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Opportunities In Life Settlements
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Copyright 2008 Penton Business Media, Inc.All Rights Reserved Prism Insight
Registered Rep. Online Exclusive
September 16, 2008
1553 words
Opportunities In Life Settlements
By Alan Lavine
As more baby boomers retire, opportunities are growing forregistered reps to sell life insurance policies directly to lifesettlement companies, cutting out life insurance settlementbrokerage firms. Financial advisors and brokers typically get amuch nicer chunk of the enormous commissions on theproducts--which can go as high as 30 percent of the policypurchase price--when they act as the broker on thesedeals.
Sales in this industry have grown to $15 billion in 2007 from $5billion in 2002, according to Douglas Head, executive director ofthe Orlando, Fla.-based Life Insurance Settlement Association. Headprojects annual sales to grow even more over the next 10years.
Why? Institutional investors and hedge funds are expected toaggressively invest in life settlement pools as cash-strapped babyboomers sell off their life insurance policies to fund retirement,say industry observers. "The life settlement transactionscould grow to $100 billion annually as baby boomers seek tosupplement their retirement income," says Head, whoseassociation represents 184 life settlement companies.
Life settlements grew out of the viatical settlement business,which launched in the 1980s when AIDS patients who were desperatefor cash began selling their life insurance policies to investorsfor upfront payment. Both viatical and life settlements involve thesale of an insurance policy to a third party for more than thecash-surrender value of the policy, but less than the deathbenefit. But life settlements tend to be less predatory thanviaticals. Life settlements typically involve policyholders whohave 10 years to 15 years of life expectancy; viaticals tend toinvolve policyholders who are terminally ill and have less than twoyears to live.
Today, there are too many boomers out there with inadequate savingsfor a 30-year retirement. For some of them, a life insurance policyis their largest untapped asset. Or, perhaps their life insuranceneeds have changed, and the old policy is no longer adequate. Forthese clients, a life settlement might be the best bet.
Life settlements are particularly attractive for older clients whoare short on funds. Say a 70-year-old male with a $1 million lifeinsurance policy needs extra cash for retirement. You might sellhis $1 million policy for a net $156,000 to a life insurancesettlement brokerage firm, like Chesapeake Financial Settlements,for example. Or, you might broker a deal with a life settlementprovider directly.
Already, over the past five years, life settlement companies havepaid out more than $340 million to individuals, according to astudy by Neil Doherty, finance professor at Wharton, University ofPennsylvania.
Of more than $30 billion in face amounts of life insurance thathave been sold since 2002, nearly 90 percent representedunderperforming universal life insurance policies. Universal lifeinsurance pays current rates of interest and permits flexiblepremium payments. However, when interest rates decline, cash valuesdon't grow as much. So policyholders must kick in extrapremiums to keep their policies in force.
"You rarely see whole life insurance or variable universallife insurance--which invests cash value in mutualfunds--sold," Head says. "The cash value growth inthese policies is strong."
Danger Zone: STOLI
The remaining 10 percent of life insurance sales involved viaticalsettlements or Stranger Owned Life Insurance Transactions (STOLI,for short), Head says. In STOLI transactions, an individual buys alife insurance policy for the purpose of selling the policy on thesecondary market for a quick profit.
Viatical settlements and sales of insurance policies purchased ingood faith for financial reasons are considered legitimatetransactions in most states that have adopted the NationalAssociation of Insurance Commissioners Model Viatical Settlementlaws. However, more states are adopting stiff legislation toprevent abuses in Stranger Originated Life Insurance.
With STOLI, a senior purchases a life insurance policy and sells itto a third party or settlement company, which typically pays thepremiums. The third party investor in the life insurance policyprofits by collecting the death benefit once the elderlypolicyholder dies.
STOLI arrangements typically involve premium financing and/ordeceptive trust arrangements, often used to cover up the futuresale of the policy to a third party. For example, last Jan. 22, aNew York-based U.S. District Court judge denied a settlementcompany a $10 million death benefit on grounds that the company wasessentially "wagering" on a 77-year-old man'slife.
The retiree had set up a trust naming himself as the initialbeneficiary. The next day, he applied for a $10 million lifeinsurance policy and designated the trust as the sole beneficiary.Six days later, the retiree sold his interest in the trust and therights to the insurance proceeds upon his death to a settlementcompany for $300,000. Five days later, he died.
California adopted legislation last August to prohibit STOLItransactions. Florida's insurance department has beenconducting hearings on the improper use of life settlements, whileNew York is expecting to adopt legislation the first of nextyear.
Twelve states this year adopted laws based on model regulations ofthe NAIC and National Conference of Insurance Legislators (NCOIL).Some states are using a combination of both models to limitSTOLIs.
"STOLI schemes are a violation of the law and insurancecompanies are against it," warns Steve Brostoff, spokespersonfor the American Council of Life Insurers, Washington, D.C."There is a lot of litigation going on involving STOLIschemes."
STOLI transactions are problematic for both the insurance companiesand state insurance regulators. Insurance companies, in part,determine policyholder premiums, based on about a 6-percent-policylapse rate. Because third-party investors hold on to policies tocollect the death benefits, lapse rates decline. This increasesinsurance company costs. The costs are passed on to newpolicyholders in the form of higher premiums. Regulators and insurers also agree that STOLI transactions violate"insurable interest" laws, which typically prohibit thepurchase of insurance if the buyer has no risk of loss.
California Insurance Commissioner Steve Poizner says life insurancesettlements can be a favorable way for a senior to access the deathbenefit of a policy for which he or she no longer has a goodeconomic need. "The problem," he says, "lies inSTOLIs, which involve investors soliciting the original purchaserof life insurance for the sole purpose of an eventualsale."
The majority of states--including Arizona, Oklahoma, Ohio,Maine, Connecticut and Hawaii--use the National Conference ofInsurance Legislators Life Settlement Model Act, which focuses onSTOLI sales abuses. The New York insurance department says itslegislation likely will have more disclosure requirements than theNCOIL rules. Meanwhile, recent amendments to the NAIC Viatical Settlement ModelAct prohibit the sale of a life insurance policy until five yearsafter its purchase--except in the case of terminal illness.West Virginia and Nebraska have already adopted this rule.
NCOIL rules require a two-year moratorium on lifesettlements--the same as the contestability period required byinsurance companies. NCOIL rules define a STOLI and limit marketing and advertising.They also make engaging in STOLI schemes such as masked trustarrangements and premium financed loans, fraudulentactivities.
Under the rules, life settlement providers must report STOLI dataannually to state insurance regulators, so that it can bedetermined if providers are initiating policies for the purpose ofsettling them.
The NCOIL STOLI act provides that a person who commits a fraudulentlife settlement act is guilty of committing insurance fraud, andsubject to civil and criminal penalties. In situations involving premium financing, insurers must adviseapplicants of the adverse consequences that might result from thelater settlement of the policy. Insurance companies are alsopermitted to require the applicant to certify that he or she hasnot entered into any agreement or arrangement providing for thefuture sale of the life insurance policy. Third parties are prohibited from receiving any proceeds orconsideration from the policy or policy owner that are in additionto the amounts required to pay the principal, interest and servicecharges pursuant to the premium finance agreement.
Steven Weisbart, Ph.D., insurance specialist with the InsuranceInformation Institute, New York, warns that life settlements cancreate problems for individuals who go into a nursing home. If theyrun out of money to pay for nursing home coverage, they could bedenied Medicaid because they assigned their insurance policy to athird party.
It's important to advise a client that the cash received froma life settlement is taxable income, he stresses. So a financialadvisor should first check to see if there are other less costlyalternatives than a life settlement.
A policyholder may be able to borrow against the cash value of thepolicy. Or, he or she might be eligible for accelerated deathbenefits for serious illnesses. Many of today's policies comewith long-term care riders. Weisbart says a client also needs to bereassured that his or her personal information is confidential andprotected.
September 16, 2008
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