Life settlements try to shake off STOLI

The life settlement market remains an important and vibrant part of the life insurance industry, says the man who helped found the strategy.

A properly executed life settlement strategy can bring significant tax advantages and help retirees cash in some benefits from policies they likely paid into for many years.

“We were early on trying to educate consumers, and it was a real challenge, because consumers look at life insurance as it only pays out when I die,” said Scott Page, a 35-year veteran of the life settlement business. “They don’t look at life insurance as a tangible asset such as a car or home or art. It’s something that has value, and that value was based on your health and the amount of premiums and the type of policy.”

But the life settlement practice continues to take hits from past investors in stranger-originated life insurance. STOLI lawsuits are playing out in federal courts coast to coast, with some defendants clinging to a life-settlement defense.

STOLI transactions took off in the early 2000s as crafty investors and resellers skirted the emerging life settlement market rules. In response, the National Association of Insurance Commissioners created a model law in 2007 to better regulate against STOLI policies. Most states adopted some form of that model.

Yet, those STOLI policies sold 20-25 years ago remain on the books, often held by insurers who took over the insurers that sold the original policies. Policyholders are dying, and life insurers are suing under new anti-STOLI laws.

It all creates a mess that will take some time to sort out.

“There are hundreds of millions of dollars of STOLI policies waiting for the insured to die to file death claims,” Page explained. “And there are a lot of states issuing decisions on how they’re going to act, and it’s setting case law. It’s going to be interesting because a lot of these funds have bought STOLI thinking they’re going to get paid … and now they’re scratching their heads thinking, ‘OK, why did we buy this hot potato?’”

Started in the 1980s

The secondary market for life insurance policies traces its roots to the 1980s, when viatical settlements emerged to give those suffering from HIV or AIDS a way to pay their medical bills. Investors offered cash to sufferers in exchange for being named their beneficiary.

Soon, what was seen as a humane practice spread to other terminal diseases such as cancer. The IRS provides special tax treatment for these cases, resulting in tax-free proceeds for viatical settlements.

In time, the resale market evolved to include a broader group of older policyholders who did not have serious health issues but had other life circumstances in play. For example, they no longer needed the benefits associated with life insurancel but needed the money to pay for long-term care or living expenses. Thus, the mainstream life settlement market was born.

The NAIC began regulating these settlements in 1994 by requiring a two-year holding period for these policies in conjunction with the contestability period.

As AIDS became more treatable by the late 1990s, viatical settlements declined and life settlements began to look sketchier. Some investors, agents and lenders began looking for older candidates willing to take out a life insurance policy. A trust was often created to pay the premiums, and the policy would be transferred to an investor at the end of the two-year hold period.

“These were not mom-and-pop kitchen table investors,” Page said. “These are large institutional investors that have lawyers and can understand risk. It was just fueled by greed and lack of creativity and determination to find real life settlements.”

More lawsuits

Insurers suing to avoid paying out on STOLI policies is nothing new. But a recent flurry of lawsuits has the issue back in the news, with some defendants claiming a life settlement defense.

Ameritas Life Insurance Co. is being particularly aggressive about challenging potential STOLI policies. The insurer has several lawsuits ongoing — mostly sold by Union Central Life Insurance Co., a predecessor of Ameritas — and settled a case earlier this year with Wells Fargo.

In a California lawsuit, Ameritas argues that a life settlement investor buying an in-force term life policy cannot exchange the term life policy for a permanent life policy because the new investor owner has no insurable interest in the life of the insured.

Amir Moghadam bought the term policy 20 years ago from Union Central with a face amount of $3.7 million.

Moghadam’s policy provides a conversion privilege, which allows the owner to convert the policy to “any permanent plan of insurance made available by the company for such purpose at the time of conversion.”

In February, Ameritas informed Moghadam that his premiums would increase from about $7,000 annually to over $73,000, court documents say. Wilmington Trust is a “securities intermediary” in the case, meaning it likely represents an investor.

“Moghadam … had no desire to pay more than ten times the premiums he was paying, so he sold his policy,”  a Wilmington attorney wrote. “The policy would have been worth a fraction of what he sold it for but for the fact it permitted the owner to convert it from a term policy to a permanent policy.”

Life settlement investors prefer permanent policies because they get paid when the insured dies and permanent policies are usually cheaper than term policies to keep in force. If the court rules that term conversions cannot be exercised by life settlement investors, it is sure to have a negative impact on the industry.

Life settlements are generally distinguished from STOLI policies at the time of purchase.

For example, under California law, any party purchasing life insurance must have an “insurable interest” in the person being insured. If there is no insurable interest, the insurer has a basis for declaring the policy void.

In the California case, Moghadam named his wife as the beneficiary.

Regardless of whatever court precedent might be established by the lawsuit, the life settlement industry will continue to carve out its niche in the industry, Page said.

“The industry will continue,” he said. “It will never be on the scale it was with the STOLI phenomenon because of all this manufactured product. But I think there’s a place for legitimate life settlements and viaticals.”

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.