A life settlement is a financial transaction in which the owner of a life insurance policy enters into a contract to sell an unneeded or unwanted policy to a purchaser for more than the policy’s cash surrender value but less than the death benefit. Viatical settlements (in which the policy owner is terminally ill) and life settlements (in which the policy owner is not terminally ill) have been regulated in many states since the early 1990s. As we have come into the new millennium, however, the pace of states adopting regulation has increased dramatically, with forty-one states now regulating viatical and/or life settlement transactions.
In 2008, which was an active year for life settlement legislation, twelve states saw the passage of new settlement legislation. This year, however, promises to be even more active, with legislation already proposed in sixteen states in just the first six weeks of the 2009 legislative session. In addition to the number of states proposing legislation, what makes the 2009 legislative activity significant is the fact that five unregulated jurisdictions, including Alabama, New Hampshire, Rhode Island, Wyoming, and the District of Columbia, currently have proposed settlement legislation pending. Additionally, several states that regulate only viatical settlements have proposed full regulation, including Massachusetts, New York and Washington, and it is anticipated that the State of California will also enact full settlement legislation in 2009.
There are currently two competing model acts under consideration by the states: (1) the National Association of Insurance Commissioners’ Viatical Settlement Model Act (the “NAIC Act”), as amended in 2007, and (2) the 2007 version of the National Conference of Insurance Legislators Life Insurance Model Act (the “NCOIL Act”). However, if history is any guide, most states will adopt a hodgepodge, grab-bag of provisions from both model acts, as well as adding their own unique provisions.
The passage of so much new settlement legislation will have a significant impact on the industry as many life settlement brokers and providers continue to rely on the existence of unregulated states in order to avoid the time and expense of obtaining licenses. As of January 1, 2009, there were still thirty-two jurisdictions in which unlicensed entities could engage in life settlement transactions (a combination of unregulated. viatical-only and the existence of loopholes in certain states’ settlement acts). However, with legislation proposed in many unregulated or viatical-only regulated states, brokers and provides transacting business may become subject to full licensure, and all of the requirements concomitant thereto, in order to engage in life settlement transactions. While the requirements that brokers and providers must satisfy will not be uniform from state-to-state, some typical requirements are: (1) fingerprinting and background checks; (2) mandatory department of insurance contract approval; (3) annual reporting; (4) restrictions on disclosing financial or medical information; (5) payment through escrow accounts; (6) mandatory rescission periods; (7) extensive disclosures to the policy owner and insured; (8) minimum payment requirements for terminally ill individuals; (9) restrictions on advertising; and (10) civil and criminal penalties for violations of the law.
Another issue getting top billing in the 2009 legislative session is so-called stranger-originated life insurance transactions or STOLI. STOLI transactions typically involve a promoter who identifies a high net worth elderly person and lends them the funds to pay premiums on a large face policy for two years. At the end of the two years, the policy owner can either pay off the loan (which is often unfeasible due to high origination and interest fees) or “surrender” the policy to the lender in full satisfaction of the loan. There is concern, both among the life insurance and life settlement industries, that these schemes violate the requirement that insurable interest must exist at the time a life insurance policy is issued because the policy was initiated at the behest of and for the benefit of an investor with no insurable interest in the insured life.
The NAIC Act and the NCOIL Act take differing approaches to the issue of STOLI. The NCOIL Act provides a definition of STOLI and prohibits engaging in schemes to originate STOLI policies. It also provides for civil and potential criminal consequences for violations. The NAIC Act, however, does not specifically define STOLI. Instead, it prohibits all settlements for five years (the so-called “five-year-ban”) from a policy’s issuance, unless certain defined circumstances are satisfied. Criticism of the NAIC Model Act has emerged because the five-year-ban effectively extends the two-year contestability period, potentially curtailing a consumer’s right to sell a valuable asset.
Brokers and providers must take note of the fact that many unregulated or viatical-only regulated states likely will adopt new legislation this year, and they should be prepared to obtain the necessary licenses to continue their business. Most states enacting new legislation include a “grandfather” clause permitting companies engaged in settlement transactions to continue their business, pending approval or disapproval of a license application, so long as such application is submitted within two to three months of the effective date of the legislation. Thus, industry participants doing business in currently unregulated states need to carefully monitor the status of new legislation and be prepared to file license applications as necessary.
Jason Cummings is an Associate in the firm’s Insurance and Reinsurance Practice. Mr. Cummings received his bachelor’s degree from Wake Forest University and his law degree from Mercer University.