Life settlements

Selling a policy instead of surrendering it

A life insurance policy is property. Its owner can keep it, let it lapse, surrender it to the insurer for its cash value — or sell it to a third party. A life settlement is that sale: the owner transfers the policy to a buyer for a lump sum of cash, the buyer becomes the new owner and beneficiary, pays the premiums from then on, and collects the death benefit when the insured dies.

The economics only work if the price sits in a specific band. The buyer pays more than the cash surrender value (otherwise the owner would just surrender) but less than the face amount (otherwise the buyer would never profit). The buyer's return is the gap between what it paid plus the premiums it will fund, and the death benefit it eventually receives. That return depends heavily on how long the insured lives — which is why the whole transaction is built around a professional estimate of life expectancy.

Viatical settlement versus life settlement

The industry started with viatical settlements: sales by insureds who were terminally or chronically ill and wanted to use their death benefit while alive, typically for medical care. A life settlement is the same transaction extended to people who are not terminally ill — most often older insureds who no longer need or can no longer afford a policy and who can get more by selling it than by surrendering it.

Florida's Insurance Code does not draw that marketing distinction. Part X of chapter 626 is titled Viatical Settlements and regulates the entire business under that one label (Fla. Stat. ch. 626, pt. X), so on the exam and in the statute, "viatical settlement" is the umbrella that covers a life settlement too. The seller is called the viator; a policy that has been sold is a viaticated policy.

Who is in the transaction

• The viator (policyowner) — sells the policy. Often, but not always, the insured.
• The viatical settlement broker — represents the owner, shops the policy to buyers

and negotiates the best offer. In Florida a licensed provider may not use anyone to perform a broker's functions unless that person holds a current, valid life agent license and has appointed himself or herself under the code (Fla. Stat. 626.992(1)).

• The viatical settlement provider — the licensed buyer that enters into the contract

with the owner and takes ownership of the policy. A broker may not use anyone as a provider unless that person holds a current provider license (Fla. Stat. 626.992(2)).

• The financing entity — an underwriter, lender, placement agent or purchaser of

securities that supplies the money or credit behind the purchase under a written agreement with a licensed provider. Its role is to fund; it may not enter into a viatical settlement contract itself, and the term does not include a nonaccredited investor or other natural person (Fla. Stat. 626.9911(1)).

• The life expectancy provider — an independent firm that estimates how long the

insured is likely to live, which drives the price.

The life expectancy provider is regulated too

Because the price of every settlement rests on a life expectancy estimate, Florida regulates the people who produce them. No one may act as a life expectancy provider without first registering with the Office of Insurance Regulation, and no provider, broker or other person in the business may obtain a life expectancy from someone who is not registered (Fla. Stat. 626.992(3)-(4); 626.99175(1)). The application carries a $500 fee, must describe the firm's methods, training and anti-fraud plan, and is deemed approved if not acted on within 60 days of being complete (Fla. Stat. 626.99175(2), (4), (9)). Every three years the registrant files an audit by a nationally recognized actuarial firm comparing its estimates to actual results, banded by life expectancy from under 24 months up to more than 180 months (Fla. Stat. 626.99175(5)). Records must be kept for five years (Fla. Stat. 626.99175(8)).

The independence rule is the one to remember: no viatical settlement broker, provider or insurance agent in the business may own, or be an officer, director or employee of, a life expectancy provider (Fla. Stat. 626.99175(6)). The person estimating how soon the insured will die must not be the person profiting from that estimate.

Fraud and stranger-originated life insurance

Florida defines a fraudulent viatical settlement act broadly: knowingly presenting false or concealed material information about the application, underwriting, premiums, ownership or beneficiary changes, reinstatement, or financing of a viatical settlement contract or of the underlying life insurance policy (Fla. Stat. 626.9911(2)(a)). It also expressly includes engaging in a stranger-originated life insurance practice (Fla. Stat. 626.9911(2)(c)).

Stranger-originated life insurance, or STOLI, is the abuse that settlement law is designed to shut out: a policy taken out from the start for the benefit of an investor who has no insurable interest in the insured, usually with the plan of selling it into the settlement market once it is in force. A legitimate life settlement begins with a policy that was bought in good faith and later became unwanted; STOLI manufactures a policy just to sell it. Florida gives insurers a specific weapon against it: notwithstanding the normal incontestability rule, a life insurer may contest a policy obtained by a stranger-originated life insurance practice (Fla. Stat. 626.99291).

What the producer must weigh with the client

A settlement is not automatically a good idea. Before pointing a client toward one, the standard treatment expects the producer to address:

• Alternatives — an accelerated death benefit rider, a policy loan, a reduced paid-up

election, or a simple surrender may serve the client without giving up the coverage.

• Loss of the death benefit — the named beneficiaries get nothing; the buyer does.
• Tax and benefits consequences — proceeds of a settlement may be taxable, and a lump

sum may affect eligibility for means-tested public assistance. The client should get tax advice before signing.

• Privacy — the buyer and its investors will track the insured's health for the rest

of the insured's life.

• Disclosure and licensing — the producer must be properly licensed for the role

played, must disclose compensation, and must never place a policy for the purpose of settling it.