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Looking Back at the Life Settlements Industry in 2019

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Looking Back at the Life Settlements Industry in 2019 Looking Back at the Life Settlements Industry in 2019 Authored by: Brian T. Casey and Thomas D. Sherman January 21, 2020 Similar to 2018, the U.S. life settlements alternative asset investment industry experienced a 2019 during which only a few legislative changes occurred, but there were further, significant developments in the areas of stranger-originated life insurance cases, progression of cost of insurance litigation, further implementation of key Internal Revenue Code changes and new privacy and data security laws affecting buyers and traders of in-force life insurance policies. With the significant number of retiring baby-boomers over the next ten years and new Congressional and regulatory focus on helping Americans save for funding their longevity financial risks, the life settlements industry is poised for solid growth in 2019. Stranger Originated Life Insurance (STOLI)/Insurable Interest Litigation While the onslaught of stranger-originated life insurance (STOLI) cases has tapered off during the last few years, there were several important STOLI, or insurable interest, cases decided in 2019. • Sun Life v. U.S. Bank1, a Delaware district court case, held that under Delaware law a life insurance policy for which the premiums were initially paid by a non-recourse premium finance loan was void for lack of insurable interest where the insurer challenged the validity of the $10 million policy ten years after its issuance. The court extended the Delaware Supreme Court’s 2011 prior Price Dawe STOLI case, finding that the insured had not procured the life insurance policy because she did not have an obligation to repay the premium finance loan, even though the original beneficiaries of the trust that purchased to policy were all family members of the insured having an independent insurable interest in the insured’s life. • In Malkin v. Wells Fargo and Berkshire Life Ins. Co.2 (also known as Malkin II)3, another premium financed STOLI case, the insured’s estate sued the investor that received the policy’s death benefit payment after the original policyholder trust settled payment of its premium finance loan indebtedness by transferring ownership of the policy to the lender, which later sold the policy to the investor. The insurable interest statute in Delaware, the state where the policy was issued to a Delaware life insurance trust, provides a private right of action to an insured’s estate to recover the death benefit paid on a life insurance policy issued without a valid insurable interest4. The court found that the policy in question was STOLI and rejected, among other defenses asserted by the investor, that the insured had released her estates’ claim to the death benefits through the settlement and release agreement entered into in connection with the transfer of the policy to the lender in settlement of the premium finance loan. • In Sun Life v. Wells Fargo5, the New Jersey Supreme Court answered two certified questions from the Third Circuit Court of Appeals: 1. Does a life insurance policy that is procured with intent to benefit persons without insurable interest in life of insured violate NJ’s public policy, and if so, is policy void ab initio? Not surprisingly, the court in this post-death policy challenge case filed by the insurer found that the insured had not procured the $5 million policy here in good faith because there was no evidence that she funded the initial premium payment and there was circumstantial evidence that third party investors unrelated to the insured had funded that premium for her life insurance trust, and therefore the 2007 issued policy was void ab initio. However, the court readily acknowledged that it could not devise a bright-line test for the factors to consider in determining whether an insured has procured a life insurance policy on his or her own, although the nature and timing of investor discussions, reason for a transfer of ownership of a policy after its issuance and length of time of ownership of a policy by its original purchaser are important, relevant factors. 2. If the policy is void ab initio, is a later purchaser, who was not involved in the illegal conduct, entitled to refund of premiums it paid while owning the policy? 1 Sun Life Assurance Company of Canada v. U.S. Bank National Association, USDC District of Delaware, Case No. 17-75-LPS, 2019 WL 1012005, February 25, 2019 2 Estate of Phyllis M. Malkin, USDC, Southern District of Florida, Case No. 17-23136-Civ, March 29, 2019 3 In Malkin I, Sun Life Assurance Company of Canada v. U.S. Bank, N.A., USDC Southern District of Florida, 2016 U.S. Dist. Lexis 4732, January 13, 2016, the trial court concluded that a Sun Life policy on the life of Phyllis Malkin was a STOLI policy and was void ab initio under DE law. 4 Similar, in many respects, for example to the laws in the states of New York, Utah, and Wisconsin. 5 Sun Life Assurance Company of Canada v. Wells Fargo Bank, N.A., United States Court of Appeals for the Third Circuit, Case No. A-49-17 (080669) June 4, 2019 www.lockelord.com | 1 of 4 Looking Back at the Life Settlements Industry in 2019 The court answered this question somewhat vaguely but nevertheless positively for life settlement investors, noting that a secondary life insurance market exists (hence the existence of New Jersey’s life settlement laws) and that a bona fide secondary market purchaser of a life insurance policy may be able to recover from an insurer the premiums that the purchaser paid (but not necessarily premiums paid by prior owners of the policy) depending on the circumstances. Tax Cuts and Jobs Act/Reportable Acquisitions of Life Insurance Policies In October 2019, the Internal Revenue Service (IRS) published final regulations implementing the reportable policy sales requirements under new Internal Revenue Code Section 6050Y, created by the Tax Cuts Jobs Act. The new reporting scheme imposes a major new federal tax compliance obligation for life settlement providers, investors in the secondary and tertiary life insurance markets as well as for life insurance companies that have issued policies that trade in these markets. New IRS form 1099-LS is a four part form: Copy A is an information return filed by the acquirer of an interest in a life insurance contract with the IRS, Copy B is a statement that the acquirer must send to the seller and other recipients of payments in a secondary or tertiary life insurance policy sale (unless the amount of the payment is less than $600 or the acquirer files a Form 1099 with respect to its payment to the payee), Copy C is provided by the acquirer to the life insurer that administers the life insurance policy that is sold (or resold)6, and Copy D is retained by the reporting acquirer. Subject to the filing transitional rules, Copy A, with IRS Form 1096 (Annual Summary and Transmittal of US Information Returns), must be filed with the IRS no later than February 28 of the year following the year in which a reportable policy sale occurred (or March 31 if filed electronically). Copy B must be sent to payment recipients no later than February 15 of the year following the year in which a reportable policy sale occurred. Copy C must be sent to the applicable life insurer by the later of twenty days after the reportable policy sale or, if applicable (secondary market or true life settlement sales) five days after expiration of the state law rescission period for the policy sale. Although IRC Section 6050Y applies to policies sales that occur on and after January 1, 2018, the IRS provided a year’s relief in its regulations making reporting obligatory for policy sales that occur on and after January 1, 2019. For reportable policy sales occurring between January 1, 2019, and October 31, 2019, Copy A must be filed with the IRS, and Copy B must be furnished to payment recipients, no later than February 28, 2020, and Copy C was required to be sent to the administering life insurance company no later than December 30, 2019. After a life insurer receives a Form 1099-LS Copy C, it must deliver a Form 1099-SB Copy B statement to the seller on or before February 15 of the year following the reportable policy sale and file a Form 1099-SB Copy A information return with the IRS on or before February 28 (or March 31 if filing electronically) of the year following the year of the reportable policy sale containing the name, address, federal tax identification number of the seller and the policy seller’s income tax basis, or the “investment in the contract” in the policy. In addition, beginning in 2020, life insurers and any other person distributing all or any portion of a death benefit will be begin delivering statements to the recipients with respect to t “reportable death benefit” payments with respect to policies which have been the subject of a reportable policy sale on IRS Form 1099-[DB]. Statements must be provided by the payors to the payees by January 31 of the year following the payment of the reportable death benefit and returns must be filed with the IRS on or before February 28 (or March 31 if filing electronically) of the year following the payment of the reportable death benefit. Cost of Insurance Litigation Cost of insurance increase (COI) litigation, including class actions, which affect life insurance policyholders both within and without the secondary life insurance market continued to work their way through their procedural processes, and a few new cases were filed in 2019.
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