SCRUTINIZING LIFE SETTLEMENT SALES
From The States
David Giusti

David Giusti is a Director for State Net's Financial Services Division (www.statenet.com), an online federal and state legislative research company located in Washington, DC.

Improper referrals?

THE 2008 STATE legislative sessions will soon convene, and life settlements will remain a hot topic. As of December 2007, at least 13 states have pending bills or regulations that concern these types of transactions. The focus of the legislative and regulatory efforts revolves around stranger-owned life insurance (STOLI).

In STOLI arrangements, life insurance policies are resold to third parties who have no insurable interest in the insured. Consequently, when the insured dies, private investors are in a position to profit from their death.

Many state lawmakers are worried that STOLI transactions are contrary to state insurable interest statutes. Such statutes require beneficiaries of a life insurance policy to have an interest in the continued life—not the early death—of the insured. States are also examining how quickly new policies are being transferred to the secondary market. Of chief concern is how to protect legitimate life-settlement practices while discouraging STOLI transactions. This past year, the National Association of Insurance Commission (NAIC) and National Conference of Insurance Legislators (NCOIL) proposed different models to address this issue.

A five-year settlement ban?

In June, the NAIC amended their Viatical Settlement Model Act by imposing a five-year settlement ban on life insurance policies that were issued with elements resembling a STOLI transaction. Most states already require individuals to wait two years before transferring a policy to the secondary market. The extended waiting period is intended to discourage brokers who issue policies then quickly resell them to third-party investors. The life-settlement industry, however, strongly opposes the NAIC's revised model and argues this approach violates consumers' property rights. They also purport that the adopted amendments will do little to curb stranger-initiated transactions, because settlement trusts are not taken into account.

A couple of months later, NCOIL unanimously adopted their own amendments prohibiting STOLI transactions. Unlike the NAIC, the NCOIL Life Settlements Model Act does not extend the customary two-year waiting period for settling policies. Rather, the model defines and prohibits the practice of initiating a life insurance policy that benefits third-party investors who, at the time of policy origination, have no insurable interest in the insured. The provisions further require life-settlement providers to report information regarding settled policies to an insurance commissioner as part of an annual statement.

With many industry uncertainties, state governing bodies continue to take charge with the issuance of life-settlemetn legislative and regulatory policies.

Currently, most states have laws that require a life insurance policy purchaser to have a legal or financial interest in the insured's life. However, "insurable interest" is loosely defined in many state doctrines, paving the way for STOLI transactions. Often, these questionable settlements and violations of state insurable interest doctrines are turned over to the courts. Accordingly, Florida has pre-filed legislation to clarify existing statutes, and many insurance commissioners have issued bulletins regarding their insurable interest laws.

Regulated in about half the states

Still, many states have not yet gotten involved with the regulation of settlement transactions. While approximately half regulate both viatical and life settlements¹, others are only involved in the sale of life insurance policies for the terminally ill. Even those states that do not regulate the industry at all will likely address whether life settlement brokers need to be licensed as life insurance agents.

Those states that do regulate the practice remain concerned that the risks to the policyholder are not transparent. Additional requirements regarding how these policies are sold are forthcoming. Specifically, lawmakers want to ensure that consumers are aware that selling policies can result in a loss of insurance protection and benefits. There are important tax implications for these transactions, which policy owners also need to understand.

Additionally, marketing practices will be reviewed during the 2008 sessions. For example, in Texas, the Department of Insurance has reminded participants that all advertising materials used by providers and brokers to solicit viatical or life settlements must be filed with the agency before the date they are used.

Still other states are issuing consumer alerts regarding life-settlement policies. The California Insurance Department issued a bulletin informing customers that third-party purchasers will have a financial interest in their death, a legal right to inspect the insured's medical records, and may periodically contact the insured to determine health status.

In general, legislators and regulators will continue to examine broker arrangements if they feel a consumer's ability to seek competitive bids is limited. Compensation agreements will also be scrutinized, with some states restricting the payment of referral fees under certain situations. Additional commission and fees disclosure requirements should also be expected for 2008.

Legislators and regulators will continue to examine broker arrangements if they feel a consumer's ability to seek competitive bids is limited.

With many industry uncertainties, state governing bodies continue to take charge with the issuance of life-settlement legislative and regulatory policies. These actions prompted the life-settlement industry to challenge a Virginia law concerning payout rates on the grounds that it violated interstate commerce. The Supreme Court declined to rule, resulting in the solidification of the states' authority to govern the industry. And while the U.S. Congress hasn't exactly been sidelined, the life insurance industry is concerned that favorable tax treatment of insurance products will prompt a federal legislature inquisition if life settlements continue to be used for investment purposes.

¹ A viatical settlement is the sale of an in-force life insurance policy insuring a person who is terminally or chronically ill.
  A life settlement is the sale to a third-party purchaser of an in-force life insurance policy for its ‘fair market value': an amount in excess of the contract's cash surrender value, but less than its death benefit—whether or not the insured is ill. Both involve the sale of an existing life insurance policy or of benefits payable under a life insurance policy to a third party.