Because I'm always interested in the life insurance industry and optimistic that we might see some radical change there, I check in regularly with Glenn Daily, a fee-only insurance consultant in New York. Daily is like a divining rod. He always knows what's going on, whether it's about industry shenanigans or a new consumer-friendly loophole. At the end of October, I wasn't expecting much good news, what with the banking crisis, the bailout of AIG by the government and the suggestions by the feds that more insurance companies would probably need help. Yet I found some nonetheless. Two pieces actually.
First, Daily has put together a policy model to evaluate no-lapse universal life policies to determine precisely how much the policyholder must pay to keep the policy in force. Paying more than that minimum amount means a policyholder is handing over a large amount of the premium to the insurance company and getting nothing in exchange. Indeed, if a policyholder dumps in a large premium, he may believe that he is putting the excess into the policy while he is, in fact, handing it over to the insurer. That could be considered malpractice on the part of his advisor, Daily says.
The second thing I learned is that Daily is working with a small group of people, including John Skar, former chief actuary of Mass Mutual, and Larry E. Fondren, head of Legacy Funding Group in Malvern, Pa., to create a loan program that could drastically change the life settlement market, making it much more efficient and more attractive to policyholders, to insurance companies and to investors. I'm going to write about the loan program now and leave a discussion of his universal policy model for another day.
The life settlement market, or the secondary marketplace for "elder" policyholders to sell life insurance policies they no longer want, has sharply divided the life insurance industry. One group says that reselling policies to investors who have no "insurable interest" in the insured is akin to trafficking in human lives. They warn that it will wreak havoc on the industry and ruin insurance companies. To some extent they have been proved right, as investors have been hiring people to take an insurance medical exam, get a policy and then sell it to them, among other things. The other group welcomes the new marketplace, arguing that it gives the elderly-and their advisors-one more financial asset to tap into in retirement.
"Viatical settlements" (viaticum is a Latin word that refers to the Eucharist administered when a person is near or in danger of death) were first used in 1989, when a company in Albuquerque, N.M., called Living Benefits Inc., announced that it had raised $102 million and that it would use the money to pay cash for life policies on the lives of terminally ill insureds.
Viatical settlements stirred controversy from the get-go. Some praised the new freedom they offered to help the terminally ill raise money to pay for medical care that might help them be more comfortable at the end of life. Some worried that an insured person who was desperately ill might cash in a policy even though the policy terms were unfavorable to him and leave his family high and dry after he died.
Still others, like Joseph M. Belth, editor of the newsletter Insurance Forum and a professor emeritus of insurance at Indiana University, found the whole idea repulsive. Belth wrote in the March 1989 issue of his newsletter that Living Benefits, the first company to offer the settlements, operated a system for the exploitation of the terminally ill.
Nonetheless, over the years, the market grew and developed to include healthy and affluent elderly people-usually over the age of 65-who might not need life insurance anymore because of a change in their circumstances or their estate plan needs. The idea is that investors in the secondary market pay the insured something more than the policy's cash value but less than the death benefit. The policyholder must pay tax. Then the policies are packaged and sold, as are mortgages in the mortgage market.
Fondren has a background in insurance and has had experience setting up Internet exchanges such as a service allowing life insurance companies to trade bonds among themselves, cutting the cost of commissions. He says he became interested in the life settlement market about three years ago when he attended an meeting of actuaries who complained about the problems they'd had with the whole secondary market.
The marketplace was littered with policies issued in fraudulent circumstances. The actuaries Fondren met worried that the tax-advantaged status of life insurance might be challenged by the government unless fraudulent practices were cleaned up. That's when he saw the light bulb. His idea was to make the deal between policyholder and investor transparent, thus making the marketplace more efficient. To do this, he proposed removing the entire middle piece of the settlement market and creating a mechanism to turn the cash out into a loan rather than a sale. With a sale, "you've got a strange situation because you have someone out there who would like you dead sooner rather than later," he says.
Working with a regional or community bank, Legacy offers a policyholder a loan and promises to pay off the premiums for the life of the policy. The bank collects at the death of the policyholder. Ten percent of the initial face value of the policy is always available to heirs. To cover the risk that the policyholder might live longer than expected, another policy called a "deferred benefit legacy," is created. This policy is designed to do the opposite of the traditional policy. The bank pays a level premium every year and the policy's death benefit increases every year so the deferred-benefit legacy policy can take over from the traditional policy once a policyholder begins to outlive his asset base.
Fondren offers as an example a 76-year-old lawyer who has a $5 million policy and wants to sell it because he doesn't want to pay premiums anymore. Rather than selling it, this lawyer could take a bank loan under the Legacy framework. The bank continues to pay all premiums. The bank will also pay premiums on the deferred benefit legacy policy and keep track of all accounting.
The bank then packages and sells the policies as securities to investors. If this sounds like the securitization that brought the economy to near collapse, it is. The difference is that there is almost no chance of default, Fondren says, because the loan is designed to wrap around those two policies. "The investor doesn't have longevity risk because there is no default risk." The only default possibility is that the life insurance company doesn't pay the death benefit when it's due, he says. "We've eliminated the flaws in the securitization process. There is continuity from cradle to grave."
Fondren worked on the product with John Skar, a former chief actuary at Mass Mutual. Skar had been distressed by how the life settlement market was disrupting the insurance marketplace and bringing in new and dubious players, Fondren said. Now Skar has retired from Mass Mutual and come on board as chief actuary at Legacy Loans. Daily too is part of the group.
Daily, who believes consumers should examine all options available to them, began advising clients on how to evaluate a life settlement buyout deal on his Web site, www.whatsmypolicyworth.com, in May 2006. So he had done all the evaluation work on policies. While he was working on his Web site, Daily met Skar and went to Springfield, Mass., to visit and do research with him. So everybody knew everybody. When a policy comes in to Legacy, it goes to Skar in Springfield and then to Daily to evaluate. Using the policy model he designed, Daily has trained a group of people to evaluate the policies once the project is rolled out.
In an October 2008 report on the life settlement market, Conning & Co., the Hartford, Conn.-based insurance research and consulting firm, reported that the life settlement market posted strong growth in 2007 and should continue to do so through 2010. But, the report said, new products such as the extra-contractual loans issued by Legacy Loans may put a crimp in market growth. Fondren says that when the report came out, Legacy got calls from insurance companies wanting more details about the program.
Fondren points out that, as an investment, the legacy loan is a non-correlated asset. "The longer the insured lives, the better it is for everyone." Legacy is just beginning to roll out the product. "We haven't opened the front door," Fondren says. When he does, he will tell policyholders to go to legacy.com and see if their policy qualifies. Fondren already has 250 policies in house, and because of the turmoil in the markets, he plans to move slowly. But he says that the community and regional banks he plans to do business with have not been caught up in the credit crunch because they are smaller players.
Mary Rowland can be reached at [email protected]. She has been a business and personal finance journalist for 30 years, a half dozen of them as a weekly columnist for the Sunday New York Times. She wrote a column called "Practice Points" for Bloomberg Wealth Manager for six years. She speaks regularly about money and values. Her six books include two written for financial advisors: Best Practices, and In Search of the Perfect Model.