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Unsettling business

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Unsettling business

Among the insurance industry trends that seem likely in 2007, two appear to be inevitably linked: continued growth in the life insurance settlement business and continued efforts by life insurance companies and regulators to rein in certain aspects of that activity.

The secondary market for life policies has grown into a multibillion-dollar business, with investors ranging from financial institutions to wealthy individuals purchasing policies from their original buyers.

For policyholders, that secondary market presents an opportunity to realize value from a policy that might no longer meet their needs as personal circumstances have changed, or even a way to recoup their expense in a policy they may have determined was never appropriate for their needs.

It also can provide a way to gain needed cash, including money for medical expenses.

However, for life insurers that rely on a huge percentage of policies lapsing each year—eliminating their exposure to claims on those policies, the notion that a greater number of claims will ultimately be made on those policies by investors who've purchased them and held them to maturity is potentially worrisome.

Even more troublesome for insurers is a rising trend toward policy settlement activity initiated by investors, who in some cases solicit seniors to purchase policies, finance the premium payments, and then purchase the policies from them.

In response to that latter trend, at its December meeting in San Antonio, the National Assn. of Insurance Commissioners, at the urging of the life insurance industry, moved to take steps to prohibit such stranger-originated life insurance or "STOLI" schemes.

Much hoo-ha about something

At the meeting, a subgroup of the NAIC recommended a change to its Viatical Settlements Model Act, proposing adoption of a five-year ban on selling policies financed with the specific intent that they be sold to investors.

To Doug Head, executive director of the Orlando, Fla.-based Life Insurance Settlement Assn., the debate over restricting life settlements is "much hoo-ha."

"People have begun to recognize that their insurance policies have value as property," Mr. Head said. "With that recognition comes shifting perspective."

"That's the miracle of the American economic system," he said. "It allows for change as understanding improves."

"If you look at the statistics, it will be very obvious why the life settlements industry is expanding," said Leonard H. Goodman, chairman and chief executive officer of New York-based First Equity Benefits of America Inc., a life settlements company that started business late last year.

"The insurance industry is not particularly thrilled by the concept for obvious reasons. But I'm of the opinion the life settlements industry will enhance and encourage life insurance sales," Mr. Goodman said. "As a buyer you think, 'Now I've got the option. I can buy it and use it for what I've bought it for and then have some place to sell it."'

"First Equity was conceived in my head about three years ago as a life settlements company to provide a viable and equitable secondary market" for both individuals and companies who might have purchased policies on key employees looking to sell their life policies, Mr. Goodman said. "It was very apparent to me through my own experience that most if not all of those people would gain a much greater cash value from disposing of their policies in a secondary market than by simply walking away from them."

Suggesting that a vast majority of the life policies bought from insurers each year "are never submitted for a claim," Mr. Goodman said, "Those policies are simply taken back into inventory by the insurance company."

"People are terminating them by the millions and not receiving fair value," he said. "Our process is not to solicit the termination of policies or to encourage it for that matter. It's simply to provide the option once that decision has been made."

To that end, First Equity Benefits doesn't deal directly with the consumer, but rather life agents, attorneys, financial planners or other advisers working with the consumer, the company's chairman and CEO said.

The current life settlements industry has its roots in the viatical settlements industry that gained momentum in the early 1990s. According to one life insurance industry representative, there is a legitimate place for "legitimate" transactions.

"There is a general appreciation that life settlements and viatical settlements are transactions that have existed for more than 20 years," said Michael Lovendusky, associate general counsel of the American Council of Life Insurers in Washington. "They do give value to the life policy. We have no beef with those secondary markets."

The concern of ACLI member companies, Mr. Lovendusky said, is limited to STOLI.

For about 18 months, there has been concern among life companies and insurance regulators "about the phenomenon of stranger-originated life insurance growing at a rate that is perceived as threatening to the fundamental franchise of the life insurance industry," Mr. Lovendusky said.

Mr. Lovendusky said industry groups representing the life insurance industry's interests will be advocating that state legislatures adopt the changes the NAIC proposed in December.

Additional pre-emptive measures

Meanwhile, the industry remains concerned that "perpetrators of STOLI are reacting to the likelihood of regulation and morphing their transactions to avoid regulation," he said. Consequently, ACLI is working to identify other regulatory and legislative changes that might be required to rein in further STOLI activity.

"One of the important things is that we do whole-heartedly believe that the NAIC's model acts do go a long distance to meeting many of the industry's concerns with STOLI," Mr. Lovendusky said. And he said he's optimistic that state legislatures will act to embrace those proposed changes.

First Equity's Mr. Goodman says that from his company's perspective, the STOLI transactions "are distinctly different from life settlements." When First Equity receives a request from a broker involving a transaction the company can tell is a STOLI concept, First Equity takes a pass, he said.

Citing a hypothetical example of a brokerage firm soliciting elderly individuals to purchase life policies and funding their premiums for two years before purchasing the policy from the original buyer, Mr. Goodman said, "PersonallyÖthat offends me. It violates the basic principles of life insurance."

But, he said, the life insurance industry has done very little to date to stop that. Life companies could ask, "'Is this intended to be a life settlement in two years,' and if it is, don't underwrite it," Mr. Goodman said. "But they don't do that because they know if they don't write it, somebody else will."

He also said his company very much supports a regulated life settlements industry.

"We are very pro-regulations," Mr. Goodman said. "We picked New York for that reason. We figured that if we are in compliance with all the regulatory requirements that Mr. (Gov. Eliot) Spitzer puts forth, we will be in compliance with every state."

On the STOLI issue, LISA's Mr. Head said his organization agrees with life insurers and the NAIC "in the conceptual idea that stranger-initiated life insurance is a problem" if it's defined narrowly.

"If you're talking about a situation in which an investor approaches a senior and says, 'I'll give you $50,000 to take out a life policy and immediately transfer ownership of it to me,' that's wrong," Mr. Head said. "And I've seen (such) letters distributed at my dad's coffee club."

'Wrong, wrong, wrong' route

But regulators shouldn't try to get at the problems by attacking the property rights of people who did buy their insurance policies legitimately, Mr. Head cautioned. "That's a direct attack on life insurance consumers in my view, and the fact that the NAIC is going down that route is just wrong, wrong, wrong."

He added that he thinks it's a mistake to deny someone their property rights to their policy if they used premium financing to help purchase the policy.

"Every week or so around here, we hear a story about somebody who was really pushed into buying a policyÖand two years later it is not meeting their needs at all and they want to sell it," Mr. Head said.

Clearly the property rights argument will be at the heart of any efforts to oppose new regulations. "I would hate to be a legislator who sponsored—in a state with conscious consumers—a bill which took the rights of consumers to their insurance policy away from them," Mr. Head said.

But the ACLI's Mr. Lovendusky takes issue with Mr. Head's suggestion that the NAIC's proposed changes would block legitimate life settlement transactions.

"We'd like to have them explain it to us. They were unable to explain it to the commissioners at their meeting in San Antonio and we do not understand what their belief is," the ACLI counsel said.

He also takes issue with the ownership rights issue.

"It's a nonsensical argument because the insurance industry doesn't disagree that there is a property right to an insurance policy," Mr. Lovendusky said.

There is, however, no property right to policies obtained through fraud or in which there is no legitimate insurable interest, he said. There is "no property right in an illegitimate policy acquired through a STOLI transaction."