United States: Developments in Life Settlement Regulation

In the 1990s, regulatory concern over potential abuses in viatical settlements, transactions in which life insurance policies held by chronically ill insureds are purchased for less than the expected death benefit, led to the development of regulation in this area. The National Association of Insurance Commissioners (NAIC) developed the current Viatical Settlements Model Act and Regulation over eleven years, from 1993 to 2004 (the Model), some version of which has been adopted by as many as 40 states.

The Model regulates as a "viatical settlement contract" an "agreement establishing the terms under which compensation or anything of value will be paid, which compensation or value is less than the expected death benefit of the insurance policy or certificate, in return for the viator’s assignment, transfer, sale, devise or bequest of the death benefit or ownership of any portion of the insurance policy or certificate of insurance. A viatical settlement contract also includes a contract for a loan or other financing transaction with a viator secured primarily by an individual or group life insurance policy, other than a loan by a life insurance company pursuant to the terms of the life insurance contract, or a loan secured by the cash value of a policy . . . ."¹ Although the phrases "life settlement" and "viatical settlement" are frequently used interchangeably, viatical settlements are generally understood to involve insureds that have a life expectancy of less than two years, while life settlements involve insureds that are seniors with a life expectancy of more than two years. Life settlements may be entered into by insureds that are not chronically ill, but no longer wish to hold life insurance for various reasons.

The emergence of a secondary market for life insurance has been described as an inevitability in the free market, given the low cash surrender value of such policies.² Commentators indicate that market forces have placed the value of many life insurance policies at 1.5 to 1,000 times their cash surrender value, and that the secondary market gives life insurance policies liquidity similar to that of traditionally tradable commodities, such as stocks and bonds.³

Generally speaking, the various state statutes and regulations based on the Model regulate life and viatical settlements and the individuals or entities involved in these transactions in a variety of ways, including: provider and broker licensing requirements; form filing and approval requirements; annual reporting requirements; privacy restrictions with respect to disclosing the identity and financial or medical information of an insured; examination and investigative authority; disclosure requirements; prohibited practices; advertising regulations; fraud prevention and control; and criminal penalties, civil remedies and regulatory enforcement actions.⁴ The Model has been subject to extensive amendment during the course of its development, and regulation of life and viatical settlements is an area of law that continues to evolve.

The accounting treatment of life settlements by investors has also recently received attention. The Financial Accounting Standards Board (FASB) has revised its life settlement accounting rules by issuing FASB Staff Position No. FTB 85-4-1, entitled, "Accounting for Life Settlement Contracts by Third-Party Investors" (the FSP), on March 27, 2006.⁵ The FASB defines a life settlement contract for purposes of the FSP as:

Accounting for third party purchasers was previously governed by FASB Technical Bulletin No. 85-4 (FTB 85-4), which has been revised by the FSP. FTB 85-4 requires the use of cash surrender value in accounting for the purchase of life insurance. Prior to the issuance of the FSP, this created a loss upon acquisition of the policy, because the cash surrender value of life insurance policies is lower than the price for which such policies are purchased in the secondary market. The FSP addresses both initial and subsequent measurement issues. The rule allows entities to elect to measure their investments in life insurance contracts either under an investment method or at fair value. The investment method uses the price paid for the policy plus the amount of premium paid to keep the policy in force to determine the policy’s total value as an asset, while the fair value approach involves an estimate of the market value of the policy. The FSP also includes specific disclosure requirements relating to each valuation method.⁷

A current trend in the life settlement market is prompting additional regulatory scrutiny. This is the leveraged purchase of life insurance policies initiated by investors, which commonly involves two years of premium financing. After the two year period, the insured may enter into a life settlement with respect to the insurance policy. Currently, the legality of investor-initiated, leveraged life settlement products is being questioned by some regulators and industry members. The objections relate to insurable interest laws, maintaining that the third-party lenders that are assigned rights in the insurance policy to secure their loans do not have an insurable interest in the life of the insured, and therefore the life insurance policy should be void. In addition to insurable interest concerns, other potential objections include anti-rebate laws, premium finance restrictions, usury laws, and other consumer protection statutes.

The New York Department of Insurance has issued a General Counsel Opinion concluding that arrangements intended to facilitate the procurement of life insurance policies for resale are not permissible under New York law because they involve the procurement of insurance solely as a speculative investment for the ultimate benefit of a disinterested third party, in violation of New York’s insurable interest statutes.⁸ The General Counsel noted that such arrangements may violate New York’s prohibition against premium rebates, because in the event of a subsequent life settlement of the underlying policy, the insured essentially receives free insurance for two years as an inducement to enter into the transaction.⁹

Industry members have also publicly questioned the legality of certain types of leveraged life settlement products.¹⁰ Some of these objections relate to products that involve one or more of the following features: (i) the lender, directly or indirectly, pays the insured or policy owner any amount at time of issuance of the policy, to purchase the insured’s unused insurance capacity; (ii) the lender or any other party takes ownership at policy inception of any portion of the death benefit in excess of the indebtedness; (iii) the lender or any other party cloaks or otherwise hides its ownership interest at the time of inception of the life insurance policy; or (iv) the policy owner pays the lender at the maturity of the loan more than the principal and interest, in order to keep the policy. Other objections relate to products that include: (i) a requirement that a policy must be sold in the secondary market to satisfy repayment of the loan; or (ii) a requirement that the policy owner share any profit with the lender or related party, from the sale of a policy in the secondary market. At least one industry member has publicly announced concern regarding these products, indicating that it will not be involved in such purchases.¹¹

Industry members concerned with the appropriate use of life insurance products have created an industry task force to examine investor-owned life insurance practices.¹² The task force, which includes members from the National Association of Insurance and Financial Advisors (NAIFA), the Association for Advanced Life Underwriting (AALU), and the American Council of Life Insurers (ACLI), is lobbying against the expansion of state insurable interest laws to facilitate investor-owned life insurance.