think of is that there may have been a whole discussion in that senior level at the time because all of these memos are in mid to mid '83, mid -- mid '83, but I don't know the reason.

Q (By Mr. Shropshire) Again, who was Pease?

A Pease was the head of Ordinary Agencies at the time.

Q And Murch was who?

A Murch, I believe, was the head actuary at the time.

And here, this shows how involved J. Dings was in monitoring replacements at the time. You may understand the memo. I don't understand it, but he could explain it, and if you ask for all memos written by J. Dings on the subject of replacements of financed insurance, my guess is you will get a wealth of information.

Q Without a document retention policy, what are the odds that an August 31, 1983 document like this would be retained?

A J. Dings saved everything forever, and if it is not in the office, I'll bet he has it at home.

Q And he lives where these days?

A New Jersey, I think.

Q Still consulting for Prudential?

A I don't think on any consulting for Prudential.

(Off-the-record discussion.)

Q (By Mr. Vanden Dooren) Back on the record. We're going to try and go through some of these documents.

A Here is another document prepared in April of 1985 by George Oxner who was, I think, the number two guy in District Agencies at the time, and it was on disbursements and it is essentially attached apart from J. Dings on disbursement check activity. I can't figure out what the numbers mean. J. Dings could help you with it, but what it shows is that rather significant effort was being put into checking on disbursements, and I don't know why, but I can't imagine that it just occurred out of the blue, but I'm sure J. Dings -- George Oxner also retired. Unless New Jersey can tell you what was going on here.

Q George Oxner, what was his title?

A Vice president of District Agencies. I can't figure out what the numbers mean. This is -

Q (By Mr. Shropshire) This is dated April 10th of '85. Does that coincide with any particular event that you can recall?

A Not that I recall. But it shows that they put some effort into tracking disbursement activity in '85.

Q Does it have any specific conclusions about disbursement activity or improper disbursement activity?

A Just an analysis. But I guess if you would talk to J. Dings -- some belief about what it shows of a VAL -

Q It says the results for the District Agencies U.S. show accelerating disbursement activity on a year to date basis in March compared to February?

A He can tell you whether he thinks that is good, bad, or whatever else he has behind it.

Disbursement activity by itself may not mean anything in '85, just mean pulling money out of a policy to put it into CD's to have a better return. You just don't know, but I would bet that he does know.

This is a June 1986 document from Walt Miller who was actuary to Bob Hill who was his boss at the time. And this talks about the change in the dividend illustration approach, going to a dynamic approach for illustrations.

Now, what this means essentially, if you will, it is going to show a higher dividend than you currently pay making the product easier to sell because it would show a shorter abbreviation time. And I drew something here to help me understand what the dynamic dividend means. Basically if a new money rate is 12 percent, that 12, that means money you invest today can get 12 percent actual portfolio, yielding 8 percent. What you do is assume that over time you will reach a 12 percent rate on your portfolio, so instead of illustrating what you are actually getting in your portfolio, you increase it over time, making the dividend larger than they otherwise would be; show a greater value (val) in the policy, shorter abbreviation periods and things like that.

Q (By Mr. Camil) This is when you switched from one type of approach, illustrating to dynamic dividend method, which Porraro mentioned in one of the booklets?

A Essentially a move to help you sell policies, not based on a need for an insurance, but it is based on accumulation, essentially just selling policies as an investment as opposed to a need for insurance.

Q (By Mr. Vanden Dooren) Let me ask you, when they switched this thing, did they keep referring to their historical experience; that is, you know, look we have never missed a payment here from the last 185 years and this stuff has just continued to increase, the dividends have continued to increase, but here you are starting from scratch, right?

A Here what you are doing is you are saying, well, it has always increased in the past. Let's assume you increase in the future and you are doing it at a time when interest rates were very high, so what you were doing is betting that interest rates would stay high and go higher. And then when it changed and interest rates started going down, we didn't change back.

Q But again, all of those representations you are making is based on apples, and we're talking oranges?

A Right.

Q (By Mr. Camil) The original method used to do illustrations and projections were actually based on what?

A Portfolio returns.

Q Over a certain amount of time the -

A The current portfolio returns. Keep in mind, portfolio returns because of the size of the Prudential portfolio, they are going to change very slowly over time.

Q Were they aware when they went to the dynamic dividend approach they were not validly reflecting what they are illustrating?

A They had to be. I haven't seen anything that shows that awareness.

Q (By Mr. Vanden Dooren) Who would be the person that you would want to talk to about this thing? Would you talk to an actuary?

A Bob Hill or Walt Miller.

Q (By Mr. Camil) Is there anything to show that when you went to this method that that method was tried and proven and was valid and accurate?

A Not that I'm aware of.

Q Is any other company or is it standard in the industry by anyone else to use this method?

A I don't know. Bill I'm sure -- Walt or Bob would know. I'm sure that would be a part of their study. This is a memo. It appears in '91 --'89 -

Q (By Mr. Shropshire) 1989.

A -- by Jim Summers who was actually in Florida. He is retired now. Basically, it states probably, this is as distinctly as possible why it was such a failure with customers. A and CSD's, these are the customers' basic complaints -- to defend the sale, if in any way possible defend the sale today, which is successful in a large majority of cases.

Basically what that means is whenever they had a complaint, the first thing they had to do if they had an oral complaint, they had to put it in writing. That knocked down a number of the complaints right away because most of our customers because of their educational level and because of their financial circumstances hesitated to put things in writing.

The second thing we did is we would get the complaint and then would ask the agent what the agent did. If the agent said he did it right, we would deny the complaint and we would hold to that denial through three or four subsequent complaints. And basically we didn't actually do an investigation except to get the statement of the person who was complained about, and that was the position in Prudential probably until late 1994. And even Jim recognizes in the memo that if this continues and isn't brought under control the expense is going to go up eventually.

Q In the sentence where it says A and CSD, basic position on financed insurance complaints?

A Right.

Q When they say "financed" is that the same as financed insurance?

A Yes, but in reality that was how they handled all complaints.

Q This looks like a memorandum to the file because I don't see a -

A I don't know where it came from or where it went, but he could explain that.

Q Is this suggesting that in September of '89 the consumer complaints people were already complaining about the number of financed insurance complaints they were having to deal with?

A Yes.

Q Now, Helfrich says in his memo that he has just been to the meeting and he is talking in 1992 when they are complaining about the same thing?

A Yes.

Q (By Mr. Vanden Dooren) So the Helfrich memo mirrors this, which is an '84 memo?

A '89 memo.

Q Excuse me?

A The Helfrich memo was a compilation of other stuff, and I am going to tell you who you want to talk to about determining what really happened in the Helfrich situation.

Q (By Mr. Shropshire) Now, the 1989 memo, who was Jim Summers?

A He was manager of the customer service division at the time.

Q In what office?

A Jacksonville. He would have been responsible for Florida.

Q And all the states in -

A In GSO south central at the time.

Q Would Jamele have been the senior vice president in the region when this memo was done?

A I think he was. I can't recall but I think he was for the District Agencies and I think Ernie Bono for Ordinary Agencies.

Q (By Mr. Camil) It looks like the thrust of the memorandum is we need additional budget money unless we somehow reduce the number of complaints, and here is one way we could do it?

A Or reduce the use of financed insurance as a concept.

Q Right and we need an additional 10.7 percent increase in -

A They already had the 10.7 percent increase. What he is saying is it is going to continue to grow as long as you use this concept and don't take steps -- and my guess is if they were seeing it down here, they were seeing it in the Northeast even greater.

Q (By Mr. Shropshire) The form of the document -does it recognize to you as something that is the way Prudential did things, manages? Were these kind of memos to the files or was it an attachment to some kind of report?

A The only thing that I can think of -- part of the budget process might have been included in the budget request -- because I don't think it was a memo to a file.

Q Kind of a supporting document to the budget request?

A Yes.

Q Who were the budgets decided by, by the senior vice president?

A It would have been in '89, it was probably Bill Nash, N-A-S-H, who was the senior vice president in charge of the south central home office.

Q So he would probably have looked at the budgets and supporting documents, and this was a supporting budget document?

A Yes, or one of his people would. I'm not sure how involved Nash was in it.

Q (By Mr. Vanden Dooren) Let me ask you a question about the document. We keep talking about District Agencies and Ordinary?

A Yes.

Q And if you could tell me the difference again.

A District Agencies is an employee agent sales force represented by the union in large part. Ordinary -- and they tend to focus on what is claimed the target market, broad middle income, broad middle to lower. Ordinary agencies is an end contractor sales force, that is, end sales. They focus on upper income really, middle income focused, and this is a distinction that grew out of years ago when the District Agencies' force walked door to door and the ordinary agents were thought to be higher class; they don't walk door to door.

Q Is there any reason why any of the stuff we have been talking about that is different, that is, financed, the abbreviation, the selling, the insurance, something other than insurance, would there be any distinction between these two?

A No, I think there is very little distinction. In fact, I think we all believed that there was a distinction going in, but we have determined that there is not much distinction. The same problems existed in both.

Q Okay.

A Can you hand me that big book?

Q This one (indicating)?

A Now, we're in 1990, and here is a set of memos. It is simply an effort by Bob Hill to obtain agreement to have applicants sign an illustration indicating their understanding that abbreviated pay, that it wasn't guaranteed and it could fall apart. And I just want to bring this forward, because in August of 1990, he attempts to get approval to go that route. And in these next few memos, people are saying, no, not going to do that.

The first one is an August 24, 1990, memo from David Rinsky, who was the number two guy in the District Agencies, and he said he doesn't want to have them signed. "While in favor of better training, we are not in favor of having each new applicant sign a statement. We are unaware of any lawsuits or cases against Prudential stating the client was unaware of dividend values shown not being guaranteed. We seem to be getting along reasonably well without this procedure."

Well, in 1990 that was true simply because they hadn't broken down yet, but completely ignores the fact that interest rates had gone down, and these were going to break down because our products, many of our products that were used in abbreviation were poorly designed, going to be dramatically affected by lowering of dividends.

Q This is Rinsky, R-I-N-S-K-Y, David. Who was he?

A Number two guy in the District Agencies at that time.

Q In Jacksonville?

A No, nationwide, in Newark.

Q Well, Robert Hill was the senior vice president in actuary?

A Right.

Q For national?

A Yes.

Q So this is the national chief actuary speaking to the national chief of District Agencies?

A Right.

Q Suggesting this procedure?

A Right. Because the initial memo was addressed to Southwell. Initial memo on August 19 of 1990 from Hill to a group: Bill Hunt who was the head of Ordinary Agencies; Don Southwell head of District Agencies; Ira Clayman who was the head of Prudential select and mortgages; Spitzer, head of District Agencies in California and Idaho, I think running an experiment out there.

The next one is a memo from Bill Hunt: "I do not believe we should have the applicant sign off on anything. Not only does this imply a lack trust toward agents, it also has the potential to build skepticism from the perspective insured regarding what they are being sold." Basically what he is saying is he not going to ask him to sign anything because it could disrupt the sale.

Q (By Mr. Shropshire) This is from Hunt to Hill?

A Back to Bob Hill.

Q August 29, 1995?

A Right.

Q Let me ask you, I notice of couple of these documents, the last couple of documents are entitled a "note"?

A Right.

Q Rather than a memo, is a note something that in Prudential had a special status?

A No, no. It is probably just Bill's way of communicating. And then here is the last one in the group. Bob's solution was to make another proposal that has the agents acknowledge that they properly explained it.

Q (By Mr. Vanden Dooren) Say that again.

A Bob, as a result of these, of the prior memos, Bob made another suggestion and that was that the agent be asked to acknowledge that they had given the client a proper explanation.

Q (By Mr. Shropshire) So this is Bob Hill having been rebuffed on his first attempt at some improvement is now making this?

A Second.

Q What, this is dated August 30 of '90. What was the date of the first suggestion?

A I think it was August 15th.

Q So within weeks of being rebuffed on his first -

A Keep in mind that the sales people really run the organization, or they did. Now, I'm not sure who runs it.

Q (By Mr. Camil) What caused him to start writing all these memos concerning APP, specifically?

A My guess is he began to get reports, and this is a guess, he began to get reports that the APP's that were sold in the mid 80's on the basis of high interest rates were about to go down, because this is right around the time where we changed the dividends and lowered the dividends, and he could see the APP's blowing up.

Q Were there certain kinds of products sold as APP's that basically weren't possible for them to ever abbreviate; that there was no foundation or system in place where actual studies showed that they would pan out?

- A Well, the only ones where it was impossible to predict whether they would abbreviate would be VAL.

Q And VLI?

A That much of it, but basically because you pick the investment category, you could never predict, but with respect to the traditional, they all would work but -

Q (By Mr. Vanden Dooren) Or could work?

A Some were very tightly strung. Mod-2,, which was called the abbreviator, was so tightly strung that a very small change in the interest rates resulted in a great lengthening of the abbreviation period. I don't remember the numbers, but I'll use an example: 1 percent change in interest rate assumption for dividends might lengthen the abbreviation point from 9 years to 14 years, so it would be a tremendous change in the bargain that the people may have thought they were getting.

Q (By Mr. Camil) Was there anything ever put together to explain to the policyholders about the potential for policies to abbreviate that there could be reappearing premiums?

A No. In fact, I'm going to look at a memo where it says essentially that we knew in 21 that that was going to happen and should have explained to them, and we never did.

Q So variable products or any product that had a registered side account would not abbreviate potentially, unlike traditional whole life; some of them probably would or could?

A They all could have, but what happened was that lowering the dividends would have a great effect on the abbreviation period.

Q Is there anything to show from the percentage or numbers of policies that were sold as APP's how many of them actually did in fact abbreviate versus did not?

A No, because we have no good way of actually knowing how much were sold by APP.

Q (By Mr. Shropshire) Did Prudential management through the 80's understand that you could not project an abbreviation point on a variable product?

A No. In fact, we did, in fact, do APP and variable products, I think, up until 1991 or '92.

Q Did I misunderstand you earlier to say that in fact you cannot accurately project?

A What we did was made assumptions but the -

Q (By Mr. Camil) Without foundation?

A The assumption is meaningless getting a 12 percent return. The reality is that variable return on VAL is very great. If you were to pick a money market account versus a stock market, that variability would be tremendous and the illustration had no meaning.

Q Let me ask you this: What is an APP?

A APP essentially says that I'm going to sell you a policy and I'm going to show you that you are going to only have to pay X number of premiums out of your pocket. After that point, the policy will support itself. The premiums can be paid from the values of the policy.

Q So now what products can you say that that is going to happen on? You said we -

A Traditional whole life.

Q Now, what interest rate do you know is going to be paid on a traditional?

A Well, the only thing you actually know for certain is the cash value.

Q Guaranteed rate?

A No. The only thing you know is the cash value. With respect to the dividend you never know whether anything is actually going to be paid, but what you do is you take experience and you say okay this is likely to occur.

Q But there is a certain amount that you guarantee to be paid on traditional, don't you?

A Not for dividend.

Q What do you call it?

A There could be a guaranteed loan rate. There can be guaranteed cash values.

Q I understand 3 or 4 percent rate. That was the 3 or 4 percent, but was there ever a minimum guaranteed rate?

A Never ever a minimum guarantee with respect to cash values, I think, and the interest on cash values.

Q (By Mr. Vanden Dooren) So what is the rate on that by the way? I mean, what was it?

A I don't know. I have an old policy that was 5 percent.

Q So you know for certain that is going to be in there?

A Only -

Q Everything else is guesswork, right?

A The cash value is not guesswork, but the dividends is.

Q That the -

A If you want to really have a good illustration of an insurance product to sell insurance as insurance you shouldn't allow the illustration of any nonguaranteed elements. And people say, oh, we can't compete. Let me tell you why: I think that if you allow only illustration of guaranteed elements what you'll do is force insurers to put more into guaranteed elements and take out of nonguaranteed to be competitive. That gives -- although it may result in a slightly lower return to the insured, it gives them certainty that they don't have otherwise.

And when you buy insurance, aren't you in fact saying, I need a certain amount of money that is going to be paid if I die? You don't want to gamble with that. Take the money you gamble with and put it in a stock market. Take it out and play Vegas or lotto, but that is why I disagree with the NAIC model illustration, facts of showing a nonguaranteed is preposterous in terms of what insurance is for and why we buy it, at least in my mind.

Q (By Mr. Shropshire) In the 80's did Prudential have, though, a formal computer system or some formal system of calculating abbreviation points on variable products?

A I think it came into place in the late 80's. Prior to that time, it was calculated roughly by agents. I can't remember exactly when it was brought in. The person you would want to talk to with respect to illustration systems is Mike Shapiro, S-H-A-P-I-R-O. He could give you the history of it and what occurred.

Q (By Mr. Camil) Is he still with the company?

A Yes, in the marketing department.

Q (By Mr. Vanden Dooren) Well, I guess, we actually came around full circle on this thing, and again I guess my question is still -- I mean, how can you have an abbreviation system on something that you don't know is going to happen, basically?

A Because it is based on assumptions.

Q All right, well -

A And if the assumptions turn out true -- if the assumption turns out not true, keep in mind it doesn't do anything with respect to Prudential. Prudential is going to continue to receive the premium until the policy lapses or until they pay the claim.

Q I mean, I could see where you can make some assumptions. Again, they are just assumptions. On a traditional product do you know and assume on a variable interest sensitive product when you don't even know if you are going to have money there the next day?

A NASD rules allow you to make assumptions about interest rates in terms -- the maximum rate is illustrated is 12, so you could use 12 as a gross or net, whatever it is, and use 12 percent, and assuming 12 percent abbreviate here -- well, think about it. Essentially you are bearing the investment risk. That is not rational, and as a result, after it was thought about, Prudential, to its credit, said we're not going to allow you to illustrate abbreviations on registered products on this investment.

Q When did they do that?

A I believe 1992 or 1993. Keep in mind that that is after we began to see the problems with the dividends and said, oh, my God, let's think about that overall.

Q I guess my question is still on traditional life products you always have a certain amount of money unless you take a loan or you get rid of it on your own. On variable interest sensitive products, you may not have any money in this from day to day?

A That's right so -

Q So to me we're talking different things here.

A Sure, you really are. One, you have some guaranteed elements. Keep in mind even in the traditional, the bulk of the value from the abbreviation comes from nonguaranteed elements, and in the interest sensitive products all of it comes from nonguaranteed elements, but I can tell you how the sale goes, if I had an illustration here, tell you which page they show you and how they show it. They show you a ledger and essentially it says they emphasize the one return, and then they say and "if you choose not to pay any more out of pocket, it ends here, and from this point on, you don't have to pay any more.".

With this investment return -- and by the way, here we were only showing you (inaudible) percent. Last year we got 26 percent. I mean I could have a ton of this stuff this year and next year with a return in the stock market and people will have no idea what they buy.

Q That is on the variable.

Q (By Mr. Camil) In 1992, 1993, you talk about Prudential agents no longer selling variable products and suggesting that they would abbreviate what change or what took place at that time period A., to cause that and B., to insure that if we know that, agents didn't continue and have not through today continued to do that.

A Well -

Q As far as -

A A -

Q Give me an illustration that shows that this VAL is going to abbreviate in 6 years if the guy puts this much money in and pulls one out from his office.

A What caused the change where Prudential quit having those illustrations available, I don't know, but if you look at it, the interest rates caused a reduction in dividends in '90 and '91. My guess is it followed that. What assures that your agents aren't doing it? Absolutely nothing, because the agents could still do it with a regular illustration simply by pulling out a pad, saying and estimating where it would occur, and a good agent can do that.

Q An agent still in a district office can tell the secretary, the manager, whomever, on so and so run me an abbreviation for this policy, or do it himself, and have it?

A Not an illustration system, but he would have to do it on a yellow pad, have to write it out.

Q After '92, '93, the computer would no longer allow abbreviations on those products?

A On the VAL, yes.

Q (By Mr. Shropshire) Prior to then, Prudential policy had no objection to salesmen providing abbreviations projections on variable products, right?

A Right, that was -

Q (By Mr. Camil) One other question: On the illustrations, as far as lap top computers and agents with software in them taking them to people's homes and using those to illustrate as far as agents have the ability to enter any interest rate they wanted, would that software still be out there even after the '92/'93 stage?

A I have seen cases where agents actually modify the software. I have seen interest rates as high as 30 something percent. The reality of it is if they kept a copy, they could still run it.

Q (By Mr. Camil) Was there ever an effort in '92/'93 to recall software that was out there that allowed running of either any interest rate or APP's from off variable products?

A I don't know, but people like Dave Dukehart or Dave Fastenberg could tell you that.

Q Would the disc that is distributed to salesmen, the disc that had the illustration software on it, were those discs just plain old DOS, D-O-S, based discs that have no copy protection on it?

A Maybe Shapiro could answer that one.

Q Do you know whether the illustration software that was given to field force, did that have the ability, though, for the salesmen to pick which interest rate could be used in creating the illustration?

A Yes. They could pick within a range.

Q What would the range be?

A On variable products I think it was up to 12, 0 to 12. I don't know what it was on other products.

Q What time frame would you have this ability in?

A Probably early 90's to current was 0 to 12. I think sometime in the 80's it might have been higher. I can't remember.

Q Are you telling me then that throughout the 80's the field force did have the ability to choose and project and produce illustrations in customers' homes using the return rate of their choice within a certain range?

A I don't recall, but I think so.

Q (By Mr. Vanden Dooren) Were they required to leave an illustration with the policyholder?

A Yes, but we had no way of knowing whether they did.

Q So that wasn't in some kind of procedure or policy that they were to leave an illustration?

A I think it was in the Agent's Guide that they had that instruction.

Q (By Mr. Shropshire) Is the Agent's Guide also called the Rate Manual?

Q (By Mr. Camil) Or Agent's Manual?

Q (By Mr. Shropshire) Which?

A It can be called both. The Rate Manual isn't put out any more. The Agent Manual is. I think it is called an Agent's Guide in one of the branches.

Another time where you'll see a large number of financing cases is in 1982 when IRA's were introduced. You found a lot of agents stripping values (vale) out of policies to sell IRA's. That would be a period, and my guess is that J. Dings can have data to support that or if not, people are lying. Dave Fastenberg, Dave Dukehart can tell you about the practice.

Q (By Mr. Camil) Can you touch on that a little more?

A When IRA's became available, what they would do is say, okay, I have this new thing for you, an IRA where you can invest and have it deducted from your taxes. People would say, I don't have the cash. People said, yes, you do, it is in the policy.

Q Churn into an annuity or IRA?

A Or IRA account at PSI, Prudential Securities.

Q So people were pushed into being told pick up an IRA, a pension plan, when IRA's were being advertised and churned into an annuity or other product or other life policy?

A Sure.

Q So selling life insurance is selling something else?

A Sure.

Q (By Mr. Shropshire) But under the IRA tax law what you get to do is to exclude a certain amount of your current income if you put it into an IRA, correct?

A Yes.

Q If you have money from previous years sitting in the cash value of life insurance policy you are not able to deduct that from this year's income, can you?

A It doesn't matter to the government where you take the money. It is your money.

Q (By Mr. Camil) What you do is take it as a loan. It is not going to be taxable anyway?

A Right. Another thing you should be aware of, these were two policies that were designed, Professional and Executive Series policies, that were designed to have early cash values. The purpose of early cash values were funding vehicles on financed insurance. It didn't go over well because to get the early cash values the commissions were lower, but that was a company effort to create a vehicle for financed insurance transactions.

Q (By Mr. Shropshire) You mean this was a product that they hoped to put to customers initially with the idea they could go back to these products fairly quickly and finance even more products?

A Yes.

Q And when were these products introduced?

A In the 80's, early 80's.

Q Do you know any of the names of the products?

A It was Executive Series and Professional Series, and the person who can best describe that process to you is Dave Dukehart.

Q And these did not succeed very well?

A No.

Q Why was that?

A Because the commission structure on it was lower.

Q (By Mr. Camil) Oh, so the agents didn't want to sell them?

A The ones that were sold if any.

Q Did they work out that way where you could go back and redo them?

A Never looked at the data. My guess is that they would of. I mean, there is no reason once you take the lower commission. It is with the idea of generating a higher commission.

Q (By Mr. Shropshire) Was the idea that the agent would tell the customer when he sold them this Executive or Professional Series policy that the whole idea is going to be that you are able to tap into these values fairly soon?

A No.

Q (By Mr. Camil) How would it be sold?

A People wouldn't know what they were buying. It was something that was designed for that purpose.

Q Regular life insurance policy?

A Right and the agent comes back and says look how this has performed. You can buy another policy with value here and it is only four years later. One of reasons it probably wouldn't work is the four-year retention rate is between 10 and 15 percent, so anybody who comes into the business assumes he is not going to be here for four years.

Q (By Mr. Shropshire) Now, this seems to me like a very fundamental and important issue. You are saying that Prudential developed a product to engage in the very activity that they were officially saying was very adverse and shouldn't be engaged in?

A That is exactly what I am saying.

Q Do you think that there is any document or how would we ever go about proving that?

A I think that you would have to use Dukehart, his testimony on what the field did and how they utilized it. What you might also want to do is ask if there are any marketing material files with regard to these policies. The third thing is ask if there are any actuary files with regard to development of policies. Keep in mind the actuary files are very dry and nondescriptive.

Q (By Mr. Camil) in creation of these policies how does a policy actually get created like this? What part within the company creates it and -

A Typically what happens is agents say we need a policy to do this, and it gets -- comes up through the sales channel and then over to actuaries, develop a product, does this. That is how it all occurs.

Q Who decided that a policy should be created for short term financing to re-rate it?

A It probably would have been, since they were mainly sold in Ordinary Agencies, for higher people. It probably would have been Skip Pease or Bill Hunt.

Q And who is Skip Pease?

A Head of Ordinary Agencies in the early 80's.

Q (By Mr. Shropshire) Do you think that there might actually be a document in which the sales and marketing people described that they needed a product that they could get back to fairly quickly to utilize values (vale) in for financing more insurance? Would there be anything that blunt?

A Yes. And I think that if you got the documents gathered by the sales practices review team, the SPRT team that I mentioned earlier, that they would probably be there. If they are anywhere, that is where they are going to be.

Q They wouldn't be in the actuary files, would they?

A No. They would be in marketing review files if such exists, but it is so long ago I don't know if they exist.

Q (By Mr. Camil) Were the commissions on that product so much lower than some of the others?

A You simply had to figure out what the fund is up front.

Q Successful immediately?

A Yes, cash funds up front that was. I want to talk about in 1987, 1990, 1991 -- actually the dividends changes reduction which would have impacted abbreviation years. The VAL (value) tilt in this resulting from this practice was discussed in memos that were sent to the field, and I don't know the date on this, but the designation for the piece IREQ-36788, the part about -this odd part about this is, I'm unaware of anything that was actually sent to customers. About the VAL (value) tilt and the -- resulting from dividend changes and -

Q (By Mr. Camil) Was there a change in how illustration organization, the rates were going to be showed to customers now that this was anticipated or looked at?

A The rates were changed when the illustrated rates were changed when the board approved the rate changes. But the reality of it is that to be effective, they should have been approved much earlier, because if I reduce the rates on January 1, and I can illustrate on December 30th the higher rate, then I know it is going to be in effect, is that right, without telling the customer; is that misrepresentation?

Q (By Mr. Camil) So the company said we're going from '87, '90, '91, we, in fact, those years would be reducing the dividends?

A They do it annually. They decide what the dividend is going to be.

Q Prior to that year beginning?

A And typically it is done about mid year.

Q (By Mr. Shropshire) Okay.

A Mid year, the third quarter.

Q (By Mr. Camil) Once they decided prior to that year it is going to be reduced at the beginning of that year, they still allowed from mid year when they made that determination until the year began, the higher rate to be used and shown?

A Yes.

Q Knowing that it was going to be reduced?

A Yes.

Q (By Mr. Shropshire) What was the first year that the dividend actually reduced?

A '87, I believe; not a very big reduction. '90 and '91 were big reductions, and they were the ones that really affected the abbreviation point.

Q (By Mr. Camil) '90, '91 about were the reductions, right?

A I can't remember. This piece went out in 1991, March of 1991.

Q (By Mr. Shropshire) What was the number you referred to as a designation number?

A I saw a designation RQ.

Q What is that?

A That is the requisition number for the piece.

Q (By Mr. Camil) If you wanted to order the piece for management or a guide?

A It would be available to order by that number.

Q (By Mr. Camil) Would that piece, does it show that it actually went to district managers, managers, agents?

A No.

Q Do you recall in and after 1987, did Prudential tell its agents, you have got to stop telling customers our dividends have never decreased?

A No. After 1991 they did, but not after '87.

Q Am I missing something? They should have told the field force that after '87, shouldn't they?

A Yes.

Q But they didn't, you say?

A They didn't. Now, individuals within District Agencies or Ordinary Agencies may have been. I'm not aware of a company piece that went out instructing them to do that.

Q Well, your suggestion that people in the district offices might have, that is pretty farfetched, isn't it?

A I don't know. I don't know. You get some managers that really are straight by the book, and I remember there is a manager in Charleston, South Carolina that lived in the town four years. He has been a manager for 30 years and everything was precisely by the book; nothing that would-- he didn't even accept financed applications.

Q Well, would Prudential have done a message to its field force concerning the reduction in dividends in 1987?

A If they would have, it would have been in District Agencies or Ordinary Agencies, a numbered memo.

Q (By Mr. Camil) If Prudential knew that rates were going to be dropped at the beginning of the year because they declared it prior to that, could they not have adjusted the illustration interest rate and those rates being shown? Is anything stopping them? The field force knew this would take place. Could they have adjusted the sales material to reflect the actual change?

A No. It would have taken a bit of time.

Q (By Mr. Vanden Dooren) What is a numbered memo and what does that mean?

A Whenever District or Ordinary Agencies wanted to put something out and keep a record of it to be sure that they keep a record, it was put out in a numbered memo. So if you were to ask for District Agencies' numbered memos on financed insurance, on APP, or on replacement, those were specific formal directions to the field.

Q (By Mr. Shropshire) Are you talking about memos issued by the regional?

A No, they are national, issued in the national.

Q And is the numbering started again each year?

A Yes. Typically each year another designator and number of the memo. There may be as many as 400 or 500 of these in a year. You just want to ask for the ones by topic or you'll get buried, and the bulk of them have no meaning in this.

Q Did they, in fact, based on your recollection, have specific memos on financing, abbreviations, all that kind?

A I don't remember.

Q Were you in a position that you would have seen them if they had?

A For maybe '90, '91 I was, and would have seen them. I just can't remember.

Q (By Mr. Camil) Concerning the task forces' report as far as the percentages of APP sold, the percentage of financing matches and all of that, do you believe that those statistical figures reflect in any way the actual number that took place by the company?

A My recollection is they showed numbers in the 23 to 25 percent range.

Q Is that right? I believe it was below that but -

A I would say anything outside, in the mid 80's, anything outside the 25 to 30 percent range is probably wrong.

Q (By Mr. Shropshire) Let me run this by you: If you take the task force numbers of financed insurance, five years from '90 to '94, there were 607,000 financed transactions. If you divide that by five years that is 120,000 financed transactions per year. If you then make the assumption that financing actually peeked earlier than 1990, so I take the average of 120,000 and multiply that by a 14-year period being examined, is there anything wrong with that reasoning?

A I would say financing was minuscule in '82, '83, '84,- and then started growing rapidly in '85, '86, '87, '88, and then started to level off probably in '90, '91, '92, and then may have even gone down a little bit in '93, '94.

Keep in mind, as you do financing you run out of policies to take money out of. And keep in mind, most of these policies that were the financing sources were $5,000 and $10,000 policies that were 33 and 34 years old, $25,000 policies, so run those values very, very quickly.

Q When you say that financed you would think it was minuscule in '82, '83, '84 -

A Began to grow in '84 very rapidly, I think.

Q How could you correlate that to the auditor general's men finding several significant hot beds of financed insurance sales in '83?

A Well, I think when I talk about minuscule, I mean as a percent of the total business written in those years. The number of the policies being written was probably 1.3, 1.4 million, and it takes time to spread across the -- -in a force the size of Prudential, it takes time to transfer people across the country. I think you'll find when Marasco transferred to the West, financial insurance jumped high in '82.

I have some documents in the 70's showing unacceptable lapse rates on financed transactions in the 70's. The one document I showed you showed 36,000 in replacement cases as being high. It shows you a difference in the 70's versus the 80's versus the 90's. 36,000 on 1.2 million was considered a lot.

Q Well, is it not possible, though, that the 36,000 figure was grossly underestimated?

A I think it is entirely possible, but what I am pointing out is they thought it was 36,000, and they thought it was a lot. You look at it, and I mean if somebody told me they were doing 36,000 finance cases a year at Prudential, I would jump up and down and be ecstatic.

Q I mean apparently by 1981 and '82 financed was well enough entrenched. Financing found its way to Cedar Rapids, Iowa, on a large scale?

A What happens is because there is no formal training of this kind of thing, it passes by word of mouth or by transfer of people. So it doesn't surprise me that you will find it pop up here or pop up there. Then after these people got to be very successful, they would go to conferences and say, this is how we do it. And then it spread countrywide, and my belief is it really got heavy in '84, '85 because illustration sold so nicely too.

Q (By Mr. Camil) Did Jacksonville home office, corporate office, say, like Cleveland, Ohio, or Cedar Rapids or this area they are the lowest sales in the nation, they have got a problem, and then send people to train people to do financing?

A I think they did it in Ohio when Schelp was the regional vice president. I'm not aware of any other time where they did it more. Valenti was big, I believe, in financed, and when he went from area to area it increased. He became responsible for the eastern half of the country. But it grew over years because people became successful and were making money. And my guess is it started out rather benign. Well, you know, you do need insurance. This is the way to do it, to something less than benign, but I don't know.

One of the people that you want to look at is a guy named Frank Marasco. He was an agent in California who actually began financing to a very large scale in the early 80's.

Q How do you spell his name?

A M-A-R-A-S-C-O. In fact, I believe during his career, he wrote something hike 1,200 to 1,400 finance policies.

Q In the early 80's, you say?

A Starting in the early 80's. And the file you want on Marasco is his contract file, but you also want the investigation file from compliance, and you want all articles written by Marasco, newspaper articles.

Q Newspaper articles?

A In publications of the company.

Q Laudatory articles.

A Now, what you'll find is that Marasco was touted as doing financed insurance the right way, and it was known by virtually everybody from the chairman down. What you will also know is that he sold virtually everyone by misrepresentation.

Q What was known by everyone from the chairman down?

A That he was doing financing as a sole means of selling insurance. He also sold to pilots and sold countrywide so there are Florida insured that were sold by Marasco by mail.

Q Did he do mass mailings?

A Yes.

Q What kind of a piece would be used on mass mailings?

A He would send them a letter that says you can get an additional $25,000 at no cost. Call me.

Q Would he have gotten the mailing list from Prudential?

A Yes. He would are gotten it and typically a lot of government business, so dealing mainly with military.

Q So Prudential management would have gotten him a list of current Prudential policy holdings with built up values (vals)?

A Yes.

Q Mostly military members?

A Yes.

Q Now, typically when you see that happen, when you have someone in one office doing nationwide mailing, the other agents around the country get upset when they see customers getting hit up like that, not being conscientious, but because they dislike losing the business, is that right?

A What Marasco did was split commissions with the other offices, and since they were old orphan policyholders no one served them. Anyhow nobody paid that much, so he was getting commission on policies that nobody could find and policyholders that nobody dealth with, so to the office it looked like a good deal, the more it looked like a good deal, and to the company it looked like a good deal.

Q (By Mr. Camil) Now, they knew that the policy that he was forwarding showed people living in Florida, and he was signing them in California. How could they not know that he was writing business in Florida as an agent in California?

A They did, and in fact all at one point because Alaska raised that question. He became nonresident licensed in every state in the country. So you will have a record of nonresident license for him probably beginning somewhere in the early 90's.

I bring him up because to my knowledge he is the biggest practitioner of the financed insurance. He is also the one where you can show by our own publications and by letters sent to him and by people visiting his office knew where to depose him, that virtually the entire management structure through the chairman of the board knew about it.

Q (By Mr. Shropshire) Well, he was selling insurance at a time when Prudential's official policy said that financed insurance is rarely a good deal for the customer; is that correct?

A Rarely in the best interest of the customer.

Q What would Prudential's management then say in defense allowing him to do it? What would they claim were their assumptions that made it okay or to allow him to be doing this?

A I can't think what they would say. I don't know what they would say.

Q What would be their best argument?

A I don't know. Keep in mind that I am personally opposed to financing insurance except in the one situation I was able to describe to you, so for me to try to figure out what their best argument is wouldn't be worth much to you.

Q Was there anything unique about these people being in the military that arguably made this appropriate?

A Makes it less appropriate because typically lower wage earners and typically less educated than the general populous.

Q Active duty or retired?

A Both, because active duty transferred around.

Q Did you refer to a complaint or case file indicating that Prudential had ultimately cracked down on his operation or there were problems in his operation knowledge?

A Sure, they had a complaint in Alabama about him, and Prudential got him licensed in all five states because of that complaint. But if you get the complaints file on Frank Marasco and, in fact, ask for all the files and publications on Frank Marasco, they could probably get it to you in two hours because it is all in one place, but you have got to figure out how to ask for it so they don't know how it came?

Q Has it become an issue recently?

A They fired him and he was sued in California.

Q (By Mr. Camil) How long ago?

A I think we fired him in the spring of this year, and I think he resides in the summer out in Costa Mesa -not Costa Mesa, northern California, just near San Francisco. I can't remember the name of the town.

Q Is part of his lawsuit part of a class action?

A No.

Q Is

A Another person in particular is Phil Portera.

Q (By Mr. Vanden Dooren) Let me stop you for a second. The files that you honed in on were the contract files?

A Contract files and compliance investigations on all publications.

Q All right.

Q (By Mr. Shropshire) Spell Portera?

A P-O-R-T-E-R-O or T-E-R-A.

Q (By Mr. Camil) I believe T-E-R-A, Phil.

A I believe Phil and probably his entire staff and possibly the entire office in Sarasota engaged in wrongful sales practices for a number of years that included selling as an investment and misrepresentation, and I think probably that was his biggest scam.

Q (By Mr. Camil) Who does Mr. Portera work for?

A Jamele.

Q (By Mr. Shropshire) Do you recognize the name of a manager in Jemele's office by the name of Garbeddia? Can you tell me about Garbeddia's reputation?

A Poor. Virtually the whole Sarasota office has a very poor reputation.

Q (By Mr. Camil) What about the name Ron ward?

A Yes.

Q (By Mr. Shropshire) Did you tell us about him?

A A piece of slime, one of the largest practitioners of wrongful practices in the state.

Q (By Mr. Camil) Mr. Al Cognetti?

A Similar to Ward -- C-O-G-N-E-T-T-I. I wouldn't -

Q Chet Beatrice?

A I don't know him, Chet Beatrice. If you look at Ward, Cognetti, Beatrice and Jemele, I wouldn't trust any of them, but there are records on Portera.

Q (By Mr. Shropshire) After Jemele fell from being senior VP for the region how did he manage to get such a cushy assignment in Sarasota?

A Don Southwell was kind of soft, so rather than take him out, what he did to avoid the problem was he offered him the highest paying job in the country as general manager of Sarasota, which at that time was the largest agency in the country, I believe, essentially raising his pay and raising his pension by a dramatic amount. I think his pay may have gone from a total pay of somewhere around $250,000 to a total pay of somewhere between $400,000 and $500,000 a year by going down there. It is the Prudential way to take care of people.

There was a manager in Coral Gables, I think, Tony Toscano who was caught stealing money, so he was transferred down to become a manager in South Florida, Toscano, Tony. It is how they dealt with problems in the past.

Q (By Mr. Vanden Dooren) Why did they generally deal that way? What was the objective?

A They didn't like to rock the boat, and they don't want to risk bad publicity for firing people, and they thought they could control them.

Q Why would that be bad publicity when you have got a guy stealing?

A Well, he didn't steal, but they are punishing me for this. That was the great fear in Prudential for a lot of years. There still is. You still see it. The people who were really bad, get treated well. The people who were good, get treated poorly at Prudential now.

Q Talk about records on Portera?

A Go to records within the field operations division concerning the file of his demotion and then his termination, which I think will describe in fair detail what he did wrong. The reason I bring him up is that area down there was, as I said, it is not only the largest, one of the largest offices for Prudential and they sold mainly to older people. Those are the people from Tampa down to Fort Myers; that if nobody else needs personal contact, they do. They have no idea what they purchase, I don't believe. I think many of them believe they bought CD's. I think many believe they bought other financial instruments and have got no idea they have got life insurance. And without a personal contact where you are made to feel comfortable, you are going to have people dying and they are going to be ripped off and nobody -

Q (By Mr. Camil) No letter in your opinion that Prudential could send to make them remotely aware of what has happened to them?

A Make them aware; I don't think it is possible. You might get a small percentage, but you won't get the person that knows Portera's past that we should get.

Q (By Mr. Shropshire) That raises a question. In the ADR program as presently proposed, it requires generally there is to be written evidence of misrepresentation in order to get the highest category of relief. Assuming that is so, do you think in this typical financed insurance case the consumer will be able to provide any written evidence of a misrepresentation?

A Oddly enough in a large enough number of cases they can. In financed insurance we see a phenomenal number of cases where an actual promise is written on an illustration or in a letter. We found that when you asked the people, they keep these documents in a surprising number of the cases. But that is still a measure that is too stringent because we also know that if you call and you say Phil Portera sold a policy and this is what he said, we know whether that is true or not because we know the way he operated, and we know he didn't put things in writing.

Q (By Mr. Shropshire) What percentage of the people in general, of the Florida policyholders in general, who were in fact churned, what percent do you think would be able to produce some written evidence of the misrepresentation?

A Probably half.

Q (By Mr. Vanden Dooren) Would that be based on some kind of personal notes?

A You will get a letter.

Q There is no company documentation?

A You'll get a letter or notation on an illustration, and you would be surprised at how many flat-out guarantees are written on illustrations.

Q (By Mr. Camil) If the person filled out a remediation form and mailed the form itself back with no documentation, mailed something back to the company, and the company says we're not going to pull every company record and document and take that with the form they filled out and determine whether or not there is evidence to show and support that claim, where would that leave the policyholder?

A Very badly, because what we have found is that the telephone contact between the policyholder or customer service representative is what fleshes out the claim.

People often times are unable to describe accurately in writing what it is they did, but when somebody who is knowledgeable about the practices questions them and asks the right question, the right attitude, you get a much better quality response. The agents tell us they call us the sales destruction center.

But the reality of it is these people bought policies in an oral setting, and you have to talk to them to pull out what was said and to refresh their memory. Dealing in abstract, it is very hard to remember exactly what was said.

Q (By Mr. Camil) Documents that were destroyed in the Woodland Hills closing, do you have an idea of what specific kinds of documents would have been destroyed, like actual policy applications or illustration organization, what those might be?

A If they were complaint files that were destroyed -- probably no policy applications were destroyed. They are taken out and returned. What was probably destroyed if they were complaint files was the written communications from the person, any notes of what investigation was done, notes about the agent's statement, the agent's statement itself, notes about the agent's history.

Q Now, normally were any of those four or five items in the complaint file ever taken by PPR or anyone else and summarized, any of those five items?

A Not during that time because keep in mind PPR didn't exist. They were consumer affairs offices at that time.

Q Did CAO ever take that information and complaint file and summarize any of that somewhere?

A There may be a short report form.

Q Would it realistically reflect the actual information as detailed as contained in each one of those items?

A No, no. And even today we are going to have Prudential's file system, which would be a very short summary of what was done. You would not contain the data behind it.

Q So if the actual record is gone, you have in fact lost a great deal of information that can never be found?

A Unless they happen to make copies of it and put it in the application file.

Q Recently an E-mail came out in the newspaper in regard to the Woodland Hills destruction, and Prudential's response in the newspaper was that there were enough summaries relating to the complete complaint file, information that would be the same as having it itself. Do you believe that to be true?

A No. The quality of the data that we gathered in summary form is very questionable. That is why when we did the policyholders' relations center, we invented a new record keeping that was on computer that captured more data. That is why doing the profile system captures data about the agent's history, because what you have is not sufficient. It wasn't recorded in any systematic fashion so that you can pull it up.

Q Was there any requirement that each complaint file even have a short summary about one of the items in it?

A No.

Q So no procedure for keeping a summary on any of the individual documents, correct?

A No, not unless this would be a local procedure, but there was no countrywide standard procedure set.

Q Okay.

Q (By Mr. Vanden Dooren) Did you get all the records for Phil Portera?

A Yes.

Q Just the position termination record?

A Yes.

Q Okay. From the field operations division?

Q (By Mr. Camil) Did he receive some sort of severance package, do you know?

A I think we fired him outright.

Q (By Mr. Shropshire) That doesn't mean he wouldn't have gotten a settlement, some kind of settlement package, right?

A I think I would have known about that. I was a lawyer down here when they demoted him, and looking at termination, I was in contact with -- Hank Victor was the guy doing the termination. I remember he called me once that they were going to have a problem, and I called somebody, called -- I think it was Dave that said Kinkade is causing a problem, fix it, and he fixed it. I don't think there was any money paid to him.

Q Would he have a negative attitude then toward Portera?

A Portera, yes, you could talk to him and see what he says, but just keep in mind that that is a guy that ripped off people in Alabama and then -- so you have to take what he says with a grain of salt.

Another scheme we recently -- scam recently discovered is vals that are overfunded, people going and saying your VAL is over financed and use that overfunding to sell you another life insurance policy when it is a new one to us.

Q (By Mr. Camil) Explain that.

A Or put in extra money to make the side fund larger. And then they would go in later on if he sold traditional products, utilizing the money from the side fund. Keep in mind that, again, he may have avoided any detection.

Q Why?

A Because the side fund is not a policy that reduces the cash value.

Q So what you are saying is any time funds were pulled from a VAL, if it was pulled from the side account, not from -- well, let me ask you what are all the benefits you can have in a PUA?

A You can have a PUA in a VAL.

Q You're not going to have a dividend?

A No, just the dividend on the side fund. The real VAL, top VAL, and just something we missed, and I don't know if it got big in Florida, but I do know it got big in about 12 or 14 offices.

Q In

A In the Western Territory.

Q So any time an agent wanted to churn or take funds from a registered product side account to go into a knew policy, there would be -- there wasn't no system, in fact, to track that or match it or say it is a possible problem or to show where the funds were coming from?

A Right, we didn't pick it up.

Q How early on was it discovered that funds were being used from the side of registered products to churn or to fund new policies?

A This year.

Q This year?

A Yes. I started to get anonymous calls at that time, end of '95, and the description was of actually buying vals and overfunding vals with traditional products, and it turned out it was just the opposite, and I didn't catch on until I saw a consumer complaint on it.

Q For an agent to go to the policyholder and say, look, your VAL is overfunded and let's take five grand out of this and put it into a VAL or another traditional life, would there be like a disbursement form filled out to take money from this and put in this?

A They would have the insured ask for a disbursement in a check personally and then -

Q Hand it to the agent?

A -- and then write the check, actually deposit and write the check. I don't know how big that is, but that is something you want to be aware of as you go through. The other one is what they call a maximum pay VAL, and essentially what this is selling is vals or retirement plans.

Q (By Mr. Shropshire) Did you say maximum pay?

A Yes. And what you do is pay the maximum allowable premium under federal law without having tax consequences and pay that for seven years. And then what they say is you pay no more, and in 20 years this is what it is worth and this is the pension that you get. And they were giving an example of a male age 40, who was promised a life time pension of $25,000 a year at age 65. When I heard about the scam, I immediately called an agent and said I want 10 of these. The reality of it is it would produce at best a pension of about $8,000 a year.

Q (By Mr. Camil) Would that story be similar to what has been called the John Anderson story?

A What is that?

Q Are you familiar with that?

Q (By Mr. Shropshire) Is it prohibited to finance the sale of a registered product?

A No. There is a regulation that says on a registered product, you can't suggest borrowing money to pay for a registered product.

Q Whose regulation is that?

A I think it is banking. I think it is banking, isn't it?

Q (By Mr. Camil) Do you know whether the funds are coming out of nonregistered products and put into registered products or a registered product and a loan was taken out? Are you familiar with that?

A It is suggesting a loan; that is, if you come -if I am selling to you and you come up with the idea to borrow, that is fine, but then how many people would think to borrow money to buy another insurance policy? You have the ask yourself that.

Q (By Mr. Shropshire) Are you familiar with some limitations in Prudential's employment contracts which hits at financing registered products?

A Oh, yes, it says that you can.

Q Says what?

A I think the contract itself says you cannot do it.

Q Cannot do it, period?

A Yes.

Q Or does it say that you simply can't suggest it?

A I think it says that you cannot do it.

Q Do you have any idea how long that contract has been in effect?

A No, but a person can, and that person would be Jim Tignanelli T-I-G-N-A-N-E-L-L-I.

Q Can you give me a ballpark, was that provision in Prudential's employment contract in the 80's?

A I just don't know. I can't remember.

Q It sounds as if you are saying Prudential's contract was stricter than the regulatory requirement?

A Keep in mind I think the law department misinterpreted the law requirement for a regulatory requirement for a number of years.

Q Misinterpreted them on the stricter side?

A Yes, much like to dismiss them, you interpreted them on the more lenient side.

Q Is it correct or not that a lot of loans against policies for the company actually help overall on the books by showing that there is no longer a debt, but it is now credit because people have borrowed the money in a large scale on that basis? Now, this is $5 million in loans taken out that now people owe the company and that is going to show as a credit and/or change the dollar value for reservation for money that has to be held?

A No. It may change your reserve slightly, but the harm in it for the company is the return on the policy loans. It is typically less than a return we can get investing it elsewhere. And the other thing is that loan policies have much -- they go off the books. The worse thing an insurance company could do is have a policy go off the books, and that is what has happened at Prudential, but it makes no financial sense for the company.

Q (By Mr. Camil) As it relates to loans?

A As it relates to loans because there are too many things that occur when loans are used to purchase other policies.

Q Let me ask you this: An agent goes in and fills out a disbursement form that he was going to take the loan out from a registered product, the registered product now is in violation of NASD rule, violates the agent statement, violates company policy, but yet wherever the transfer is done, it is being allowed to be done?

A That is what I said, when you see a statement that says, "we shall not" -- ask what is behind it to enforce it to make sure it occurs. What you find is they are making a lot of statements, but there is nothing behind it to see that it happens, and that may be one of the cases. I don't know.

Q Are you familiar with policies referred to as direct recognition policies?

A Yes.

Q My understanding of direct recognition policies is if I do a loan on one of those policies, that is the dividend, you receive approximately 2 percent less each year; is that correct?

A I don't know if it is correct or not. That is what I heard.

Q Do you believe that is correct?

A I don't know, I just don't. The person that would know that is Esther Milnes, M-I-L-N-E-S.

Q Okay. And the illustrations that would be run for n abbreviation or when a policy might abbreviate on a direct recognition policy, was there some system possible to take into account that this person is going to get to show 2 percent less?

A Not to my knowledge. I think the illustration systems are not that sophisticated.

Q Do you know what percentage of a policy or products there are in percentage to the whole that are, in fact, direct recognition policies or the percentage of those that are sold?

A No.

Q (By Mr. Shropshire) Let's go off the record.

(The witness was excused.)

(The sworn statement was adjourned at 4:45 p.m., until the following day, October 1996, at 9:30 a.m.)

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