FINRA Panelists Detail Complexities of Life Settlements

Baltimore
Life settlements are complex transactions that need careful consideration before an entity allows its representatives to offer them to clients, a panel cautioned during the annual FINRA conference here.

The complexity and number of potential issues associated with selling them was pivotal to a decision by John Hancock Financial Network, Boston, to continue to prohibit its sales force from participating in life settlement transactions for compensation, according to Thomas Horack, chief compliance officer with John Hancock, the panelist explained.

Broker-dealers are also looking into the issue, according to Brian Casey, a panelist and partner with the Atlanta office of Locke Lord Bissell & Liddell LLP. Casey noted that in the last two weeks, he has received five calls from broker-dealers asking whether they should be allowing their registered representatives to participate in these transactions, what the risk would be if they are permitted to offer them and how policies and procedures can be put in place if life settlements are offered.

John Hancock’s Horack explained that in 2008 the insurer at the behest of its field force did a thorough examination of whether its agents should be allowed to offer these transactions to their clients. Ultimately, after an extensive examination, the company decided that its field force would not be allowed to offer a life settlement. The reason, he said, was that a life settlement is a complicated transaction that the company did not want to supervise. However, if a client expressed interest in a settlement, producers could offer contacts that would be able to offer that service.

Horack detailed the decision making process for attendees. The issue was examined in the same way that due diligence is given to any potential entry into a product market, he said. Among the initial questions that surfaced were whether the company wanted to set up an infrastructure; and whether there were legitimate cases in which a settlement may be a viable alternative such as business owners who have buy-sell agreements using insurance and are faced with a business that dissolves, a policy’s poor performance or clients who can’t afford premiums any more.

If a client is considering a life settlement, John Hancock looked at how to determine whether a client was rushing into a life settlement and whether reduced
paid up insurance or a 1035 exchange may be more appropriate.

Other issues, he said were reviewed included death benefit issues, tax issues, how a settlement may impact Medicaid benefits and the possibility that funds from a settlement may be available to creditors. In addition, Horack said, the infrastructure, licensing and disclosure requirements helped the company decide that it was not a business it wanted to enter. The business would have been an accommodation to agents and not a big revenue producer, he continued.

Under one model that was considered, he said, Hancock would have brokered its own policies or the policies of other carriers. Another model that was considered, Horack added, was working with life settlement brokers and broker-dealers with a life settlement component which would supervise activity and give the insurer reports. In the course of this due diligence, he said, it also became apparent that a life settlement is not a quick transaction. And, he added, it was not going to be a core business like life insurance and mutual funds.

Locke Lord’s Casey responded that another factor that would now have to be evaluated is the change to the cost of insurance that may be surfacing in the market. And, Horack continued, Hancock would have to monitor suitability and whether agents would turn to life settlements before they explored other solutions. He said it concerned his company that an agent would either knowingly or unknowingly become involved with STOLI (stranger-originated life insurance), leaving Hancock to figure out what to do with commissions and refunding premiums.

He also expressed concern over potential litigation of heirs of the deceased insured and the “real or perceived” compensation rate which was said to be about 20-30 percent, and how to handle a potential situation if a rep got paid commission on the settlement of a contract and then on the sale of a mutual fund or an annuity.

That issue was raised by Larry Kosciulek, director of FINRA Investment Companies Regulation, Washington, who asked why compensation is so high when most commissions for other sales are in the 5-6 percent range.

After these considerations as well as others such as reputational risks, reduced lapse rates and lower profits, Hancock considered the possibility of working with settlements with contracts that had features including a minimum age of 65, a minimum face amount of $250,000, a policy that was in force for five years; and a 10%cap on commissions with anything above that going toward the client offer. The contracts would be restricted to Hancock’s registered reps.

But in the end, he said, the company decided not to proceed because of continued concerns over the complexity of the transaction and the ability to supervise the transactions. And there was uncertainty over whether Hancock’s field force was more concerned with a revenue source or offering an accommodation to a client, Horack said. Finally, he said the due diligence was finished in the fall of 2008, during the deepest part of the recession.

The complexities of the life settlement market detailed by Horack’s analysis were reinforced by Locke Lord’s Casey who said for instance that beneficial interests in a life insurance trust and puts on beneficial interests are open to interpretation, although he believes that these transactions are life settlements.

Another instance that adds a wrinkle to the business is how different states define life settlement broker. In states such as Texas the definition is broad with tracking services and analyzing confidential viator or settlor information included within its scope.

What is more clear cut, he said, is that the industry is no longer the ‘Wild West’, but rather an industry regulated in 38 states covering over 80% of the population, with New York recently on board and California about to come on board on July 1.

A question from the audience raised the issue of whether a firm that does not allow its rep to participate in life settlements risks breaching a responsibility to a client by discussing all financial options. Horack reiterated that a broker is allowed to refer a client to others but can’t participate in the transaction. And, Casey responded that the life settlement law does not create that duty when you are a life settlement broker. Kosciulek said that FINRA doesn’t require a firm to sell anything and that a firm can’t allow reps to sell something that they don’t understand. He said that if there is a lack of understanding, there is a lack of ability to supervise and if you can’t supervise, then you can’t sell. He says that this is his response when he receives inquiries from the life settlement industry about why there isn’t a requirement to mention the life settlement option.

This article first appeared in Life Settlement Review.