There is no doubt that the
life insurance settlements industry has secured a permanent place
for itself in the US life market. However, reports by the
Government Accountability Office and the Securities and Exchange
Commission have highlighted many serious inconsistencies in its
regulation.
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Even the life settlements
industry’s strongest detractors in insurance circles have little
choice but to acknowledge that it is here to stay. Almost as
certain is that regulation governing the industry is set for change
following release of the US Government Accountability Office’s
(GAO) report on life settlements to Congress’ Special Committee on
Ageing.
Adding weight to
the potential for change was the almost simultaneous release of a
report on life settlements by the US Securities and Exchange
Commission’s (SEC) Life Settlements task force established in
August 2009.
For its report, the GAO surveyed 49
life settlement providers licensed in two or more states. The GAO
came to the conclusion that while life settlements hold definite
benefits for policyholders as an alternative to surrendering them
to the writer, they also pose significant regulatory
challenges.
That there is a regulatory
challenge leaves little to the imagination. In its study, the GAO
correctly summarised the life settlements industry as being
“largely an informal network of intermediaries facilitating the
sale of life insurance policies by owners to third-party
investors.”
Indeed it is so informal that there
is no certainty as to its scale in the US. While the GAO report
highlighted that no comprehensive data exists, it noted that
estimates indicate it grew rapidly from its inception around 1998
until the recent financial crisis.
Estimates of the total face value
of policies settled in 2008 ranged from $9bn to almost $13bn while
in 2009 the financial crisis took its toll with the estimated
amount significantly lower at $7bn. Notably in 2007, consultancy
Conning estimated that the market at $12bn in face amount of life
insurance settled, and forecast that it would grow to between $90bn
and $140bn in face amount settled by 2016.
However, industry commentators
cited by US media are now mixed about growth prospects after
Goldman Sachs’ exit from the market in early 2010 and Deutsche
Bank’s earlier downsizing of its life settlement operations.
The financial crisis has also left
casualties in the life settlements market, among the most recent of
these being QOC, an owner of previously issued life policies. QOC
filed for Chapter 11 bankruptcy in September 2010, according to US
media reports.
According to filings with the SEC,
QOC I has assets of $100m and debt of $500m. In its filing, QOC
stated that since 2009 it has operated in an extremely unfavourable
global business environment, which included a lack of liquidity in
the credit markets and falling asset values. QOC owes US bank Wells
Fargo some $120m under a loan agreement that is secured by
policies.
Patchwork
regulation
Vagueness surrounding the life
settlements market’s size has a parallel in a rather patchy
regulatory approach. According to the GAO, as of February 2010, 38
states (now 40) had insurance laws specifically to regulate life
settlements. 12 states and the District of Columbia had no laws
specifically governing life settlements, while disclosure
requirements among those that do can differ.
The GAO noted that states that
regulate life settlements do so to protect policy owners by
imposing licensing, disclosure and other requirements on brokers
and providers. In addition, the SEC, where its jurisdiction
permits, and state securities regulators control investments in
life settlements to protect investors. One type of policy, variable
life, is considered a security, thus settlements involving these
policies are under SEC jurisdiction.
The SEC also asserts jurisdiction
over certain investments in life settlements involving
non-variable, or traditional, life insurance policies, but, noted
the GAO, their status as securities is unclear because of
conflicting court decisions.
SEC’s view
Providing
background to the US life settlements market, the SEC explained
that while life settlement transactions can be structured in
various ways, they typically involve an insured individual or the
owner of the policy, a producer who may be a financial advisor or
an insurance agent, one or more settlement brokers who may also be
insurance agents, one or more life expectancy underwriters, one or
more providers who typically represent the party acquiring the
policy, and one or more investors.
When multiple settlement brokers,
providers or investors are consulted, it is generally to obtain and
compare multiple offers for the same life insurance policy. The SEC
noted that according to its research, the majority of investors are
large institutional investors looking to acquire pools of
policies.
In the opening section of its
report, the SEC focused on negative aspects of the life settlements
industry, noting that it had brought a number of enforcement
actions alleging fraud in connection with life settlement
investments. The SEC said these enforcement actions have typically
involved misrepresentations to investors about the profitability
and safety of the underlying life insurance policies, including the
life expectancies of the insured persons, and Ponzi schemes whereby
investor funds have been used to pay promised investment returns or
have been simply misappropriated. The schemes in these cases ranged
from tens ofms of dollars to at least one billion dollars.
Based on its evaluation of the life
settlements industry, the SEC task force made five
recommendations:
Life insurance industry body the
American Association of Life Insurers gave the SEC task force’s
report its full backing.
“As the SEC task force report
shows, there is a lack of transparency in life settlements and
uncertainty over regulation of a market that has been awash in
litigation,” said ACLI president and CEO Frank Keating in a
statement.
“ACLI hopes that the report will
add new momentum to efforts in the states and in Congress to
protect investors, as well as senior citizens.
Keating continued: “The report
addresses many of ACLI’s concerns with this market. The task
force’s analysis is bolstered in many areas by a separate report
issued today by the Government Accountability Office.”
Far from standing up in opposition
to a better regulatory structure for the life settlements industry,
the industry’s major body, the Life Insurance Settlement
Association (LISA), applauded the GAO’s report.
LISA executive director Doug Head
said: “The GAO and SEC reports document that life settlements are
here to stay, that they provide tremendous value to consumers and
that the rapid development of state regulation of the market, while
not always uniform, has provided strong consumer protection in life
settlement transactions.
“More Americans should learn that
before they surrender their policy back to the insurance company
that they can sell it in a well-regulated market and receive an
average of 700% more than the cash surrender value.”
Welcomed by industry
body
The industry body stressed that it
and its members have been champions of state regulation of life
settlements and “are proud” that the laws on the books in 40 states
provide more protections and transparency for consumers than any
other insurance transaction in the US today.
LISA noted that the 40 states that
have life settlement laws represent 86% of American consumers with
legislation currently pending in several other states, most notably
Massachusetts and Michigan. Most of these laws, LISA added, are
based on model life settlement law adopted by the National
Conference of Insurance Legislators in 2007, which ensures strong
consumer protections in life settlement transactions.
While LISA conceded that there are
inconsistencies in state regulation, it emphasised that there are
very few reports of consumer complaints in the life settlement
market.
Specifically, LISA cited the
National Association of Insurance Commissioners (NAIC) which has
reported that since 2007 there have been fewer than 20 reported
complaints involving life settlement transactions from
consumers.
By comparison, the industry body
stresses that the NAIC reported that state regulators had received
some 80,000 consumer complaints involving life insurance and
annuities over the same period.
Where insurers
stand
The SEC
task force also examined the position of life insurers in the life
settlements market, noting in its report that the majority of
states have no requirement that an insurance company disclose to an
insured that there is a life settlement option prior to permitting
the lapse or surrender of a life insurance policy. There are six
exceptions to this: California, Kentucky, Maine, Oregon, Washington
and Wisconsin.
In its report, the task force also
commented that the impact of life settlements on the primary
insurance market has been debated since insured individuals began
selling their policies. The report noted that academic research
suggests there are two principal points of view:
The first view is that a secondary
market for life insurance will enhance liquidity for policy owners,
which may increase the number of individuals purchasing policies
and help the primary market grow by making life insurance more
attractive to buyers in the long term, while increasing consumer
welfare.
The second view is that life
settlements will increase the cost of insurance in the primary
market. Currently, noted the report, insurers may experience
economic gains associated with lapsed policies because insurers
will have received premiums for these policies but will not be
liable for payment of death claims associated with these policies.
These economic gains may be used to subsidise remaining policy
owners. Since life settlements provide policy owners with an
alternative to allowing their policies to lapse, they may cause
lapse rates to decline and reduce the subsidies available to the
remaining policy owners.
On the second point the task force stressed that while life
settlements may impact an insurer’s profitability and financial
condition by leading to declining lapse rates, it had been told by
experts that the extent of this impact is likely to be small.
Industry observers, noted the task force, have predicted that life
settlements will have an insignificant impact on the insurance
industry in the aggregate, given the very small%age of in-force
policies that have been settled.
