Life Settlements
Life Settlement Forecast 2008: Growth, But No Major Changes in California
by M. Bryan Freeman

Our industry continues to thrive as more consumers learn about viaticals and life settlements. This is especially true in the Golden State where educated consumers and the state’s more sophisticated advisors have been early adopters. In 2008, these consumers will increasingly call on insurance and financial professionals, accountants, attorneys, and others to inform them about the settlement process and guide them through it.

A life settlement is the sale to a third party of an existing life insurance policy for more than its cash surrender value, but less than its net death benefit. Such transactions are usually undertaken (based on the insured’s shortened life expectancy) for the purposes of estate-planning or financial planning. The option also is available to some people who are terminally ill. Such cases are called viatical settlements under California’s viatical settlement law. You’ll see just a bit later why I am intent on proliferating settlement definitions.

Consumer Demographics

It may be stating the obvious, but it is so important that reiteration cannot hurt: As never before, simple demographics will drive the settlement industry in 2008. Baby Boomers are retiring or beginning to plan seriously, which is having a significant impact on the settlement industry. Soon we’ll see the first Baby Boomers qualify for a true life settlement – settlement transacted by seniors based on older-age mortality and not terminal illness. In the meantime, these well-informed Baby Boomers are advising their parents at least informally. Many of the parents will want or need to access life policy funds through a settlement whether it’s based on age, illness, or some of both.

Also, consumers of any age should know about life settlements when they are considering a life policy purchase, particularly those within sight of retirement – 50 or 55, for instance, and certainly still in that Boomer window. Just knowing about life settlements helps them understand the true value of life insurance. They know that their investment in it is not locked in until their passing. It is the producer’s role to help these middle-aged folks understand that life settlements enable them to rethink this important asset or redirect it as needed. Likewise, understanding the added value of life insurance through settlements may help them feel more comfortable about purchasing a policy. That’s good business for you and your client.
All told, the potential for Baby Boomer settlement business is significant. As the first Baby Boomers nudge toward their retirement years, an estimated $100 billion in life insurance policies will qualify for settlements. Five times as much coverage as that ($500 billion) is thought to be held by those 65 and older.

Will the purchasing market support the vastly increasing settlement purchases of Baby Boomers and their parents? It is very likely, given that life settlements are an increasingly attractive choice for institutional investors, especially as they consider the weaker prospects of traditional financial markets, such as mortgages, whose weakness is expected to continue in 2008 and beyond. This means that significant funds are available to purchase the life policies of Baby Boomers and their parents.

ILITs and Settlements

The existence of irrevocable life insurance trusts (ILITs) is another reason your clients need to know about life settlements, especially Baby Boomers. Your settlement work is influenced by the hundreds of thousands of ILITs in the United States. If an ILIT contains an under-performing policy, having the trustee ask the grantor for more premiums is not the only option. Instead, a settlement can be conducted and the proceeds can be used to purchase a more appropriate, better-performing, and newer model policy.

Your clients may not know that life insurance evolves and that the policy they purchased 20 or 25 years ago has become outmoded. Even some policies purchased in the past 10 years have become outmoded, costly, and not on track to perform well into the future. More policies held in ILITs are being settled than ever before. I think this trend will continue to grow in 2008 as more and more trust officers and other fiduciaries begin to understand that newer and better policies are available for their clients.

Regulation Holds Steady

It’s unlikely that we will see a change in California law addressing life settlements or viatical settlements in 2008. Now that the National Association of Insurance Commissioners (NAIC) and the National Conference of Insurance Legislators (NCOIL) have wrapped up their settlement model acts, California has two competing models that it may review in forming legislation. As you may know, these model acts are intended to serve as legislative and regulatory templates that states may adopt. They provide legislative guidance on various topics.

Since California has a viatical settlement law and regulations, it is not likely to adopt a new model impulsively. This is particularly true of the revamped NAIC Model Act, which sparked controversy throughout the insurance and settlement industries and statehouses across the country. Many have said that it was adopted in an incomplete and possibly tainted process.

California regulators have forestalled a decision on regulating the life settlement market for the non-illness-related life insurance settlements. The state is likely to continue putting off a decision in 2008. Even so, it’s important to keep an eye out because, if it happens, it will change the licensing program for handling life settlement policies for all Californians. It would likely impose other duties, disclosures, and responsibilities on all parties as well.

More Than a Name

In 2008, I hope to see the end of a trend of life agents using life settlements for what should be treated as viatical settlements. The fundamental difference is that life settlements are undertaken by seniors who do not have a terminal illness and are selling a life policy for estate planning or financial planning purposes.

In contrast, viatical settlements are undertaken on people of any age who face a life-threatening condition and have a life expectancy of 24 months or less. California law is clear on this point. The broker has a fiduciary duty to act in the client’s best interest under California viatical law and under common law. That best interest probably includes discussing the viatical classification option even if the unlicensed broker cannot participate in the transaction and receive a commission.

This matters because of the legality of licensing; California differentiates between life settlements and viatical settlements. The two transactions, their fundamental aspects, and their names are not interchangeable. Also, the benefit to consumers is vastly different. A consumer who qualifies for a viatical settlement under California law would miss federal and state tax-free treatment if their broker treated it as a life settlement. In some cases, that tax amount is close to 50% of the settlement amount. California is one of only a few states that treat the proceeds of a viatical settlement as tax-free under their state law. It is very likely that, when underwritten as a viatical, the seller would receive a higher settlement payout than if it was underwritten as a life settlement.
So why have some viatical settlements been processed as life settlements? Probably because the entities involved can broker or purchase a life settlement, but are not licensed to handle viatical settlements in California. This is not a good reason to proceed with the case as a life settlement when it is a viatical settlement under the law. Doing so is a clear violation of the law for all parties involved.

Consumers lose when a viatical is processed as a life settlement because they miss out on the higher settlement amount and the tax-free treatment. As unlicensed middlemen, brokers and providers can lose too including receiving a cease-and-desist order. This misdeed is a misdemeanor under California law, but I have heard that it may be upgraded to a felony in the future. However, that’s not a change that’s expected this year.

No matter how this misclassification of settlement is treated under the law, it still opens agents and brokers to charges of breach of fiduciary duty once the client discovers their case was mishandled and they could have received a higher settlement and legally avoided taxes on said settlement. The provider may also be penalized under the law for unauthorized and illegal purchases in California.

The word is getting out about the differences, with an increasing number of agents and settlement firms gaining a better understanding of the viatical settlement/life settlement dichotomy. California regulators are aware of the viatical misdeeds in specific settlements and they are keeping their eyes and ears open for these violations of trust and of law. We should see more settlements identified and processed correctly in 2008. It never makes sense to me why a successful broker would put their whole business at stake to transact one case or even a few cases incorrectly. An increasing number of settlement educational options are out there. This relatively young industry is now old enough so that courses are now available to help the players better understand the nuances and legalities of settlements.

What Lies Ahead

The viatical and life settlement forecast for California for 2008 is bright – robust, even. The settlement industry in California is reaching young maturity and has a long life ahead.
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M. Bryan Freeman, a licensed insurance agent for 29 years, is founder and president of Habersham Funding LLC, an Atlanta-based life settlement provider that does business nationally. He completed four terms as president of the Life Insurance Settlement Association, and now leads LISA’s government relations efforts. He can be reached at 888-874-2402 or bfreeman@habershamfunding.com.