In August 2006, the National Association of Securities Dealers issued Notice to Members 06-38 addressing “Member Obligations with Respect to the Sale of Existing Variable Life Insurance Policies to Third Parties.” The Notice reminds NASD members that life settlements involving the sale of variable life insurance policies are sales of securities, and NASD members involved in such sales are subject to applicable NASD rules.
The Notice defines a life settlement as the sale of an existing life insurance policy to a third party for less than its net death benefit but more than its cash surrender value.
The Notice is primarily focused on the duties and obligations of the NASD members and associated persons to their customers when recommending the sale by such customer of an existing VL insurance policy. While the Notice reminds NASD members and associated persons of their duties to their customers under NASD regulations related to sales to such customers of VL policies (i.e., suitability, due diligence, training, supervision, best execution and compensation), the Notice also says the NASD “is also concerned” about life settlement transactions involving non-variable life insurance polices.
Best practices for life settlement transactions
The Notice implies what might be some best practices for NASD member firms to adopt in supervising life settlement brokerage transactions by associated persons who also act as life settlement brokers. For example, in reminding regulated persons of their duties regarding suitability, the Notice states, “[the sale of an existing, in-force] variable life insurance policy is not necessarily suitable for a customer simply because the settlement price offered exceeds the policy’s surrender value.” The Notice states that the seller may have a continued need for coverage and should fully understand the tax and other implications relating to a replacement life insurance policy if the transaction contemplates a replacement for the policy sold.
Regulated persons should document their analysis and discussions with their clients relating to the client’s continued need for life insurance coverage and the related tax implications in light of these specific references in the Notice. NASD member firms should develop checklists for life settlement transactions which would include items relative to these factors. Development and use of such a checklist would be consistent with the practice prescribed in the NASD’s NTM 00-44 addressing VL insurance sales. An NASD member firm should also consider developing a tracking report similar to that suggested in NTM 00-44 with respect to policy replacements for life settlement transactions where the NASD member firm or associated person was involved in both the original policy sale and its life settlement.
The Notice also states concerns regarding confidentiality of the identity of the insured and medical records regarding his or her life insurance policy in the life settlement transaction. The concerns appear to be a reference to a best practice suggestion of only recommending a life settlement where the “life settlement provider” maintains confidentiality, even where it may not be mandated by law.
As to “best execution,” the Notice states the NASD’s “belief” that NASD members recommending life settlements to their clients should provide to those clients a range of choices of approved life settlement providers, based on the member’s review of such providers. The NASD states that due diligence of available markets for settlements and prices within those markets is a “core duty” in meeting the best execution obligation. The Notice also reminds NASD members of their obligation to provide appropriate training and supervision of their registered representatives and refers to Rule 2820(g)’s prohibition upon an associated person accepting compensation from anyone other that the member firm with which the registered representative is associated.
Looking forward…should firms take all life settlements “in-house?”
The Notice ends with the cryptic statement that life settlement transactions involving non-variable life insurance policies are also an area of concern for the NASD. That concern may relate to the uncertainty regarding whether transactions involving a non-variable life insurance policies are securities transactions.
The NASD has issued strong statements in the past with respect to “uncertainty” regarding the securities status of other insurance transactions; namely, indexed annuities in NTM 05-50, referenced above. In NTM 05-50 the NASD “encouraged” firms to consider additional “supervisory procedures,” specifically including NASD member firms requiring all sales occur through the firm, rather than as an authorized outside business activity. One wonders if a “suggestion” by the NASD that member firms supervise the sale of all life settlements within the firm, including the purchase of such life settlements as investments by their clients, might soon follow.
NASD-regulated persons should consider the impact of the Notice on their current practices relating to variable as well as non-variable policy life settlement transactions and consider adopting “best practices” of representing only life settlement providers who are pledged to confidentiality, conducting due diligence on such providers, developing checklists for sales representatives to use in documenting their recommendations and for registered principals to use in supervising such recommendations, developing life settlement activity tracking reports, and securing multiple bids.