WHEN ARE ANNUITIES HELPFUL AND WHEN ARE THEY HARMFUL TO OUR CLIENTS

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1 WHEN ARE ANNUITIES HELPFUL AND WHEN ARE THEY HARMFUL TO OUR CLIENTS TERESA K. BOWMAN, JD JERRY A. HYMAN, JD, LLM, CFP Boyer & Jackson, P.A. 724 Yorklyn Rd., Suite N. Washington Blvd, Suite 21 Hockessin, DE Sarasota, FL (tel. & fax) (tel.); (fax)

2 HARMFUL USE OF ANNUITIES BY OLDER PERSONS (by Teresa Bowman) I. What Makes an Annuity Harmful? Any attorney working with seniors is going to come across annuities when reviewing a list of a client s assets. Understanding the impact a bad annuity can have vs. a good annuity is important. Equally important is understanding HOW to deal with a bad or unsuitable product, and possibly how to deal with the fact that it may have been sold using unfair, and possibly predatory, sales practices. As elder law attorneys, when faced with a bad annuity we must find a way to help our clients effectively deal with its consequences, and this can make all the difference when helping our clients manage long term care costs. Every year thousands of annuities are purchased by seniors in every state and Florida is no exception. What may be an exception is the number of complaints about those annuity sales. In 2008 the Chief Financial Officer, Alex Sink (of the Florida Department of Financial Services), reported that the number of complaints filed with her department had increased over 40% from the previous year. 1 More recently, in an announcement regarding stricter penalties for improper sales of annuities, she stated that the number of complaints from seniors has nearly quadrupled in the last three years and out of 472 investigations on financial fraud involving seniors, 1 Alex Sink, Address, Update to Florida Senate s Insurance and Banking Committee, (Tallahassee, Fla., Mar. 18, 2008) (copy at 2 of 40 BOWMAN/HYMAN

3 approximately 70% of those were related to annuity and life insurance sales. 2 In 2009, the Department opened 227 annuity investigations. 3 The clients I see have typically purchased fixed or variable deferred annuities usually with the idea of either creating income as they age, or preserving dollars for future generations. Often the annuities have been rolled over from one to another, sometimes more than once, upon the advice of an agent to get the latest and best new product. This is not always done with the intent to help the client prepare for the future, but to generate fees and commissions. These practices, called churning and twisting 4, are part of the reason there are so many complaints. For example,. Mr. and Mrs. Older purchased a deferred annuity 5 years ago when they were 75 and 72, respectively. They were retired teachers and lived modestly. They attended a seminar at a local restaurant titled Protect Your Assets Risk Free Investing. They were approached after the seminar by a young woman who gave them a business card with her name and the title Senior Advisor. She reminded them of their daughter, and after chatting for a few minutes she offered to meet with them in their home to review their assets and investment goals. The next day she came over and during the meeting she seemed genuinely concerned when she looked at an annuity policy the Olders currently owned. She told them that if they were her parents, she would advise them to consider transferring the funds as soon as possible because, although it was not public knowledge just yet, the company was in financial difficulty. 2 Alex Sink, Press Conference, (Tallahassee, Fla., Feb. 17, 2009) (copy at 3 Alex Sink, Press Conference, (Tallahassee, Fla., Feb. 12, 2010) (copy at 4 Twisting occurs when policies from one company are surrendered with the intent of purchasing policies from a different company. Churning is switching policies within the same company. BOWMAN/HYMAN 3 of 40

4 (Unfair and Deceptive Practice #1: Use whatever means available to GAIN THE CUSTOMER S TRUST.) Thanking her for sharing this industry secret with them, but concerned about surrender charges on their existing annuity, the Olders felt better when the agent assured them that any surrender charges would be offset during the first year of the new policy, because there was a guaranteed rate of return of 7%, and if they signed the surrender papers today, and agreed to purchase the new, better annuity, they would receive a bonus during the first year of the policy in the amount of $15,000. (Unfair and Deceptive Practice #2: CHANGE THE SUBJECT. The guaranteed rate and bonus, even if true, have nothing to do with surrender charges on the old policy; they would be available even if there were no surrender charges on the old policy.) The Olders shared with the agent that they didn t want their children to ever have to take care of us financially and that one of their goals was to have enough income to stay out of a nursing home. The agent told them not to worry, that they would generate enough income from this new annuity that they would never have to worry about paying for a nursing home or having their children burdened with paying for their care. But, she warned, if they didn t act fast she couldn t guarantee the same product would be available later on. (Unfair and Deceptive Practices #3 and #4: INSTILL FEAR and FAIL TO DISCLOSE the required free look period.) The Olders also told the agent that there was a family history of dementia and heart disease and that while healthy now, they were concerned about the future and what a serious illness could mean to their finances. She assured them that if one of them had a medical emergency, and they needed some of the money, they could draw out a lump sum whenever they wanted and cashing in the policy was as easy as filling out a few papers. (Unfair and Deceptive 4 of 40 BOWMAN/HYMAN

5 Practice #5: MISREPRESENTATION, in this case that drawing out the lump sum would not escape steep surrender charges in all medical emergencies.) The Olders felt confident that the agent was looking out for their best interests and signed the papers to transfer their current annuity, plus $50,000 in CDs (their entire savings) into a $100,000, 15-year deferred annuity with a surrender charge that began at 19% during the first year. The Olders never received the first year bonus they were promised, and when they tried to contact the agent she was never available to take the call and messages were left unanswered. Five years later when Mr.Older developed dementia and the family wanted to get some cash to hire in-home care, they discovered too late how truly unsuitable, and grossly inappropriate this product was for the Olders. The above scenario is a compilation of several recent actual cases involving Florida seniors. 5 This illustrates why deferred annuity sales to seniors can be inherently suspect. When unfair sales practices are used, it is often with the intent to sell an unsuitable product to a senior investor. Such practices are often driven by the following: 1. Little or no training of sales agents, or a lot of training on how to use high pressure sales tactics. 2. High commissions or other sales incentives that are not disclosed to the purchasers. 3. Omissions, misrepresentations, or outright falsehoods used in the sales presentation such as: 5 Safeguard Our Seniors Task Force, Senior Investors, (assessed Mar. 1, 2010.) BOWMAN/HYMAN 5 of 40

6 a) This provides an income you can t outlive, when in fact the product restricts annuitization, making it statistically unlikely that they purchaser will live long enough to receive the promised income. b) There is no risk, when in fact, the underlying investment can lose significant value and the purchaser can lose money under the terms of the contract, or, if there is a guarantee against loss, this is only possible by sacrificing significant investment gain. c) You will always have access to your money, when in reality withdrawals will generate high surrender charges for many years. d) The agent fails to inform the purchaser of his or her right to a free look. e) You need this to avoid probate, when in reality the purchaser would not be subject to probate or could avoid probate another way. f) You ll achieve tax savings, even though in some cases the purchase will result in higher taxes than the purchaser would have incurred without the sale. 4. Making false statements regarding the riskiness, tax features, or other features of the purchaser s current products or investment vehicles. 5. Stating or implying the existence of insurance against loss of principal that does not exist. 6. Signing documents for the purchaser, or encouraging the purchaser to sign documents without reading them. 7. Making a sale to someone who lacks the capacity to understand it. Notwithstanding the above, there are certain characteristics that make an annuity unsuitable for the senior investor regardless of how it was sold. When unfair and deceptive sales 6 of 40 BOWMAN/HYMAN

7 practices are combined with the following unsuitability factors, the result is a recipe for disaster for the unsuspecting and vulnerable senior. 1. The surrender penalty period lasts longer than life expectancy. 2. The surrender charges are higher than the industry norm (>7% or 8%). 3. The contract places significant barriers on the purchaser s ability to fully annuitize at any time after purchase. 4. The purchaser will have significant portions of his or her investment assets in deferred annuities after the purchase (>40%). 5. The purchaser is in a low income tax bracket, thereby making the costs and restrictions of a deferred annuity not worth the tax deferral benefit conferred by the annuity. 6. The purchaser s fixed income barely meets current expenses now, making it unsuitable to lock up any additional investment income in a product that only pays out ncome at a later date. 7. The purchaser is ill or has a history of illness, thereby implying a need for income now and not later. 8. The purchaser has little or no investment experience. 9. The purchase is a rollover of a tax deferred retirement account that was essentially free, to a new deferred annuity that provides no greater tax benefits but at a much higher cost. 10. The purchase is a rollover of a maturing annuity to another with few, if any, additional benefits but with a new set of surrender charges and other barriers to the purchaser s money. BOWMAN/HYMAN 7 of 40

8 The Older s case demonstrates a number of these unsuitability factors, as well as many of the unfair, and in this case predatory, sales tactics. Using misleading statements and failing to fully disclose the real terms of the product, combined with preying on the fears and trusting nature of the Olders, the agent led the purchasers to tie up a significant portion of their investments in a deferred annuity that carried high surrender charges, and offered them little access to the income when they needed it. II. How does Florida Regulate the Sale of Annuities to Seniors? Regulating the sale of annuities to seniors is serious business in many states. California, Florida, Arizona and other states with large senior populations are working hard to make companies and agents careful, and more importantly accountable, when selling insurance products, and more specifically, annuities to seniors. Florida Statute Sec , amended in 2008, as the John and Patricia Seibel Act 6 sets standards and recommendations regarding the sale of insurance products to senior consumers. The act was named for a Florida couple who were sold $600,000 worth of deferred annuities although both were in their 80's and could not access the funds for 15 years without paying large penalties. 7 The purpose of the statute is to hold agents to a standard and impose a duty to appropriately address the insurance needs and financial objectives of senior consumers at the time of the transaction. 8 The statute lists 11 items of information an agent should collect , Fla. Stat. (2009). 7 R. Michael Underwood, Florida Tightens Laws on Suitability of Annuity Sales to Seniors, (July 1, 2008) (found at (1)(a), Fla. Stat.(2009). 8 of 40 BOWMAN/HYMAN

9 at a minimum when determining the suitability of an annuity product. 9 The information is collected on a form completed and signed by the agent and the applicant. This form is found in the Florida Administrative Code, Rule 69B and is appropriately called the Annuity Suitability Questionnaire. 10 The statute requires the agent, or insurer if no agent is involved, to make reasonable efforts to obtain 11 : 1. Personal information, including the age and sex of the parties and the age and number of dependents; 2. Tax status of the consumer; 3. Investment objectives of the consumer; 4. The source of funds used to purchase the annuity; 5. The applicant s annual income; 6. Intended use of the annuity; 7. The applicant s existing assets, including investment holdings; 8. The applicant s liquid net worth and liquidity needs; 9. The applicant s financial situation and needs; 10. The applicant s risk tolerance and; ,(4)(b), Fla. Stat.(2009). 10 Publication DFS-H1-1980, as adopted under Rule 69B , F.A.C ,(4)(b), Fla. Stat. (2009). BOWMAN/HYMAN 9 of 40

10 11. Such other information used or considered to be relevant by the agent in making a recommendation to the consumer regarding the purchase or exchange of an annuity. While consumer responsibility is not ignored, these changes were an important step in the right direction and require due diligence on the part of the agent to accurately collect information used when recommending an annuity product to a senior consumer. But will this alone protect senior investors? The answer is not clear-cut. In 2009, the Florida Department of Financial Services brought suit against an agent for inducing [seniors] to make unsuitable or inappropriate investments through fraud, misrepresentation, or non-disclosure of material terms and conditions. 12 The suit resulted from two separate transactions conducted by the agent regarding the sale of equity index annuities (deferred annuities whose earnings are pegged to an index of equities i.e., common stock). In the first sale, the annuity carried an 18% surrender charge the first year, which decreased over the life of the annuity to a 1% surrender charge at year # At this point the purchaser would be 90 years old. The second transaction involved the sale of 6 annuities in all, similar to the one in the first sale, totaling over $1.4 million. 14 In the second sale the investors opted for a 14 year surrender period in order to receive a 10% bonus. 15 The purchasers were both over 65, had clear investment objectives, and were well-educated; in fact, one was a retired accountant. 12 Dept. of Fin. Serv. v. Tust, 2009 Fla. Div. Adm. Hear. LEXIS 802 (November 3, 2009). 13 Dept. of Fin. Serv., LEXIS Dept. of Fin. Serv., LEXIS Dept. of Fin. Serv., LEXIS of 40 BOWMAN/HYMAN

11 In both cases, it appeared to the Department that the sales were inappropriate based on the age and investment objectives of the purchasers. However, as decided in November of 2009, the Department was unable to prove, based on the appropriate standard of proof 16 (in this case, clear and convincing evidence), that the agent willfully misrepresented the annuity contract, demonstrated a lack of fitness or trustworthiness to engage in the insurance business, or was involved in unfair methods of competition or deceptive acts or practices. In short, the agent did not run afoul of the unfair sale practices listed earlier nor were the annuity products in violation of the suitability factors listed earlier. Based on factual determinations, the finding was that in both cases the investors were educated enough to understand the language of the contract, and signed disclosure statements regarding all of the policy provisions including the surrender charges and limitations on withdrawals. It is important to note that in this case, the Department did not charge the agent with any violations under the provision of FL Stat as discussed above. In both cases the purchasers surrendered the policies within the first few years and paid high surrender charges, but the state was unable to prove that the purchasers were duped into buying the policies, nor was the state able to prove that the policies were inappropriate for the purchasers. Significant for the examiner was the fact that, despite the high surrender charges (which the purchasers should have understood), the annuities could be annuitized at any time without penalty or restriction. Therefore, the purchasers could always convert the contracts into a stream of income, the primary rationale for any annuity purchase. In response to the increased number of complaints regarding unsuitable annuity products, The Florida Department of Financial Services, kicked off a Safeguard Our Seniors statewide 16 Dept. of Fin. Serv., LEXIS 802 at 7. BOWMAN/HYMAN 11 of 40

12 blitz in February of this year. The Department is seeking support, for the third year running, on the Safeguard Our Seniors Legislation that would increase penalties on agents who mislead investors. 17 Although the Department has helped Florida seniors recover nearly $9 million and put some senior scammers in jail, this year alone saw another 800 complaints filed with the Department. 18 In the past two years over 386 Safeguard our Seniors events have been held across the state, including workshops to help educate seniors about annuities and other financial products. 19 The proposed legislation would limit surrender charges on annuities to 10 years and 10%, extend the free look period from 14 to 30 days, require agents who violate the law to make restitution to senior consumers who were harmed, prohibit the Department from re-licensing an agent who had a license revoked due to the solicitation or sale of an insurance product to a senior consumer, and require a cover sheet on all new annuity purchases clearly outlining the free look period and how to contact both the insurer, and the Department. 20 The legislation would make the act of twisting or churning an annuity to a senior consumer a third degree felony with up to 5 years in prison. 21 The bill, SB 844, sponsored by State Senator Mike Bennett and State Representative Keith Fitzgerald passed the Senate Banking 17 Alex Sink, Consumer e-views, Newsletter, Volume 7, February 12, (copy at 18 Id. 19 Id. 20 Id. 21 Id. 12 of 40 BOWMAN/HYMAN

13 and Insurance Committee unanimously on March 10, It later passed the Senate as a whole, but was not heard in the House. III. What Are Other States Doing? California in 2004 passed changes to the California Insurance Code 23 specifically aimed at protecting seniors who are targeted during sales presentation in their homes. Before agents or brokers can visit the home of a senior, they must provide a written notice 24 hours prior to the visit that states: 1. That the reason for the visit is to give a sales presentation; 2. That the senior may have family members at the meeting or a financial advisor or attorney; 3. That the senior has the right to end the meeting at any time and the agent must leave if asked to do so; 4. That the senior has the right to contact the Department of Insurance for information or to file a complaint; 5. That the senior must be told who will be coming to the home and their licensing information; California also has increased the free look period to 30 days in which the policy may be returned for a full refund. 24 IV. How does the Industry Regulate the Sale of Annuities to Seniors? 22 Id. 23 Cal. Ins. Code Id. at BOWMAN/HYMAN 13 of 40

14 The sale of both annuities and life insurance were exempted from federal regulation of securities when the Securities Act of 1933 was enacted. That exemption is still the law today. 41 The regulation of insurance and insurance products, such as annuities, has generally been left to the states. Therefore, an inappropriate sale of an annuity by an insurance company or its agent can serve as the basis of a complaint to the state insurance commission or department. Variable annuities where the investment performance is based upon the ups and downs of the securities (typically, stock) markets are, however, regulated as securities. The sellers of these products must hold securities licenses at the state or federal (SEC) level. Complaints against securities dealers and their agents can be directed to the state s securities department or commission, the Securities and Exchange Commission, and to the securities industry s selfregulatory body the Financial Industry Regulatory Authority (FINRA). Furthermore, complaints may be lodged with these securities regulatory agencies whenever a dually-licensed (insurance and securities) entity or person sells a purely life insurance (i.e., annuity) product deceptively or inappropriately. Financial professionals who hold the prestigious Certified Financial Planner (CFP ) designation, must abide by a code of ethics enforced by the Certified Financial Planning Board of Standards. An inappropriate sale by someone holding this designation could also be the basis for a complaint to that Board (which could result in suspension or loss of the seller s CFP designation). An industry trade group, the Securities Industry and Financial Markets Association (SIFMA), held a conference in 2007, in which it outlined annuity best practices aimed at U.S.C. 77c(a)(8). 14 of 40 BOWMAN/HYMAN

15 reducing the reducing the number of arbitrations involving the sale of annuities. They cited the following as the top reasons leading to arbitration: 25 annuities; - Agent s failure to adequately advise of the risks associated with deferred variable - Agent s sale of annuities to clients age 65 or older without obtaining supporting documentation from client regarding adequate disclosure; -Agent s failure to clearly advise the client of the surrender period and the fees associated with early withdrawal of funds; - Agent s failure to obtain supporting documentation from the client when one annuity is surrendered in order to purchase another; The conference materials outline how an agent can create a defensible sale by making sure never to complete forms for a client, always get a disclosure signed, and review a client s application for accuracy regarding age, assets, risk tolerance, short- and long-term financial objectives and annual income. 26 Agents are further advised to terminate the sale if at any time the senior seems confused or unable to understand the product or appears to have diminished capacity, or to consult the client s family members, trusted advisor or legal representative prior to finalizing the purchase. 27 V. How Can You Help a Client Stuck with a Harmful or Unsuitable Annuity? A. Economic Initiatives from the Policy Itself 25 Michael S. Hill, Presentation, Understanding Variable Annuity Regulation and Compliance, Independent Firms Conference, April 24, Id. 27 Id. BOWMAN/HYMAN 15 of 40

16 Imagine Mr. and Mrs. Older coming into your office and telling you about their annuity. What can they do now? Are they stuck with an unsuitable product because they were too trusting? The first rule is to read the policy! Looking inside the policy itself is where you might find a way out for the Olders. Often clients don t know what they have and may have never really read the policy. Don t take the client s word as the truth; read it yourself. If you find confusing language or are unsure about the policy provisions get permission from your client to call the company directly, either with your client in the room or after they have given the company permission to speak to you. If you get an answer different from what is in the policy ask for this in writing and follow up. Things to look for within the policy itself include: 1. Annual penalty-free withdrawal provisions. Many times the policy will state the purchaser can withdraw up to 10% of the premium annually. In the 2009 case discussed above this was an available option with a maximum withdrawal over the first 10 policy years of 50% of the premium paid. 28 Depending on the amount allowed, this annual withdrawal might be enough to cover current needs. 2. Nursing Home or Skilled Nursing Waivers. Sometimes a policy will have a waiver that allows penalty-free withdrawals to be made if there is a nursing home stay. The language in the policy regarding what is defined as skilled nursing or a nursing home is critical. If there isn t a definition page ask for a definition in writing. 3. Annuitization and other payout policies 28 Dept. of Fin. Serv., LEXIS 802, at of 40 BOWMAN/HYMAN

17 Read the policy to see when the contract begins to pay out without penalty. However, polices will often have several payout options and one may work for your client. Check the policy for the following: a) Options for annuitizing the policy- The policy may offer several different annuitization options from which to choose. b) Surrender policies- If the policy has been in effect for a while, the current surrender charge may not be significant and simply asking for a surrender form may be the best option. If high surrender charges apply you can always ask that the charges be waived based on need and financial hardship. Based on current public policy, and on-going issues regarding the sale of annuities to seniors, you may find companies more willing to negotiate these days. c) Withdrawal policies- Check the policy for one of the following: -GMWB (Guaranteed Minimum Withdrawal Benefit) which allows the withdrawal of a certain percentage (typically 5%) of a Guaranteed Withdrawal Base amount each year for life. -GMIB (Guaranteed Minimum Income Benefit) which guarantees annuitization at a certain minimum level even if all accumulation in the contract falls to zero. If the contract has gained in value, then the annuitization payment will be higher than the minimum, starting at an age specified in the contract (usually age 85). Beyond requesting a waiver of surrender charges, if you feel the sale of the annuity was inappropriate based on your client s age at the time of purchase, or feel that the agent misinformed the client, or in a case I had, ignored the fact that the client was just months away from skilled nursing and applying for Medicaid, you can do more. BOWMAN/HYMAN 17 of 40

18 B. Bureaucratic or Legal Remedies: Going outside the Policy First of all get all the facts. Ask to see the entire policy and any paper work associated with the sale. If the client can t find copies ask the company to provide copies. Once you get everything and review it, then talk to your client again and verify that the situation was as it appears to be an unsuitable sale of an annuity product. Once you feel you have a true inappropriate or unsuitable sale, you need to: 1. Do Some Research Find out all you can about the agent who sold the product by checking to see if he or she had the proper license insurance and/or securities to sell the product. 2. Complain to the Issuing Company Contact the insurance company directly, in writing, and ask for either a full surrender of the policy without penalty, or for a full refund of the entire investment. Tell the company why the sale was inappropriate or unsuitable and how this has negatively impacted your clients. Be specific; they may check the facts you outline in your letter and look to see if they have any documentation to disprove your allegations. 2. Complain to the Financial Institution Send a copy of the letter to the agent s home office if they sold the product while working with a bank or other financial institution. They will do their own internal investigation even if the agent is no longer employed there. 3. Complain to Other State Regulatory Agencies Send a copy of the letter to your State Insurance Commissioner and/or Securities Commissioner (in Florida the Department of Financial Regulation). When I sent a complaint to 18 of 40 BOWMAN/HYMAN

19 the Department I received a follow up letter within a week and a phone call followed. These complaints, although numerous, are all taken seriously and each is investigated to determine if further action is needed. 4. File Suit or Join in a Class Action Across the country suits are being filed against companies for sales of annuities to seniors. The chief complaint is the lack of oversight by the companies when they are approving annuities sales and in one recent settlement the company was required to improve its suitability review procedures and make full restitution to consumers. In 2003, a class action was brought in the United States District Court for the Middle District of Florida, against American Equity Investment Life Insurance Co. on behalf of 23,000 identifiable members for fraudulent and negligent misrepresentation regarding the sale of equity indexed annuities. 29 Facts revealed that a standardized sales process involved meeting with an elderly client, establishing a relationship of trust, and then providing an incomplete and misleading description of the products sold. 30 In reality agents knew little about the products themselves, so they were as misinformed as the clients. However, the products carried extremely high commissions which led to high pressure sales and deceptive sales tactics. In fact, agents were encouraged to do whatever is necessary to make a sale. 31 As part of the settlement, the company was required to begin web-based training for its agents, and revamp its marketing material to include previously missing material 29 Trevor Thomas, Life and Health Insurance News, news.com/news/2009/12/pages/great-american-settles-with-minnesota.aspx (Dec. 29, 2009). 30 Id. 31 Id. BOWMAN/HYMAN 19 of 40

20 information regarding the products sold. As relief, consumers were given the option of annunitizing their policy over 10 years, and receiving a 2% annuitization bonus. 32 In December of 2009, an even bigger settlement was reached between Minnesota s Attorney General and Great American Life Insurance Company and its affiliates, Annuities Investors Life and Loyal American Life. 33 The settlement allows purchasers, 65 and over who purchased a deferred annuity between Jan 1, 2001 and August 1, 2008 to ask for a full refund, without penalties, plus 4.5% interest! 34 Over 2,000 policies fell into this time period. Policies sold after August 1, 2008 could also be included in the settlement under certain circumstances, if the consumer feels they were sold an unsuitable product. 35 The company responded by saying that although they admitted no wrongdoing, they had improved their suitability procedures and put new plans in place to address evolving practices and standards of various state and federal regulators. 36 Michigan reached similar settlements with the Allianz Life Insurance Company of North America in 2007, American Equity Investment Life Insurance Company in February of 2008, AmerUsLife Insurance Company and American Investors Life Insurance Company in Oct. of 2008, and Midland National Life Insurance Company in December of VI. Issues With Immediate Annuities 32 Id. 33 Id. 34 Id. 35 Id. 36 Id. 37 Id. at of 40 BOWMAN/HYMAN

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