The ongoing controversy over how to stop stranger- or investor-originated life insurance is one of the more bitter regulatory stories to emerge in recent memory.
The Hatfield-McCoy-like bitterness, played out over 2 years at public meetings of the National Association of Insurance Commissioners, Kansas City, Mo., and the National Conference of Insurance Legislators, Troy, N.Y., is likely to continue, at least in the near term.
At press time, NCOIL was planning a full-day discussion of the issue on April 21 in Washington, following several hours of testimony at its spring meeting in Savannah, Ga., in early March.
Representatives of the life settlement and life premium finance industries are vowing to fight recently adopted amendments to the NAIC’s Viatical Settlements Model Act. The amended model draft was unanimously adopted by the NAIC’s Life and Annuities “A” Committee and awaits full adoption by the NAIC at its executive committee and plenary session during the summer NAIC meeting this June.
Even if the model is adopted, interviews by National Underwriter suggest the controversy will be removed to state houses, where legislatures will possibly face 2 models and a battery of lobbyists representing life insurers, life settlement and premium finance representatives, and possibly even a new trade group, the Institutional Life Markets Association, representing institutional investors. (See related story on page 27.)
The source of the depth of feeling being expressed by all sides is hard to pinpoint. But threads from discussions over 2 years raise major issues, including ‘insurable interest,’ which goes to the heart of the principles of life insurance, and property rights, which goes to the heart of American law and how Americans perceive their rights under law.
Throw into the mix complex issues such as product pricing, product arbitrage, contestability periods, tax treatment of life contracts, genuine need as defined by a list of life events, and what recourse and non-recourse premium finance laws are, and when they are and are not legitimate, and as testimony suggests, the issue is even thornier.
A timeline offers an overview to counterbalance the detail work on both the NAIC model, which at press time seems largely complete, and the NCOIL model as it evolves.
The first signs of that evolution surfaced in December 1998, during a public hearing and session of the viatical settlement working group held at the winter NAIC meeting in Orlando. The hearing was held to review how viatical settlement contracts should be regulated. Discussion reflected how the viatical settlement industry, the precursor to the life settlement industry, was maturing. Comments centered on the shift from viatication by terminally ill or health-impaired individuals to the sale of a contract by healthy policyholders.
During testimony reported in the Dec. 14, 1998, issue of NU, ACLI counsel Julie Spezio cited instances where companies reported cases of viatication within 10 days after a policy had been purchased. The cases, she explained to regulators, involved high net worth individuals.
Tom Foley, a life actuary and then-North Dakota regulator, noted that the trend could have “significant tax effects” for insurers. “By eliminating insurable interest, we could have Treasury looking at the tax benefits of insurance and asking why should they have these benefits. This is going to happen.”
Foley said at that meeting of the viatical settlement working group that it was essential regulation cover the health-impaired, well consumers and those who purchase contracts for the purpose of viaticating them.
Kevin McCarty, then a working group member representing the Florida department, noted his department had already received “a tremendous number of calls from investors. There could be a huge destabilization in the life insurance market.”
McCarty is now insurance commissioner with the Florida Office of Insurance Regulation. In 2005, Florida passed legislation that permits settlement of a life insurance contract and allows investment in a contract that is in force for less than 2 years. The law also contains significant disclosure requirements.
Lester Dunlap, a regulator with the Louisiana department at the time, said that regulation could either incorporate guidelines for healthy viators into a model regulation or create a separate regulation.
And Doug Head, then-compliance director with the Medical Escrow Society, Tavares, Fla., said the regulation should be adopted as is. Head said: “Life insurance is a form of property and an owner has fair discretion over what they do with it. The viatical settlement industry is working toward a real need.”
Head has since gone on to become executive director of the Life Insurance Settlement Association, Orlando, Fla.
The comments were a precursor to work on changes to the Viatical Settlement Model Act, adopted in 1998 and again in 2001.
The original model was adopted in 1993. As it moved toward adoption, it faced issues including a call that a “broader spectrum of interested parties be allowed to develop a proposal that would have consensual support,” according to NAIC legislative history. Some states, this record said, wanted to eliminate the market altogether, while other states did not want to limit any financial activity. During the course of the discussion, according to the NAIC records, one commissioner suggested that in addition to the model, insurers be encouraged to offer accelerated benefits.
Among the states that took action following the 2001 adopted version were North Carolina, Pennsylvania and Virginia. State legislation varied, with some bills focusing on traditional viatical settlements, some on guidelines for brokers and their responsibilities to viators and others including both viatical settlements and life settlement contracts.
Even as states started adopting the revised model act, regulators continued to grapple with the Viatical Settlement Model Regulation, the tool used to implement guidelines in the model act. Separate licensing requirements for life insurance producers and those who also are life settlement brokers delayed the model’s adoption. Ultimately, it was adopted without separate requirements.
Life insurers had expressed disappointment that the model reg had been delayed; they argued that the life insurance and life settlement industries are really separate businesses and that the viatical industry is really a “factoring industry” related to future cash flows a policy will provide.
In 2003 and 2004, several stories in NU covered Internal Revenue Service scrutiny of both life insurance products and investor-owned life insurance. A July 2003 article detailed 2 revenue rulings, Rule 2003-91 and Rule 2003-92, which banned the purchase of life insurance and annuity contracts primarily for tax-avoidance purposes.
And in June 2004, the IRS turned its attention to investor-owned life insurance products, as detailed in an article about a Senate Finance Committee hearing on whether tax-exempt organizations are abusing their status. The comment from IRS Commissioner Mark Everson was in response to a question posed by Sen. Jeff Bingaman, D-N.M.
The arrangements under scrutiny involved selling fixed income security interests in a trust owned by a charity to institutional investors. The trust then purchased both a life insurance policy on the donor and an immediate annuity to make payments on the life policy. The charity benefited from the value created by the arbitrage created from the difference in pricing between the life contract and the annuity contract.
The arrangements were called Lilacs and had the life insurance industry seeing red.
At that point, both Gus Comiskey, president of the Association for Advanced Life Underwriting, and David Woods, CEO of the National Association of Insurance and Financial Advisors, both in Falls Church, Va., issued a statement saying they were working with the American Council of Life Insurers to prevent state insurable interest laws from being relaxed. In fact, the ACLI had told the Senate Finance Committee that it had set up a CEO-level task force to address the use of life insurance and annuity products sold as part of these transactions.
Bills had been proposed in Louisiana and North Carolina. Tennessee, Nebraska and Texas permit Lilacs. Legislation had been rejected or tabled in Maryland, Florida, Alabama, Louisiana, Oklahoma and South Carolina, according to the ACLI, which was cited in a July 1, 2004 article.
At the time, Frank Keating, ACLI president and CEO, said the concern among insurers was that it would endanger favorable tax treatment of insurance proceeds if Congress saw death benefits being used for investment purposes.
The issue received its first major public discussion at the June 2005 summer meeting in Boston during the NAIC’s “A” Committee, chaired by North Dakota Insurance Commissioner Jim Poolman.
Within a year, Poolman, along with then-New York Superintendent Howard Mills, would hold another public hearing on May 3, 2006, one that drew a packed crowd of 250 participants and featured major industry leaders such as New York Life’s CEO Seymour Sternberg offering their solutions to the problem of life insurance originated by investors.
During the Boston meeting, according to NAIC meeting minutes, the ACLI, along with NAIFA and AALU, submitted a letter with the support of the National Association of Independent Life Brokerage Agencies, Fairfax, Va., pointing out that in such transactions, the charity receives–at best–5% of the benefit, with the rest going to investors.
The hearing also included testimony outlining how transactions generally take place when a private entity sets up a trust or a limited liability corporation.
J. Leigh Griffith, then representing LILAC Capital LLC, (now called InsCap Management LLC) based in Nashville, Tenn., said these arrangements are not examples of investor-owned life insurance but rather trust-owned policies, according to minutes. Griffith noted that corporate-owned life insurance is a form of investor-owned life insurance, the minutes detail.
In response to a question from Poolman, Griffith said the LILAC trust owned over $1 billion in new life insurance policies on wealthy individuals.
Poolman said the specific debate before the “A” Committee was, “Were the insurable interest laws set up to facilitate arbitrage?” He also noted that there is a difference between COLI and the trust described by Griffith, which has no relation to the insured.
Griffith expressed surprise that insurers were supporting a bipartisan bill that would create an excise tax on IOLI.
And, according to an NU article, Alabama Insurance Commissioner Walter Bell said, “I’m astounded that insurance companies would be in Congress asking that there be legislation to tax insurance.”
He noted that “it is a slippery slope” and wondered whether at some point in the future he might end up paying tax on his own life insurance.
On the issue of IOLI, Bell had noted that when a person is trying to buy life insurance when he/she enters into one of these (investor-owned) transactions, often when there is something for free, there is also something wrong.
Bell is currently NAIC president.
The “A” Committee ultimately adopted a resolution opposing the expansion of insurable interest laws that largely reflected an earlier one adopted by NCOIL.
The resolution was followed in December 2005 by a decision issued by the New York insurance department stating that IOLI transactions are invalid. The decision was made following a request for guidance about having a put option agreement to the insured allowing the provider, a European hedge fund, to buy the policy on the exercise date at a set price. The department, according to the NU article, is that such arrangements are intended to create policies strictly for resale, contrary to law.
The issue began to surface in other regulatory discussion. During a March 2006 discussion on nonforfeiture at the NAIC spring meeting, regulators listened to a dialogue about the contract’s failure to recognize economic value and offer more cash value in a contract. The deliberation among regulators and insurers noted that viatical and life settlement companies are stepping in to offer more value to contract holders.
The thoughts on contract value were only a precursor to the extensive comment that insurance regulators received during a May 3, 2006, NAIC hearing run by both Poolman and Mills.
Among those who testified were the ACLI’s Keating and New York Life’s Sternberg, who called STOLI a “contrived transaction designed from the start to get contracts into the hands of speculators.”
According to a May 8 NU article, Poolman noted, “I think that there is consensus that premium financing with the intent to settle is something that we absolutely have to address.” A 5-year settlement moratorium was one option he raised.
During the hearing, Bob Thompson, then a partner with InsCap Management, argued there was a place for premium financing. He said that what was important was that it was clear where capital came from, how the firm interacts with the consumer and whether the transaction is “fair and legitimate.”
He explained to regulators how after his firm completes a transaction, the structure is like an asset-backed security in which “the balance sheet exposure is transferred to institutions in the asset-backed security marketplace.”
Shortly after, on May 8, 2006, the ACLI’s board of directors voted to support a federal excise tax on stranger-owned life insurance. The vote to pursue the policy was 26 directors in favor, 4 opposed and 1 abstention, according to sources. ACLI confirmed it will “explore” pursuing the policy in Congress. The board had said that premium financing can have a place in the life insurance industry but that the STOLI arrangements in question give parties who are unrelated to the insureds a mechanism for ignoring state insurable interest laws.
Life settlement providers including M. Bryan Freeman, president of Habersham Funding, Atlanta, wondered, “Why are you asking Congress to tax your insurance?” In the May 22, 2006, article, Freeman said that once the “camel’s nose is under the tent,” it may open up life insurance contracts to the possibility of further taxation, including a contract’s inside buildup and death benefit.
The decision was made less than a week after a May 3 hearing by state insurance regulators of the NAIC, which was happening at the same time the Life Insurance Settlement Association, Orlando, Fla., was having its 12th biannual spring meeting in New York.
That hearing drew a packed crowd of over 250 participants who heard CEOs offer their solution to the problem of life insurance that is originated by investors.
The discussion threaded its way through the summer, culminating in the release of a 39-page draft dubbed “the Poolman draft,” which received discussion during the fall NAIC meeting in St. Louis on Sept. 10, 2006.
The draft went through several incarnations during the fall, including new versions on October 6 and November 29, a week before the winter NAIC meeting in San Antonio, where the model was unanimously adopted at “A” committee on December 10.
The model that was adopted at the Dec. 10 meeting includes provisions such as a 5-year ban on the settlement of a life insurance contract, with exceptions for contracts in which there is a life event such as a divorce.
Additional language was presented by then-Ohio Insurance Director Ann Womer Benjamin to help address concerns raised by banking groups that the model violated the National Bank Act and the Gramm-Leach-Bliley Act.
The model does not address STOLI transactions sold through trusts.
Life insurers and producer groups expressed support for the action, but groups including LISA and LIFA questioned the lack of time to review the model, which was released a week before the meeting, and the fact that the model did not regulate the use of trusts in transactions that resemble life policies purchased solely for the purchase of settlements.
The “A” Committee action prompted the life settlement and life premium finance industries to ask NCOIL to look at the issue.
That process started in early January 2007, when NCOIL held 2 conference calls on Jan. 5 and Jan. 25 to examine the issue. A decision was made to use NCOIL’s own model as a starting point. Among the issues that NCOIL focused on included: the definitions of “fraudulent viatical settlement act” and “viatical settlement contract”; license and bond requirements for companies in the life settlement markets; requirements for disclosures to viators and insurers; and practices that should be prohibited.
It continued during the NCOIL spring meeting in Savannah on March 1-4, 2007. During that meeting, legislators asked many questions ranging from the nuances of life settlement contracts to property rights and the differences between a 2- and 5-year ban. Kentucky Executive Director Julie McPeak testified before legislators attempting to answer questions that they raised about the NAIC model. She was asked whether the NAIC was making decisions for legislators. Ultimately, NCOIL decided to issue a resolution requesting that the NAIC delay action until December 2007.
A week later, during the spring NAIC meeting, insurance commissioners at the executive session agreed to send the draft model amendments back to “A” committee for further consideration that they said would be limited in scope and in time.
On April 2, in a unanimous 11-0 decision on a conference call, “A” Committee moved the model back to executive committee and plenary for action. Five amendments addressed issues including those raised by the Office of the Comptroller of the Currency, as well as the definition of a fraudulent viatical settlement act and a requirement that a viatical settlement broker disclose the amount and method of providing compensation. Action could be taken at the June NAIC meeting in San Francisco.