Life Settlements
Is a Stranger-Owned Life Insurance a Red Herring?
by Doug Head
In June, the National Association of Insurance Commissioners (NAIC) issued a poorly considered series of amendments to its Life Settlements Model Act. The amendments seem less about addressing stranger originated life insurance (STOLI) and more about rolling back consumer rights. Instead of limiting abuses, NAIC actions bring a renewed hostility toward life insurance consumers.
To be sure, STOLI abuse is cause for concern. But, these abuses should be dealt with through targeted, well-crafted regulation, not through an overarching rollback of consumer rights.
The question of what to do about STOLI has sparked a robust debate. Numerous groups representing consumers, life settlement providers, carriers, legislators, and others have ideas about how to curb abuses. The debate should lead to thoughtful and balanced regulation. But, it has apparently fallen on deaf ears with one key regulatory body.
Behind the NAIC Proposal
The Model Act amendments were added supposedly to protect consumers and stop stranger originated life insurance (STOLI). But, the amendments donÕt close the loopholes that allow the purest forms of STOLI to persist. A host of unrelated amendments fails to address these transactions altogether. The NAIC action seeks to limit all transactions when the policy is used as security for a loan.
The key element of NAIC's plan is a five-year ban on the sale of a policy from the date of inception. The ban includes a convoluted list of prohibitions. The most revealing is the explicit prohibition on the sale of a policy if the policy or the insured has ever been evaluated for a settlement or if the policy owner uses the policy's market value to collateralize a premium finance loan. The amendments punish consumers just for asking about the value of their policy. They also discriminate against any policyowner who exercises a legitimate right to use a policy as collateral for a loan.
The NAIC slipped several additional provisions into the Model with no notice, explanation, or public discussion. These provisions include an unprecedented financial responsibility requirements and an extended rescission period of 60 days. Consumers who are facing hard financial times would be forced to accept their policy's cash-surrender value even when it is worth far more.
So, instead of targeting specific STOLI concerns, the NAIC model amendments attack the very basis of the secondary market for life insurance.
Most ominously, the amendments might criminalize the activities of any agent who helps settle a policy under these conditions. This is a raw form of intimidation.
According to the NAIC amendments, a policy's cash surrender value is the only measure of worth in the first five years of the policy. This radical approach favors the life insurers' monopolistic take-it-or-leave-it pricing practices and diminishes the market value of life insurance policies. These policies, which are rooted in the property rights granted to policyowners, have delivered billions of dollars over cash value to consumers through life settlements. This proposal would deeply damage consumers, considering that almost half of all policies lapse or are surrendered within the first five years from the date of issuance.
A Dark Agenda
Interestingly, two life insurance trade groups rushed to congratulate these measures, despite opposing them previously. The National Association of Insurance and Financial Advisors (NAIFA) applauded NAIC's "tightly drafted limitations [which] protect the value of insurance policies for legitimate insurance purchasers." Yet, only three months earlier, NAIFA issued a letter criticizing NAIC's proposed language as "vague" and "unnecessarily broad," and stated that it would have "a harmful impact on legitimate life insurance arrangements and life settlements."
Readers should wonder about this shift in position. Are the NAIC amendments tightly drafted or are they vague and unnecessarily broad Do they protect insurance purchasers or do they have a harmful impact?
The American Council of Life Insurers (ACLI) also changed its position. Early on, ACLI pledged, "The legislation pursued by ACLI will not affect life settlements entered into more than two years after policy issuance." This promise has been replaced by ACLIÕs active support of a five-year ban.
What would cause ACLI to embrace such anti-consumer regulation? According to its Website, "ACLI supports the right of legitimate policy owners to sell their policies in the secondary market when they decide they no longer need or want coverage."
However, ACLI also states that STOLI arrangements "violate the letter and spirit of insurable interest law, which is designed to ensure that a person buying a life insurance policy has an economic interest in the continued life, not death, of the insured." For all the rhetoric about insurable interest, ACLI and NAIFA have long supported the concept purchasing policies on individual lives for investment purposes.
Many businesses, including ACLI members, use corporate owned life insurance (COLI) to fund employee benefits. Under the typical COLI arrangement, the business acts as investor by initiating policies on employees with the full intent of keeping the policies in force after the employee leaves the company. The company continues to pay the premiums on the former employees' policies and pools the collected death benefits to fund ongoing operations.
It is telling that ACLI and NAIFA don't object to the fact that the company's insurable interest dissolves when the employee leaves the company or that these policies are initiated as investments to fund corporate operations instead of providing financial security for the insured.
ACLI readily acknowledges that the more than $500 billion in company owned life insurance does not benefit families or the insured's loved ones. ACLI's COLI "FAQ" sheet dated Jan. 17, 2003 reads, "Do employees' beneficiaries get death benefit protection from COLI policies?" "Usually not. COLI is not a direct employee benefit"
Throughout the STOLI debate, ACLI and NAIFA railed against "schemes that threaten the special tax treatment for life insurance that protects widows and orphans from the death of a breadwinner" (NAIFA Frontline, May 1, 2005).
So what are ACLI's objections to STOLI? Its complaints clearly arise from the existence of a secondary market in which consumers, not insurers, are in the driver's seat. As recently as 2006, ACLI has made public statements supporting Òlegitimate life settlements." But, ACLI president, Frank Keating has been quoted as supporting "settlement agreement only to policyholders with terminal illnesses who were in need of funds for medical expenses."
Most revealing are recent comments by ACLI officials during STOLI hearings. Under the pretence of fighting STOLI, the ACLI is pushing for an extension or total revocation of the contestability period when carriers can rescind a policy for fraud. Incontestability statutes are found in every state's insurance code. They were established more than 100 years ago to remedy some of the most egregious consumer abuses in the industry's history.
This systematic attack on consumer rights and protections is a serious challenge to the entire insurance industry. It threatens a return to the dark ages when consumers were at the mercy of a protectionist industry that put itself above the law and saw consumers as pawns.
The Bottom Line
What does it all mean for advisors? For starters, the NAIC action does not change the way advisors do business. The amendments are only suggestions. Considering their dubious formation, these proposals are not likely to be enacted in many states when policy makers weigh in. Meanwhile, the insurance industry's more reasonable parties are continuing to debate and to implement more effective remedies for STOLI. The secondary market continues to create value for consumers, which is something that advisors and the industry as a whole should embrace.
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Doug Head is the executive director of the Life Insurance Settlement Association. Doug has been involved in the Settlement Industry since 1992 and has been Executive Director of LISA since 2001. During this time, LISA Membership has grown one thousand percent, reflecting the growth in the industry. He can be reached at 407-894-3797.
