Issues of Continuing Concern

The most prominent topic of conversation in legislative and regulatory activities throughout the country continues to be Stranger Originated Life Insurance, or “STOLI,” which is generally viewed as a practice that conflicts with traditional insurable interest concepts. Differing legislative responses to STOLI practices have included: 

• Extended waiting periods following issuance of a policy before it may become the subject of a settlement transaction: Two years still remains the rule in the vast majority of life settlement laws, although a few have enacted laws based at least in part on the NAIC five-year rule, which apply primarily to premium-financed policies. There are certain exceptions stated under all 2-year and 5-year statutes, which vary widely from state to state. States that have adopted laws that include some form of the 5-year rule include: IA, ND, NE, NV, OH, OK, OR, VT and W.VA. 
• Insurable interest and anti-STOLI laws: A number of legal experts argue that STOLI could potentially be deemed to be an illegal practice or a violation of insurable interest laws based on inferences drawn from current law in a majority of states. Several states have now enacted statutes that expressly declare STOLI programs to be illegal. Often, these laws are integrated into new or amended settlement laws, although Arizona elected to adopt a stand-alone anti-STOLI statute without adopting any settlement laws. Minnesota recently adopted a new insurable interest law, applicable to policies issued after the May 2009 effective date of the law, which essentially says that any settlement within four years after the policy was issued is presumed to be part of an illegal STOLI transaction. However, that presumption may be rebutted and a settlement can be lawfully conducted if it can be affirmatively proven that the policy was not a STOLI product. This places the burden on the policy owner (and the producing agent) to document details about procurement of the policy and the source of premium payments from the inception of the policy through the date of the proposed settlement. Likewise, settlement brokers and providers will need to obtain copies of such documentation prior to entering into any settlement transaction. 
• Beneficial interest transfers: A few states have recently enacted legislation that expressly includes within the definition of a “settlement contract” any transfer of beneficial interests in an insurance trust or other vehicle established for the primary purpose of owning one or more life insurance policies. Even in states that have not adopted express statutory language that specifically addresses transfers of beneficial interests in the policy-owing entity or vehicle, an argument might be made that such transfers could be covered by more generic provisions that include “indirect” transfers of a policy or transfers of the beneficial interest in a policy.
• Non-recourse premium financing: On a consistent basis, settlement laws adopted in 2008 and 2009 have identified non-recourse premium finance transactions as either falling within the definition of a “settlement contract,” or as a primary element of consideration under anti-STOLI provisions, or both. Exceptions are often provided, such as for policy loans from the carrier, loans from banks or licensed lending companies, loans that are fully recourse to the policy owner or insured, loans that are secured by assets other than the policy, or loans for which the lender’s collateral interest in the policy does not exceed its cash surrender value.
• STOLI Litigation: Regulatory enforcement actions aimed at STOLI practices have yet to surface on a widespread basis, but various insurance carriers have filed lawsuits seeking to void policies alleged to be the product of STOLI programs. In some cases, preliminary rulings seem to favor upholding the enforceability of policies based on the contractual terms of the policy documents and statutory contestability laws – even in situations where there is evidence of misrepresentations in the original policy application when responding to questions as to whether the applicant intends to settle the policy or as to whether premiums are being financed through a third party.

Lawmakers also remain focused on disclosure requirements, as more states adopt or amend requirements for disclosures to be given to policy owners. Some examples of new types of disclosures that may be required in certain states include: 

• More detailed specifications as to the disclosure of the amount and method of calculating broker commissions, with some states also requiring that commissions be disclosed as a percentage of the total settlement proceeds (as opposed to a percentage of the face value of the policy). Vermont went further to limit broker compensation to no more than two percent of the amount paid to the policy owner, causing a number of settlement companies to suspend any plans for further business in that state.
• Some states have enacted laws that now require additional disclosures related to risks that should be considered by a policy owner prior to selling a policy. 
• A few states have also embraced the concept of requiring carriers to provide disclosures to policy owners alerting them to the possibility of settlement as an alternative to letting a policy lapse or surrendering it for cash value. Such laws have been passed in both Maine and Washington. 
• In lieu of adopting the NAIC approach of prohibiting settlements during the first five years after policy issue, a few states have adopted requirements for brokers and providers to notify carriers in advance if they intend to pursue settlements prior to the expiration of five years from issuance of the policy. Others have enacted new annual reporting requirements that call for more detailed reporting of transactions based on the number of years since policies were issued.

Legislative Activities at the State Level

A review of legislative and regulatory activities during the first three quarters of 2009 continues to show significant interest in the life settlement industry in a majority of states, as well as at the federal level. Since the beginning of this year, six states enacted new life settlement laws, while ten other states have amended existing life settlement acts. 

Only a minority of states, 16, have not yet enacted any laws regulating life settlements, but legislation is pending in 6* of these states with a likelihood of adoption in one or more of them before the end of the year. A quick summary of the current landscape as of September 2009: 

• States that have adopted life settlement laws: AK, AR, CO, CT, FL, GA, HI, ID (eff. Jul-09), IA, IL (eff. Jul-2010) IN, KY, KS, LA, MA, MD, ME, MN (eff. May-09 & Aug-09), MS, MT, NC, ND, NE, NJ, NV, OH, OK, OR (eff. Jan-2010), PA, TN, TX, UT, VT (eff. Jul-09 & Jan-2010), VA, WA (eff. Jul-09) & W.VA
• States that have recently amended previously enacted life settlement laws: AR, GA, IA, ME, MT, ND, NV, TN, UT & W.VA
• States that currently regulate only viaticals: CA*, DE, MA*, MI*, NM, NY*, & WI*
• States that have not enacted any settlement life or viatical settlement laws: AL, AZ, D.C., MO, NH, RI*, SC, SD & WY 
• *States with proposed legislation currently under review: CA (sent to Governor for signature), MA, MI, NC, NJ, NY, RI, TN, TX, & WI
• Administrative rule-making is currently in process or expected in near future in the following states: AR, GA, HI, ID, LA, MT, NV, OH, OR, VT, WA and W.VA

Taxation of Settled Policies

In May 2009, the IRS released two rulings related to the taxation of proceeds from settlements, which may be taxable as capital gains or ordinary income, or a combination of both: 

• Revenue Ruling 2009-13 addresses the amount and characterization of income from the standpoint of a policy owner (other than an investor-owner) resulting from either a surrender of the policy for cash value or sale of a policy through a settlement. The full text of the Revenue Ruling 2009-13 can be downloaded from the IRS website at http://www.irs.gov/pub/irs-drop/rr-09-13.pdf. 
• Revenue Ruling 2009-14 addresses tax treatment on a post-settlement basis, upon a buyer’s receipt of the death benefits from a previously settled policy, or upon re-sale of the policy, including discussion of calculation of the amount and characterization of income recognized under varying scenarios. The full text of the Revenue Ruling 2009-14 can be downloaded from the IRS website at http://www.irs.gov/pub/irs-drop/rr-09-14.pdf.

Following the publication of these tax rulings, Life Settlement Solutions, Inc. and the Life Insurance Settlement Association presented webinars on the rulings to help provide a better understanding of the potential impacts. To access a recording of Life Settlement Solutions webinar visit the 2009 resources section of www.lifesettlementawarenessmonth.com, or contact the Life Insurance Settlement Association at www.thevoiceoftheindustry.com.

Proposed tax changes affecting life insurance are also under discussion on Capitol Hill, including proposals to eliminate the deductibility of expenses associated with certain employer-owned policies. Other proposals would require informational returns to be filed by settlement providers and other purchasers of settlement policies in connection with the purchase of any policy, as well as by insurance carriers upon payment of death benefits. As proposed by the IRS, these informational returns would be required to include the name and address of each party receiving any proceeds from sale of a policy or payment of death benefits, the amount of each payment, the policy number and the name of the issuing insurance carrier.

Proposals for Federal Regulation of the Insurance Industry

In February, the U.S. Treasury Department issued its report, Financial Regulatory Reform, A New Foundation: Rebuilding Financial Supervision and Regulation, which articulates a commitment to the continued regulation of insurance at the state level, but also notes concerns with respect to the “patchwork” approach to regulation at the state level and the resulting lack of uniformity from state-to-state. In response to these concerns, the report recommends establishment of a federal Office of National Insurance, within Treasury, to “gather information, develop expertise, negotiate international agreements, and coordinate policy in the insurance sector”. The report also proposes that Treasury assume greater oversight with respect to insurance holding companies, as well as bank holding companies and other financial institutions. 

Subsequent to publication of the Treasury report, the National Insurance Consumer Protection Act was introduced in Congress as HR 1880. If passed, this bill would establish the federal Office of National Insurance as recommended in the Treasury report. However, HR 1880 goes much further to appoint a National Insurance Commissioner as head of the Office, whose primary duties would be to (1) oversee the organization, incorporation, operation, regulation, and supervision of national insurers and national insurance agencies and shall issue charters therefore; and (2) license, regulate, and supervise national insurance producers. 

HR 1880 also proposes the establishment of an optional national charter for insurance companies, as well as national licensing for producers. This concept has been bandied about for a few years, but uniformly opposed by state regulators. If adopted and subject to a few exceptions, HR 1880 would provide that any nationally chartered insurer, insurance agency or insurance producer would be regulated at the federal level only, and would not be subject to licensing, examination, reporting, regulation, or supervision by any State as related to the insurance operations of such insurer, agency or producer. 

Alternatively, HR 2554 has been introduced seeking to reestablish the National Association of Registered Agents and Brokers “to provide a mechanism through which licensing, continuing education, and other nonresident insurance producer qualification requirements and conditions can be adopted and applied on a multi-state basis (without affecting the laws, rules, and regulations pertaining to resident insurance producers or appointments or producing a net loss of producer licensing revenues to States), while preserving the right of States to license, supervise, discipline, and establish licensing fees for insurance producers, and to prescribe and enforce laws and regulations with regard to insurance-related consumer protection and unfair trade practices”.

Meanwhile, HB 2609 seeks to establish an Office of Insurance Information, the Director of which would report to the Secretary of the Treasury, serving information gathering and advisory purposes similar to the description previously set out in the Treasury Department’s report. HB 2609 provides the Director would be responsible to (1) collect, analyze and disseminate data and information from state insurance departments and from other sources, (2) coordinate federal efforts and establish policy on international insurance matters, (3) determine whether State insurance measures are consistent with federal policy, (4) serve as a liaison between the federal government and the states regarding insurance matters of national or international importance, (5) serve as the primary advisor to the Treasury representative on the Trade Promotion Coordinating Committee with regard to promoting the export of U.S. insurance products, and (6) advise the Secretary of the Treasury on major domestic and international insurance policy issues.

All bills pending in the U.S. House of Representatives may be accessed through the following website: http://thomas.loc.gov/home/c111bills.html 

Federal Watchdog Group to Study Settlements Industry

In April 2009, the Senate Special Committee on Aging held an informational hearing, captioned as Betting on Death in the Life Settlement Market - What's at Stake for Seniors? The hearing did not provide for open comment, but did include a number of speakers, including both lawmakers and industry players, who discussed life settlements in general, securities law implications, STOLI and corresponding consumer interests. The written testimony of persons invited by the Committee to speak and a video of the hearing are available for review on the Committee’s website at http://aging.senate.gov/hearing_detail.cfm?id=312228&

1. The Senate Committee on Aging has now asked the U.S. Government Accountability Office (GAO) to undertake a review of the settlement industry, focusing on three fairly broad questions:
2. “What are the characteristics of the current market for life insurance settlements and the securitization of those settlements?
   “What concerns exist regarding life insurance settlements and securitizations for consumers, life insurers, and investors?
3. “How are life settlements and related securitizations and the associated participants and markets regulated and to what limitations, if any, exist with such regulation?”

The GAO is known as "the investigative arm of Congress" and "the congressional watchdog," which seeks to improve the performance and accountability of the federal government. The GAO is a highly respected, independent Congressional office and any report issued by this office is likely to have great influence over future legislative and regulatory activities at both the federal level and among the various states.

Concurrently with the GAO study, the U.S. House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises Congress, has announced that it will examine recent innovations in securitization, especially those related to life settlements. In a release published on September 15, 2009, Subcommittee Chair Paul E. Kanjorski stated: “As we work to reform the rules by which the financial industry operates, let us remain cognizant of the dangers of excess that securitization can cause.” Chairman Kanjorski’s statement also acknowledged that he has difficulty understanding how securitization of life settlements could contribute to economic growth, but that securitization can play an important role in our financial system and that he looks forward to learning more about how settlements can provide a benefit to people.