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.