STATES TARGET STRANGER-OWNED
From the States - Autumn 2009 | By David Giusti
WITHIN THE PAST three years, state lawmakers have aggressively pursued new laws to regulate life settlement transactions. In 2009, 19 bills were enacted and 13 regulations were adopted in 20 different states.
Life settlements allow individuals who no longer want life insurance coverage to sell their policies as an alternative to surrendering it for cash value or letting it lapse. The practice has existed for over two decades and serves a legitimate purpose for policyholders who need money for medical expenses and have no dependents.
Recently, states have focused their attention on stranger-owned life insurance (STOLI) transactions. These policies are purchased for the purpose of reselling them to third-party investors who have no insurable interest in the insured. As a result, private investors who hold the policy are in a position to profit from the death of the insured.
A vehicle of speculation?
Many believe that STOLI violates the purpose of life insurance since it is used as a vehicle for financial speculation on human life. Furthermore, the subprime lending fiasco has heightened states' sensitivity to the flipping and reselling of bundled policies in the secondary market. Yet while the concept of stranger-owned life insurance violates the insurable interest laws of many states, it is often difficult to distinguish a STOLI transaction from a legitimate life insurance settlement.
Consequently, legislators have introduced legislation to clarify and strengthen the insurable interest laws in their states. Much of the legislation is based on the National Conference of Insurance Legislators (NCOIL) Life Settlement Model Act. The NCOIL provisions establish criteria for determining when stranger-oriented life insurance practices are present in the sale of insurance, and states are now prohibiting certain transactions based on the statutory definition and guidelines set forth in this model.
Viatical settlements were largely unregulated in many states several years ago, but this is no longer the case.
Many states are also adopting the Viatical Settlements Model Act that was put forth by the National Association of Insurance Commissioners (NAIC). This model establishes a five-year period in which a prospective purchaser of a new policy is prohibited from entering into a settlement contract unless specified circumstances are present. The moratorium focuses on the settlement of policies with non-recourse financing, settlement guarantees, and life expectancy evaluations. The language does not attempt to explicitly ban STOLI transactions; however, the waiting period is intended to make these transactions unappealing to investors. Although the NAIC model prohibits the sale of life insurance until five years after the policies were issued, several states have decided that a two-year settlement prohibition is sufficient.
In general, states are beginning to implement a more proactive position. Legislators are imposing more supervision within their respective state regulatory bodies to keep a more watchful eye on representatives who sell life settlements. Most states no longer allow representatives to broker or solicit life settlements without a state license. Bond requirements, continuing education requirements, and grounds for revocation of a license are being established by enactments and new regulations. Fingerprinting and criminal background checks are now mandatory for life settlement brokers in several states. Bills have also been enacted to require all settlement contracts and forms be approved by the state's insurance commissioner, and annual state reporting requirements have become more stringent.
Coupled with greater oversight, state legislators are pursuing better transparency. The most important disclosure is the clear tax liability warning that would result from a life settlement transaction. Additionally, sales representatives are being required to divulge that sacrificing a life insurance policy may jeopardize one's ability to obtain insurance coverage in the future. Legislation is also being enacted to force brokers to share the compensation they will receive from the policy being sold. Finally, because health and financial records are accessible by third-party investors if a policy is resold, states are imposing restrictions on sharing a customer's personal information.
Consumer advocates weigh in
In addition to the insurance oversight, consumer advocacy is playing a major role. Consumer advocates are focusing their efforts on preventing fraud and coercive practices that target the unhealthy and the elderly. Legislation has been enacted to prohibit misleading advertisements that indicate life settlement transactions are free of charge. Lawmakers are also improving underwriting guidelines to better determine a policyholder's intent when purchasing life insurance as well as extending a customer's right to rescind a life settlement contract to 60 days.
The life insurance industry believes that stranger-owned life insurance damages the reputation of legitimate producers and brokers. Since most life insurance policies lapse and do not result in a claim, the industry also has a financial interest in preventing STOLI contracts: if life insurers pay out more death claims than anticipated, they could be forced to raise premiums. Therefore, associations such as the American Council of Life Insurers (ACLI), National Association of Insurance and Financial Advisors (NAIFA), and the Association for Advanced Life Underwriting (AALU) are leading the fight to create laws that prohibit these transactions.
Petitioning the federal government
Finally, since securitization is outside the jurisdiction of state insurance regulators, many are also petitioning the federal government to take action. In August, the Securities and Exchange Commission (SEC) established an internal task force to examine the distinction between life settlements and securities. The following month, the Life Insurance Settlement Association (LISA) and the NAIC testified before the House Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises regarding proceeding with the regulation of the industry. State and federal courts, too, are considering a number of cases related to the legitimacy of STOLI transactions.
Viatical settlements were largely unregulated in many states several years ago, but this is no longer the case. Going forward, brokers, agents and producers involved in these transactions will be more heavily scrutinized through oversight to ensure legitimacy, legality, consumer protection, and transparency.
David Giusti is a Director of Client Services, State Net Financial Services Division (Washington, DC)