When considering a life settlement arrangement for clients, financial professionals need to be able to assess the ethical practices of the players in this new and innovative industry. This article looks at some of the key due diligence issues this review should cover.
First, a brief history. Begun in the late-1990s as an outgrowth of the viatical settlement industry, life settlements entail the sale of an existing life insurance policy by the owner to a third party. In return for a cash settlement, the policyholder transfers ownership and all other rights of the policy to that third party. This allows the policyholder to receive cash for a life insurance policy that is no longer needed or cost-effective.
Unlike viatical settlements, life settlements contain no requirement that the insured be terminally ill.
Life settlements are typically generated through insurance agents, brokers and other financial professionals who send an application on behalf of the client to the life settlement company or “originator.”
However, before any of this can occur, financial professionals should be mindful of the ethical practices of the originators whom they are considering for the arrangement. Here is a framework to follow:
Determine the source of the originators funding.
During the peak of the viatical business in the early 1990s, various players typically bundled several life insurance policies and sold them to individual, or “retail,” investors, who were lured by a supposed high rate of return.
However, besides offering unreliable funding, this practice created the potential for privacy concerns, since the individual investors had a direct stake in the insured. Further, this practice has led to a series of well-documented abuses by both viatical companies and fundraising affiliates, causing the industry irreparable damage.
A more preferable funding method–and one that assures clients privacy needs are being met–is when “institutional” investors provide life settlement companies with the necessary funding for backing the life settlement offer and payment of future premiums. Institutional investors include commercial and investment banks and insurance and reinsurance companies.
Learn how to recognize a true “institutional investor.”
The institutional investing spectrum is filled with many gray areas. For starters, some companies engage in questionable, limited ventures where the funding itself is not clearly identified, forming trusts and limited liability corporations referred to as “institutions” but still utilizing retail investors.