Before the viatical settlement bond market was virtually shut down by then-unforeseen developments in drug therapies for AIDS patients, the National Association of Insurance Commissioners, or the NAIC, protected its own interests by enacting professional guidelines for setting up the policies.
Now that the NAIC is looking to draft a set of guidelines that will hem in a burgeoning practice that some call premium financing, securitization professionals wonder how hard it will hit the asset class known as senior settlement bonds. In early May, the group held a hearing on the practice called premium financing, a portion of which ends up feeding into the life settlement securitization market. The call for regulation was clear.
"In an industry that has many competing interests, we witnessed many unified concerns," Jim Poolman, chair of the NAIC's Life Insurance and Annuities Committee and North Dakota Insurance Commissioner, said in a statement. "After today's hearing, there is consensus on the committee that there are life settlement transactions that need to be regulated."
The bonds which are also sometimes called senior settlement bonds, are backed by future proceeds from life insurance policies, according to Boris Ziser, a partner in the structured finance group at the law firm Brown Rudnick.
Although precise numbers are unclear on the current amount of bonds outstanding, those familiar with the deals estimate that it is a $7 billion to $10 billion market right now. It is one that keeps attracting investors, they say.
"We have three or four hedge fund clients that are trying to get into premium [financing]," said Scott Olson, managing shareholder of the law firm Greenberg Traurig's Dallas office. His firm has advised clients on about $800 million of life settlement deals.
Unlike viatical settlements, which were crafted to allow AIDS patients and others with terminal illnesses to cash out their life insurance policies, the sellers behind senior settlements are usually senior citizens, typically 70 years old or older, who don't have a terminal illness, said Ziser. The transactions are also sometimes called life settlement bonds.
"There was always the specter of fraud with these things," said Lisa Sloan, a shareholder at Greenberg Traurig in its Philadelphia office. The life settlement market, she said, conjured images of unscrupulous insurance brokers taking advantage of the elderly.
On the contrary, insurance companies ultimately lose out on life settlement transactions, because the practice upsets the industry's actuarial assumptions on life expectancy on the insured, say market sources. Typically, a lot of consumers with life insurance let the policies lapse, allowing the insurance companies to collect a windfall in premiums on those contracts, without ever having to pay on a policy.
"Once the policies get into the secondary market, and an investor keeps up the payments, the more likely that the insurance company will have to pay out a settlement," said Olson.
The lapsed policy factor touches on a potentially huge problem for the insurance industry, one that could draw unwanted attention from the various state insurance commissions, say people familiar with the situation. As life insurance companies compete for business, they may under price policies.
"If the policies are sold into a market wherein they are held to term, these practices will come to light and regulators will turn to the insurers and say you do not have enough [capital] reserves'."
Life insurance companies that want to curtail what they see as policy flipping can take a few simple steps to do so, say market sources. For one, they can cull the speculators from the applicant pool by asking if they intend to sell the life insurance policy to an investor, and hold them accountable for cashing in the policies soon after.
For its part, the financial community has already built protections into life settlement deals that curtail speculation within the asset class. Most professionals that put together life settlement securitizations make sure that policies in the collateral pool have aged beyond the so-called two-year contestablity period.
Also, state insurance oversight entities, such as the New York Insurance Department, are beginning to discuss whether to void policies wherein the beneficiary does not have an insurable interest on the person whose life is being insured, market sources say.
Any discussion about life settlement regulations will have to consider that the person buying the policy, in the first place, has the most insurable interest in his or her own life and the life insurance policy represents a form of personal property, market sources say. The process will also re-address the question: is a life insurance company is the only allowable means trough which an individual to control their that property.
"That is one of the definitions of property - I can do what I want with it," a source said.
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