Is the Life Settlements Industry Ready to Mature?
by Brian Havey

With the rapid growth in the life settlement industry, you have to wonder whether it will reach critical mass in the near term. Some of the pretenders are starting to fall by the wayside and the unregulated states are ready to provide comprehensive legislation. But maturation is likely to come very slowly with so many competing entities with vested interests to protect.
      Life settlement transactions may seem new to us, but they have been commonplace in Europe since the 18th century. An older Dow Jones video depicted the beginnings of our own securities industry with a gaggle of traders gathered under an elm tree at the foot of Wall Street. Transplant that vision to a similar assembly in an English village. Instead of shares in a company depending on its business prospects, we have the fair market value of an insurance contract varying with fluctuations in the health and physical condition of the insured. Let your imagination roam a little further. What might occur if the wrong person purchased a policy on the life of another? In fact, this is what caused the concept of insurable interest to be created.
      It took another 100 years or so for our Supreme Court to recognize that, as personal property, an insurance contract was eligible to be traded (Grigsby vs. Russell-1911). However, these transactions did not become common in this country until recently.
      Only a few years ago, I suggested a life settlement as an option to a client with a relatively simple problem. It seemed straightforward until my broker/dealer informed me that it forbade these transactions.
I had thought that the life settlement would become commonplace and be a welcome addition to the insurance industry. Shortly thereafter, I discovered that, at best, it was a rather crude, ungainly, and time-consuming transaction widely misunderstood and misinterpreted. Although the industry continues to grow in terms of numbers, the process has changed little.
      It’s expected to become a $150 billion to $200 billion dollar industry, according to Bernstein Research. But there have been some major impediments to these projections – the insurance industry and the lack of education and comprehensive, meaningful regulation.

Education

The agent population, which is wary of anything new unless it is generated internally, has yet to embrace the concept. This is compounded by some employers that will not allow the transactions. The same can be said for other types of financial advisors.
      Unfortunately, the people who could benefit from these transactions know even less about them. Nothing happens without a trusted advisor to suggest the option. Unfortunately, there is a serious liability issue for people who are supposed to act in the best interest of the client. Wouldn’t it be wise for the insurance companies to encourage training in this area? Even though they might not endorse the transactions, shouldn’t the agent be encouraged to identify a local professional resource for referral as they would use an attorney or CPA? After all, most settlement proceeds have been reinvested in new insurance, annuities, or investment products.

The Insurance Companies

Another key obstacle comes from the major insurers. Many went so far as to forbid their agents to participate. The rumors suggest that some agents had their pension participation threatened. Some companies changed their tune when a financial advisor was sued successfully for failing to present the option.
Now, approval may be obtained on a per case basis. Some allow agents to suggest the settlement option to clients as long as they do not participate (earn commissions) in the transaction. While many underlying reasons have been put forward, the real culprit is the lapse-pricing model that most companies have to derive premiums. Less than 2% of term policies ever mature. This is used as an incentive to have the client purchase the more lucrative permanent protection. However, the NAIC points out that most universal contracts lapse as well.       Premiums are priced to reflect these situations. An older policy that remains on the books to maturity is not always a good thing to the issuing company. So, insurers continue to pad their wallets under the guise of protecting the consumer. Many of us in the insurance industry remember when the insurers dragged their heels on 1035 exchanges. Some would change a word within or change the color of their forms on a monthly basis in order to lengthen the process in order to make a few extra dollars on the float. They are using similar tactics as life settlement brokers and providers need in-force illustrations to maturity in order to evaluate policies for sale. It may take forever to get these documents because the companies don’t yet approve of the transactions.

Life Settlement Brokers, Providers, and Agents

The life settlement industry is the final piece of the puzzle. Without regulation, the cowboys can ride into town, rob the bank, and disappear over the horizon. Some unscrupulous practices that caused problems and restrictive regulation in the viatical arena continue to surface. There is more than a little bit of Teflon on some of the players as they stretch the limits of credibility and vie for positioning.
      The number of investor owned life insurance (IOLI) and stranger owned life insurance (STOLI) contracts continues to multiply. They represent a real opportunity for the agent with multiple commissions on older insureds with large amounts of coverage. But, they often they cause real questions that may affect the viability of the transactions.
      Some buyers are major financial institutions with strict compliance rules. Did an insurable interest really exist if a contract was manufactured for eventual sale? Two questions come to mind with many of these contracts becoming part of some mutual funds. Will they be available to trade or will the NASD seek to securitize and thus regulate the transactions? For example, if a policy is purchased with the intent for sale at a profit in the foreseeable future, is it an investment? We are still dealing with the equity indexed annuity dilemma. Someone even told me that some questionable sources of funds have been involved. Imagine what might happen if an insured with a large policy lived well past their projected life expectancy.
      It should be easy to see where this is headed. The industry needs comprehensive regulation. The NAIC and other bodies are positioned to provide guidance now. Effective legislation would define the acceptable reasons for the transactions, regulate the process, license brokers, and providers, and provide commission guidelines. It is also necessary to have the participation of the insurance industry. Who has the most to gain or lose? Who is better qualified and staffed to accomplish the process? They already have underwriters. The evaluation methods are reasonably well defined. Life settlements provide a viable solution if there are real losses generated by their lapse-pricing dilemma.
      Don’t most large insurers have the major portion of their reserves invested in high quality bond portfolios? The current yield is not very exciting. Actuaries tell me that they can predict returns from a diversified life settlement portfolio with 99% accuracy. What would a 3% to 5% increase in yield do to the reserve requirements over time? Lastly, the educational process needs to be improved. The consumer and the agent need to be aware of instances in which a life settlement makes good financial sense.
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Brian Havey of The Havey Connection, a licensed CE provider in California. haveyconnection@gmail.com 866-656-5317.