Legal Challenges
The
secondary insurance market has also faced significant legal challenges
to "stranger-originated life insurance," where speculators solicit
individuals to acquire life insurance policies for later resale to
investors. These deals, also known as STOLI transactions, usually
target the elderly, who may receive up-front cash payments and some
form of non-recourse premium financing as inducements to take out a
policy. The problem with STOLI is that the speculators originating the
transactions have no interest in the insured individual's continuing
life. Since all states require that a policyholder have this "insurable
interest" in the insured when the policy originates, STOLI transactions
may violate state laws.
Several major insurance companies, meanwhile, have filed suits to rescind alleged "STOLI" policies. They claim that the insured customers committed fraud by misrepresenting (1) their intentions to sell the policy to an investor, (2) the existence of premium financing and (3) their true net worth. Certain companies have gone further and charged the policyholders with conspiracy, claiming that they conspired with insurance agents to carry out a scheme to defraud the insurers. The carriers want to rescind the policies, retain the premiums and collect additional damages and attorney's fees from the named defendants.
As a result, insureds who participated in these arrangements could face significant personal liability. Furthermore, if the carriers win the right to rescind the policies and retain the premiums, the investors and lenders involved in these transactions may also sue the insureds personally in order to cover their losses. Such cases have also hurt sales of premium financed policies in life settlements by making investors wary of such financed policies because of the STOLI association.
What Now?
Despite
these recent events, life settlements are here to stay. Investors
continue to buy policies and are adjusting their policy valuation
models to reflect longer estimated life expectancies and to ensure more
accuracy in policy valuations.
While longer lives may lead to lower policy values for policy sellers, in the long run more accurate valuations should increase investor confidence and bring more funders to the market. The divergence of life settlement performance from that of the turbulent stock market also continues to attract investors. For that reason, even some life insurers are getting in on the action by launching life settlement subsidiaries designed to purchase policies or by offering lending programs that let individuals borrow against the market value of their insurance. A significant growth in life settlement investing, however, will require the fuller development of a derivatives market based on settlements.
Shift In Supply And Demand
The
economic crisis has somewhat shifted the balance in the secondary
market's supply and demand. Before, investors flooded the market,
creating a high demand for policies. Now, more individuals are trying
to sell their policies in order to supplement their dwindling savings
and retirement accounts, but there are fewer buyers in the marketplace.
This increased supply is reducing policy values for consumers. In some
financing cases, policy values have dropped below the outstanding loan
obligations. Buyers with available investment capital, however, may be
at an advantage under the circumstances, as they could be in an ideal
position to buy policies at discounted rates.
Changes in Marketability
The
types and quality of policies sold also has changed. The market for
small face-value policies will likely increase as the economic downturn
and tight credit market force more individuals to find other sources of
cash. In addition, investors are seeking "quality" products and "clean"
paper; this means a higher demand for properly issued policies that are
acquired by policyholders with a valid insurable interest in the
insured individual and that are supported by full and accurate
applications for insurance coverage. Policies that involve third-party
financing, incomplete or inaccurate applications or other questionable
practices will likely be sold at a discount or will otherwise be
unmarketable.
Tough Times For Financing
Unfortunately,
the premium financing market may continue to struggle under current
conditions. The freeze in the credit markets has severely limited the
availability of premium financing. It has also made it extremely
difficult for policy owners to refinance maturing premium finance
loans. With these obstacles to refinancing or selling a policy, owners
who financed through hybrid loan programs may face personal liability
if the lender requires them to "make good" on their personal
guarantees. Alternatively, policy owners who are able to negotiate
workouts with their premium finance lenders could face unexpected tax
consequences if some or all of their personal liability is forgiven.
Increased Regulation
These
developments and the increased litigation in the secondary insurance
market have prompted more state regulation in the industry, with
lawmakers focusing on transparency, disclosure and consumer protection.
Regulators will likely emphasize increased transaction transparency,
asking life settlement brokers and/or providers to divulge transaction
commissions and fees. Regulators will also want these parties to
develop and follow a code of ethics and best practices that includes
fiduciary duties owed to policyholders and insureds. Although 12 states
passed new life settlement regulation in 2008, major life settlement
markets such as California, Illinois and New York remain unregulated.
Each of these states has life settlement bills currently pending, so it
appears likely that they and other states will pass life settlement
legislation in 2009.
A New Operating Environment
Ultimately,
individuals entering the premium finance or life settlement markets
will play in a drastically changed environment. Policy owners seeking
premium financing will need to meet much higher standards, demonstrate
their creditworthiness and properly document their net worth. They also
will need to be ready to take on some substantive level of personal
liability, since the market value of a life insurance policy likely
will no longer be sufficient to collateralize most of these loans. The
cost of financing may go down as these standards become
institutionalized.