Financial Services Commission
Commission des services financiers de l’Ontario
Neutral Citation: 1999 ONFSCDRS 23
Appeal P98-00027
OFFICE OF THE DIRECTOR OF ARBITRATIONS
RICHARD N. LAFORME
Appellant
and
ECONOMICAL MUTUAL INSURANCE COMPANY
Respondent
Before:
David R. Draper, Director's Delegate
Counsel:
Joseph M. Dillon (for Richard N. LaForme)
Peter N. Downs (for Economical Mutual Insurance Company)
APPEAL ORDER
Under section 283 of the Insurance Act, R.S.O. 1990, c.I.8, as amended, it is ordered that:
The appeal is dismissed and the arbitration order dated June 11, 1998 is confirmed.
Economical Mutual Insurance Company will pay Richard N. LaForme appeal expenses fixed at $250.
February 3, 1999
David R. Draper
Director's Delegate
Date
REASONS FOR DECISION
I. NATURE OF THE APPEAL
This is an appeal by Richard N. LaForme from an arbitration decision dated June 11, 1998. He claims the arbitrator erred in determining how his weekly income replacement benefits should be calculated. More specifically, he objects to the arbitrator's conclusion that part of the commissions he received in the 52 weeks before the accident were loans, not income.
II. BACKGROUND
Mr. LaForme was involved in an automobile accident on February 13, 1995. At the time, he was running his own business - Structured Financial Group Incorporated ("Structured Financial"), an agency specializing in selling life insurance policies to high-income individuals for the primary purpose of estate and tax planning. These were not standard life insurance policies, but were specially designed by PPI Financial Group ("PPI") for the "carriage trade." Mr. LaForme's income came mainly from commissions paid by PPI on the sale of the policies, with a commission of approximately $75,000 on an average policy.1
The dispute on appeal centres on the nature of these commissions. It is clear, however, that in the years 1992-1995, Mr. LaForme reported the full amount of the PPI commissions on the company's financial statements and to Revenue Canada as income in the year they were received. In 1994, the year before the accident, his gross commissions were about $400,000.
Following the accident, Mr. LaForme did not return to work right away. His automobile insurer, Economical Mutual Insurance Company ("Economical"), accepted his claim for weekly income replacement benefits ("IRBs") under O.Reg 776/93, as amended, the Statutory Accident Benefits Schedule - Accidents after December 31, 1993 and before November 1, 1996 ("the SABS-1994"). However, there was some question about the amount.
IRBs are based on the insured person's pre-accident earnings. Because Mr. LaForme was self-employed, he could choose either the 52 or 156 weeks before the accident, whichever was to his advantage. He chose 52 weeks. According to section 83 of the SABS-1994, his income from self-employment over this period is calculated in the same manner as his profit under the provincial and federal Income Tax Acts, subject to some exceptions not relevant here.
Economical retained an accountant, Mr. Jeff Jenner, to help determine the amount it should pay. Mr. Jenner reviewed Mr. LaForme's financial records, including income tax returns and financial statements. Based on this information, he concluded that Mr. LaForme was entitled to IRBs at the maximum rate of $1,000, even after his collateral benefits were taken into account.
Mr. LaForme returned to work in about May 1995, roughly three months after the accident. As a result, Economical stopped paying IRBs. Structured Investments continued to operate, with Mr. LaForme receiving gross commissions of approximately $500,000 in 1995. However, in about April 1996, after working for just under a year, Mr. LaForme stopped working completely. He claimed that his accident-related injuries prevented him from continuing, but Economical refused to reinstate his IRBs.
Economical did not accept that Mr. LaForme's ongoing problems - fibromyalgia and pain in his low back and right hip - were caused by the accident. In addition, the parties could not agree on the proper amount of any IRBs payable to Mr. LaForme, including the appropriate deductions for post-accident income and collateral benefits.
The dispute over the amount of the benefits arose because in September 1996, Mr. LaForme refiled his 1992-1995 income tax returns. Instead of treating the PPI commissions as income in the year he received them, he reported them as a combination of income based on the sale of the policy and a loan extended in anticipation of future renewals. This was done to reduce Mr. LaForme's tax liability. However, from Economical's perspective, it meant that his income in the 52 weeks before the accident was lower than originally reported. Mr. Jenner, the accountant retained by Economical, reviewed the situation and prepared a second report, concluding that the commissions should be treated as a combination of income and loan. The parties agree that this approach reduces Mr. LaForme's entitlement to IRBs.
Mr. LaForme objected to the change in Economical's position, claiming that its original calculation was correct. He maintained that he could choose whether to report the commissions as a "heaped" payment on the sale of the policy, the usual approach for life insurance commissions, or take advantage of the alternative scheme introduced by PPI to spread the income over a number of years. Before the accident, he says he adopted the former approach because he expected his income to continue rising and, therefore, did not need to defer income. After the accident, however, there was a tax advantage to spreading it into the period after he stopped working and his income was lower. In his submission, his accident benefits should be calculated based on his income as he reported it at the time of his accident and would have continued to report it if the accident had not intervened. The alternative approach, he claims, understates his losses.
At some point, Mr. LaForme instructed his accountant to withdraw the refiled tax returns. However, by the time of the arbitration hearing in April 1998, they had not been withdrawn. On appeal, I was advised that the refiled returns had been accepted by both the provincial and federal authorities, although Mr. LaForme says Revenue Canada was prepared to accept either approach as long as it was used consistently.
The arbitrator was not asked to calculate the exact amount of Mr. LaForme's IRBs. Rather, he was asked to rule on the proper approach to the PPI commissions. Were they income when received (the approach taken by Mr. Jenner in his first report), or a combination of income and loan, with only the income being included in the calculation of IRBs (the approach taken by Mr. Jenner is his second report)? Mr. LaForme argued it was the former, while Economical claimed it was the latter.
The arbitrator released his decision in June 1998. On the disability issue, he concluded that the automobile accident significantly contributed to Mr. LaForme's ongoing disability and, therefore, he was entitled to IRBs. With respect to the amount of the benefits, the arbitrator accepted Economical's position. He concluded that the PPI commissions were a combination of income and loan, and only the commissions Mr. LaForme earned through the sale or renewal of policies in the 52 weeks before the accident should be included in his pre-accident income. The loan portion did not become income until the policy was renewed and he was credited for it. Finally, the arbitrator held that IRBs are not reduced by Canada Pension Plan disability benefits.
Mr. LaForme appealed from the arbitrator's conclusions about the treatment of his commission income. Economical responded, arguing that there is no reason to interfere with this part of the arbitrator's decision. In addition, Economical filed its own appeal, challenging the arbitrator's decisions on the causal connection between the accident and Mr. LaForme's ongoing disability, and his ruling about the deductibility of Canada Pension Plan disability benefits. Before the appeal hearing, however, Economical withdrew its appeal. Therefore, the appeal proceeded only on the treatment of Mr. LaForme's commissions.
III. ANALYSIS
Because Mr. LaForme applied for arbitration after November 1, 1996, his appeal is limited to questions of law.2 Economical argues that the appeal does not raise a question of law, but merely challenges the arbitrator's factual finding that the commissions paid by PPI were a combination of income and loan. I do not agree. In my view, the characterization of these payments involves a question of law that can be pursued on appeal. However, for reasons that follow, I agree with the arbitrator's analysis.
As noted above, the SABS-1994 includes specific reference to the provincial and federal Income Tax Acts, providing that income from self-employment is to be determined in the same manner as in the tax legislation. While arbitrators must determine the insured person's income, tax rulings are outside their general area of expertise. Therefore, they should be cautious in second-guessing income tax returns that have not been challenged by the tax authorities, particularly where, as here, the insured person has reported his or her income consistently over a number of years. In this case, however, are a number of reasons, including Mr. LaForme's decision to refile, that justify the arbitrator's decision to look behind the original returns.
The arbitration decision includes three critical findings, each of which is supported by the evidence. First, the arbitrator found that Mr. LaForme had to do a significant amount of work to obtain policy renewals. He accepted the evidence of Mr. LaForme's colleague, Mr. Reg Whaley, that due to the large amounts of money and complicated financial planning issues involved, he and Mr. LaForme nearly had to resell the policy to get the renewal. This undercuts Mr. LaForme's argument on appeal that his right to the full commission was triggered by the sale of the policy, subject only to a charge-back if it was not renewed.
The arbitrator's finding also provides some justification for PPI's decision to adopt a payment plan different from that generally used in the life insurance industry. The arbitrator relied on the following explanation provided by Mr. LaForme's accountant, Mr. Mike Davies:
Many insurance companies pay a commission on what is referred to as a "heaped" basis. This method usually pays most of the commissions in the first year with a limited number of smaller renewal commissions. PPI Financial Group created a shift to product pricing that created ongoing commissions far beyond the first few years of issue. This was done in order to provide incentive to the insurance professional to service the account over a longer time frame and thus resulting in lower lapse rates in ongoing service to the client. In order to provide a flexible cash flow mechanism for the insurance professional making the transition from the heaped compensation to level or life time compensation plans an arrangement was made to provide for financing against future commissions. In order to do this PPI Financial Group established a separate entity to provide the insurance professional with a loan against the future commissions to be earned on a "level" policy. Interest is charged on these loans. When commissions are earned in the second, third, fourth and fifth year of the policy they are used to repay the loan made at the original time of sale. Structured Financial Group Inc. took advantage of this loan arrangement and therefore many [sic] of the cash received was in fact a loan and not revenue. As a result the financial statements were restated in order to disclose the amount of the loan liability, the reduction in revenues and the increase in interest on the loans.
This leads to the second important finding. The arbitrator found that the PPI commissions were not a heaped commission, but a combination of commission and loan. The evidence on this point is overwhelming. As set out in its brochure, PPI saw numerous problems with the heaped commission approach for its "associates," like Mr. LaForme. As a result, it adopted a "level" or "lifetime" compensation plan, with commissions paid at a relatively flat rate on the sale of the policy and each renewal. The example in the brochure shows commissions paid at the same rate on the sale of the policy and the following four years, and at half that rate for the next five years, assuming the policy continues to be renewed.
If Mr. LaForme had received his commissions in this manner, there would be little debate about his income. However, PPI offered an optional "renewal capitalization" plan that Structured Investments opted for. This was not a different form of compensation. As the brochure states, "[t]here is a difference between Renewal Capitalization and Compensation."
Renewal capitalization provided the associate with an up-front payment similar to a heaped commission. However, it is clear from the agreements signed by Structured Investments that it was not a heaped commission - most of the initial payment was a loan financed through the Canadian Imperial Bank of Commerce,3 with the repayment schedule designed to coincide with anticipated renewal commissions. When a policy was renewed, the associate was credited with the renewal commission (the same amount payable under the flat or lifetime commission approach), which was used to repay the loan.
As Economical's counsel argued, it is difficult to see how the funds advanced under the renewal capitalization agreement can be considered income when they were subject to interest at prime plus 1.5%. I agree that the more accurate characterization is that the sale of the PPI policy gave the agent a right to a commission equal to that paid under the flat or lifetime commission approach, plus the right to borrow an additional amount based on a formula worked out between PPI and the Canadian Imperial Bank of Commerce.
Finally, there is the question of the income tax treatment of the payments from PPI. Mr. LaForme testified, supported by Mr. Terry Zive, PPI's Vice-President of Marketing, that PPI associates could choose how to report. Depending on their particular situation, some associates reported the full amount as income when it was received, while others spread it over a number of years.
Despite this evidence, the arbitrator did not accept that Mr. LaForme could choose how to characterize the payments. Relying on the accounting evidence, he found that the proper method was to treat the loan portion as a loan, not income. It does not become income until the renewal is obtained and a further commission is due. As the arbitrator points out, this means that Mr. LaForme should be credited for any commissions he earned on renewals obtained in the 52 weeks before the accident even if the initial sale was earlier and he received payment according to the renewal capitalization plan.
I find no error in the arbitrator's reliance on the accounting evidence which, in my view, is quite compelling. In early 1995, PPI retained the accounting firm of Coopers & Lybrand to provide advice on the income tax and accounting implications of the renewal capitalization plan. The resulting report clearly states that the loan portion should not be treated as income, and gives advice on what associates who have "incorrectly" reported it as income should do to correct the situation.
Mr. LaForme's own accountant, Mr. Davies, agreed with the Coopers & Lybrand analysis, although he felt it was a clever arrangement that might be challenged by Revenue Canada. When he initially prepared Mr. LaForme's financial statements and income tax returns, he was unaware of the renewal capitalization plan. After he was informed, he prepared the revised returns, moving the loan portion of the payments received by Mr. LaForme out of income. In a letter to Mr. LaForme's lawyers, he explained that it "was necessary to correct prior years financial statements to recognize the over statement of income and the understatement of the loans payable and interest expense."
Mr. Jenner, the accountant retained by Economical, also accepted Coopers & Lybrand's analysis. His testimony at the arbitration hearing differed from that of Mr. LaForme and Mr. Zive. Mr. Jenner agreed that PPI associates could choose whether to opt for renewal capitalization, but if they did, they did not have an additional choice about how to report their income. Like the other accountants, he viewed the commissions as income, but not the loan. In contrast, Mr. LaForme and Mr. Zive spoke about renewal capitalization as if it were the same as heaped commissions. For reasons set out above, there was ample evidence for the arbitrator to conclude that they were mistaken.
Mr. LaForme also objects to the arbitrator's statement that Revenue Canada was unaware that some of the funds he received were loans that might have to be repaid. In his submission, there was no evidence to support this finding and, further, it is contradicted by evidence that many PPI associates reported their income as he did, without challenge from Revenue Canada. In my view, however, the arbitrator was responding to the suggestion that Revenue Canada's acceptance of Mr. LaForme's original income tax returns should be taken as proof that he had the option of reporting the payments either way. He makes the reasonable comment that without evidence that Revenue Canada has made a specific ruling, the absence of a challenge cannot be taken as determinative.
For all these reasons, I find no error in the arbitrator's decision. Therefore, the appeal is dismissed.
IV. APPEAL EXPENSES
Mr. LaForme submits that he should receive his appeal expenses regardless of the outcome. He argues that his appeal raised novel, technical issues that he was justified in pursuing through appeal. He also claims that although Economical withdrew its appeal, he incurred expenses responding to it that should be compensated.
Economical argues that the appeal had little merit and, therefore, expenses should be denied. Further, it argues that it should not be penalized for withdrawing its appeal, a responsible step taken as soon as its new counsel was able to properly review the file.
As stated in previous decisions, expenses are not routinely awarded to an insured person who is unsuccessful in his or her appeal. While I accept that Mr. LaForme's appeal raised legitimate issues of importance to him, I am not persuaded they were of such significance that Economical should bear the cost. However, Economical must take responsibility for filing an appeal despite its later decision to withdraw. Mr. LaForme had modest expenses that will be fixed at $250.
February 3, 1999
David R. Draper
Director's Delegate
Date
Footnotes
- Structured Financial operated through a holding company owned by Mr. LaForme and his wife as the only shareholders. Despite this arrangement, the parties agreed that all income earned by Structured Financial should be treated as Mr. LaForme's income.
- Insurance Act, R.S.O. 1990, c. I.8, as amended, s. 283(1).
- The Canadian Imperial Bank of Commerce was involved by 1993, before the time period in issue here.