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May - June, 2006 |
Vol. 1, No. 1 |
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With the new year, legislators and regulators throughout the country go back to work with a number of issues receiving attention. Among them:
NAIC Hearing Scheduled for May 3: On May 3, the NAIC held a special public hearing in New York to explore insurable interest issues in connection with both premium financing and life settlement transactions. In addition to insurance regulators, testimony was provided by representatives of life insurance companies, life settlement companies, premium finance companies, and industry professionals from New York as well as other states. Similar discussions will take place at the NCOIL meeting in Boston in July.
Federal Regulation of Life Insurance and Life Settlements under Discussion: Discussions are taking place on a national level regarding the concept of an optional federal charter for life insurers, similar to nationally chartered banks. A charter for life insurers could result in decreased power of state regulators and perhaps greater uniformity in practices and procedures nationwide. Some talk is also continuing about the topic of possible taxation of life settlement transactions. Many industry experts view both of these issues as unlikely to result in adoption of any changes in the near future, but as topics worth watching.
Good News from FASB. The Financial Accounting Standards Board has published an amendment of its position on the value of life settlement contracts, as now set forth in FASB Staff Position No. FTB 85-4-1. Previously, FASB required that life settlement contracts (life insurance policies acquired through life settlement transactions) be accounted for based solely on their cash surrender value, which is typically well below market value. Under its new pronouncement, FASB recognizes two acceptable methods of valuation – fair-value or investment – either of which may be adopted by an investor upon acquiring a life settlement policy. Under the fair-value method, the company accounts for the policy at the transaction price, with a re-valuation of the asset each reporting period to take into account market forces and costs associated with maintaining the policy, which may result in recognition of gain or loss in each period for which there is a change in value. The alternate investment method recognizes the initial investment at the transaction price plus all initial direct external costs, with future carrying costs being capitalized and no gain or loss is recognized until the policy matures. These new rules now offer significant advantages to U.S. companies investing in life settlements as an alternative asset class. It is expected that the International Accounting Standards Board will consider adoption of these same valuation methods at some point in the future for application to international investors.
Facilitating change of policy domicile may be viewed as fraudulent. Effective July 1, 2005, Florida amended its viatical/life settlement laws to make it a crime, punishable as a felony, to “knowingly or intentionally facilitate the change of state residency of a viator to avoid the provisions of this chapter”. [FS § 626.99275(1)(d)] Similar legislation expressly prohibiting change of ownership of a policy or change of residency of a seller, if done to avoid regulation in a particular state, are being considered for adoption by other states as well. Some proposals are limited to change in domicile of in-force policies (aimed at settlements), while other states are considering application of similar principles to prohibit the initial issuance of a policy in one state for an insured that resides in another state if done for the purpose of avoiding regulation or laws in force in the insured’s state of residence. Alabama, Arizona and Georgia are among the states currently considering such legislation.
Insurer disclosure proposals. Settlement brokers and providers have typically been required to provide written disclosures to policy owners and insureds regarding certain risks or potential disadvantages of a settlement transaction. Proposals are currently circulating in some states that would require insurance carriers to provide written notice to certain policy owners regarding the advantages that might be offered through a settlement transaction (i.e., if the policy owner seeks to cash in a policy for its surrender value, or if the carrier receives an inquiry regarding the availability of accelerated death benefits, with any notice of lapse of a policy, etc.).
Broker commission disclosures. It is expected that more states will be moving toward requiring express disclosure of the amount and method of calculation of commissions paid to settlement brokers and agents in connection with settlement transactions. Some brokers oppose such requirements based on the belief that it would interfere with the ability of honest brokers to compete against others that may not fully comply with such laws. The primary argument in favor of such disclosure is that it is consistent with the concept that the broker/agent acts as the fiduciary representative of the seller and fiduciaries have long been held to a high standard of full disclosure. Some large distribution networks are voluntarily disclosing commissions and placing caps, around six percent, on commissions to maximize their ability to provide a higher value of service to their clients.
What is "insurable interest" and why does it matter?
- The legal concept of “insurable interest” is based on the question of what the policy owner stands to lose upon the death of the insured (not what they will gain through recovery on the policy). It is the loss flowing from the death of the insured that a life insurance policy is designed to cover.
- Spouses, dependents and other close family members are presumed to have an insurable interest based on their relationship with the insured alone.
- Business entities, even family-owned companies or family partnerships, do not enjoy any such presumption, but must instead show that the insured is a “key person” in the operation of a business enterprise, the loss of whom would have an adverse economic impact to the company.
- Insurable interest is determined by the relationship between the insured and the original owner and beneficiaries of the policy and beneficiaries, as measured at the time the policy is issued.
- The lack of an insurable interest at the inception of the policy renders a policy void.
- In nearly all states, an insurable interest defense survives expiration of the contestability period and can be asserted by the carrier at any time during the term of the policy or after death of the insured, against either the original owner or any subsequent owner of the policy.
- Legislators are expected to continue ongoing discussions of proposals to either expand or contract insurable interest rules in various states.
New York Insurance Department Concludes No Valid Insurable Interest Exists in Premium Finance Program with "Put" Provision. In December 2005, the general counsel of the New York Insurance Department issued an opinion concluding that a full-recourse premium finance program was prohibited under New York law due to a put provision by which the policy owner could compel a third-party hedge fund to purchase the policy if requested to do so by the policy owner as of a specified date. The general counsel states that the arrangement does not conform to the requirements of New York law because the transaction involves the procurement of insurance solely as a speculative investment for the ultimate benefit of a disinterested third party, inconsistent with insurable interest laws. The opinion also went on to speculate that there may exist other problems with the arrangement, such as rebating violations. This opinion is one example where regulators or representatives of the insurance industry have condemned various forms of premium financing programs as either unlawful or contrary to traditional purposes of life insurance and insurable interest laws. Legislators are expected to continue ongoing discussions of competing proposals to either expand or contract insurable interest rules in various states through 2006, and perhaps into 2007.
AALU Issues Policy Statement on Insurable Interest & SOLI. On April 13, 2006, the AALU issued a statement of concerns about SOLI, as well as IOLI. AALU describes a SOLI situation as one in which a policy is issued to a person having an insurable interest, but that person incurs no significant liability and contributes no significant resources in order to acquire the policy, in contemplation of a likelihood of reselling the policy sometime after two years later to someone that does not have an insurable interest. AALU compares SOLI arrangements to IOLI arrangements, which it describes as a similar situation in which an entity funded by private investors uses a charity’s rights under insurable interest laws to take out life insurance that would otherwise not be available to that entity or its investors. AALU believes these types of arrangements are inconsistent with the intended purposes of insurable interest statutes and that they present a threat to the present favorable tax treatment of life insurance products. Because of these concerns, AALU and others are supporting efforts to tighten viatical and life settlement laws to preclude circumvention of the purpose of insurable interest laws. AALU’s policy statement contrasts more traditional arrangements, expressly stating that its insurable interest-related concerns do not extend to situations in which there is either “(1) full recourse or adequately collateralized non-recourse premium financing and the intent is for the long-term retention of the policy by one who has an insurable interest in the insured, or (2) a valid life settlement motivated by circumstances arising after the policy issuance.”
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