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. Lincoln Life’s case pending in the Southern District of New York received class certification last March. A life settlement asset manager brought a new COI action against Lincoln Life in the same venue last June. Transamerica had settled a federal class action in California for $195,000,000 late in 2018, but there were significant opt-outs which trimmed the settlement to approximately $110,000,000.

Feller v. Transamerica Life Insurance Co., 2:2016-cv-01378, SD CA, 2019. At least one of those opt-outs, BroadRiver II (Ireland) Ltd, has filed a separate action against Transamerica.

John Hancock settled a cost of insurance class action for approximately $91,000,000. 37 Besen Parkway, LLC v. John Handcock (U.S.A.), Case No. 15-cv-9924, SDNY, 2019. Other 2019 insurance company defendants in cost of insurance cases include Midland National Life Insurance Company, USDC SD Iowa, AXA USDC SDNY, and PHL Variable Life Insurance Company, USDC SDNY. While some secondary life insurance policy investors own life insurance policies that are the subject of COI increase, generally these investors have not historically filed their own actions against life insurers to challenge these COI increases which can have significant adverse impacts on their expected rates of investment returns and depress the value of life settlement policies resold in the tertiary life insurance policy trading market.

6 Reporting the amount of a policy’s sales price to the life insurer is optional and likely not to be reported to life insurers) www.lockelord.com | 2 of 4 Looking Back at the Life Settlements Industry in 2019

Legislative and Regulatory Developments Life Settlement Laws and Regulations • Rhode Island’s law (adopted in 2018) requiring life insurers to send notices to their individual life insurance policyholders advising them if they are considering changes to a policy that they should consult with a licensed insurance agent or financial advisor and can find more information about policy change options on the Department of Business Regulation’s website. The law, which became effective on January 1, 2019, required the Department of Business Regulation to develop, and post on its website, a written notice informing policyholders of their alternatives to the lapsation or surrender of a policy and their rights as an owner of a policy, that are related to the disposition of a policy, including a life settlement. The Department of Business Regulation published its website notice via its Insurance Bulletin Number 2018-12. • New Cost of Insurance Laws In 2018, the California Assembly passed Assemble Bill 264 regarding adverse changes to current scales of nonguaranteed elements of certain in-force flexible premium life insurance policies. This law requires life insurers to send notices to their customers summarizing any change to scales of nonguaranteed elements that increase or may increase a charge, or reduces or may reduce a benefit, other than a change in a credited interest rate or index account parameter based on the insurer’s expected investment income or hedging costs, not less than ninety days before the effective date of such a change. The required notice must inform affected policyholders of their five options: (i) take no action, (ii) pay increased premiums, (iii) reduce the policy face amount of death benefits, (iv) surrender the policy or (v) if applicable convert the policy, but does not require notice that a life settlement of the policy may be a sixth option. This law applies to flexible premium life insurance policies issued on or after April 1, 2019 and to adverse changes occurring on or after July 1, 2019. Over in Texas, House Bill 207, which became effective on September 1, 2019, requires notice of an increase in a nonguaranteed charge to a life insurance policy and notice of a decrease in the credited interest rate to the accumulation account of a life insurance policy, other than a variable universal or indexed life insurance policy, similar to the new California law but not with the policyholder options statements.

Cybersecurity and Privacy Laws and Regulations • NYDFS Cybersecurity Regulation The New York Department of Financial Services’ Cybersecurity Regulation (23 NYCRR 500) became fully effective in March 2019 after a two-year phase in period. All life settlement providers and brokers licensed in by the New York Department of Financial Services (NYDFS) are now fully subject to the data security regulatory requirements. However, because life expectancy providers and life settlement investors, both of which possess large amounts of medical information about life insureds, are not licensed by the NYDFS, they are not subject to this NYDFS Regulation. The exemptions from the NYDFS Regulation are limited, not wholesale, in nature, and thus all NYDFS licensed life settlement providers and brokers are subject to many of its requirements.

• NAIC Data Security Model Law During 2019, the legislatures on Alabama, Connecticut, Delaware, Mississippi and New Hampshire adopted the National Association of Insurance Commissioners Data Security Model Law. This law is the analog to the NYDFS Regulation and embraces many of its concepts with a few differences. Other states are expected to adopt this NAIC law in 2020, which will affect life settlement providers and brokers licensed in those states as well as potentially life expectancy providers if Florida and Texas, which require registration and licensure, respectively, of life expectancy providers, adopt this model law.

• CA CCPA Like many businesses, both within and without the insurance industry, the life settlement industry spent much time and effort during 2019 assessing compliance with the California Consumer Privacy Protection Act, which became effective on January 1, 2020, but with a delayed enforcement date later this year likely on July 1, 2020. While life settlement providers and brokers are generally subject to the Gramm Leach Bliley Act (GLBA) privacy and security laws and regulations implemented by the states for the insurance industry, the CCPA only exempts GLBA regulated persons to the extent that the GLBA protects non-public personal financial and health information. Because of the CCPA’s broad definition of “personal information”, life settlement providers and brokers may be subject to the stringent requirements of the CCPA if they collect personal information that is beyond GLBA protected data, unless a life settlement provider or broker is exempt from the CCPA (mostly likely, if at all, on the basis of having $25 million or less of annual gross revenue).

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Limitation on Life Settlement Provider Licensing Exemption and Void Policy Sale In a rare life settlement regulatory based case, a Texas federal district court found that the West Virginia exemption under the life settlement provider licensing law that allows a natural person to buy one life insurance policy per year without being licensed, which is a common feature of the life settlement acts, applied on a nationwide basis and is not limited to a single exempt natural person purchase transaction from a West Virginia resident life settlor.7 The court attributed to the natural person purchaser at issue many prior life settlement transactions in which he was involved on behalf of his licensed life settlement provider employer during the year in which the West Virginia life settlement transaction occurred. Moreover, as a consequence of inapplicability of the natural person transaction exemption, the court held that the life settlement agreement was unenforceable because the purchaser was not licensed in West Virginia as a life settlement provider and had used a life settlement agreement form that the West Virginia Insurance department had not approved, despite any express private right of action or other authority in West Virginia’s viatical settlement act negating the enforceability of a life settlement contract entered into by an unlicensed life settlement provider.

Securities Law Litigation/Howey Test Applies to Non-Fractionalized Life Insurance Policies In Living Benefits v. Kestrel Aircraft Co.8, the Fifth Circuit Court of Appeals in 2020 affirmed a Texas district court’s decision that a life settlements origination agreement was unenforceable in a bankruptcy case because the originator party was not registered under the federal Investment Advisers Act of 1940. While there are several federal and state cases holding that investments in fractionalized life settlement policies are securities under the well-known Howey test used for determining when an investment contract form of a security exists, the Living Benefits case found that the sale of an investment in a whole life insurance policy also was an investment contract and thus subject to federal securities laws, here the Investment Advisers Act of 1940. This case raises a myriad of both federal and state securities laws compliance issues for routine life settlement transactions for both life settlement providers and brokers as well as life insurance agents that receive transaction compensation.

Transactions and Business Trends Sale of Major Life Settlements Asset Manager The life settlement industry experienced one of its most significant corporate transactions in 2019. Vida Capital, one of the industry’s largest life settlements asset managers was acquired by two private equity firms that coinvested in the transaction.

Direct-to-Consumer Business Growth More life settlement providers began testing the direct-to-consumer business model, and the few that were already engaged in this method of sourcing new life insurance policy purchases saw moderate growth, in 2019. However, transaction closing efficiency and streamlined transaction documentation continue to be challenges for this non-broker intermediary business model.

Brian Casey is a partner and Co-Chair of the Regulatory and Transactions Insurance Practice Group and Thomas Sherman is of counsel in the Atlanta office of Locke Lord LLP. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its -cli ents, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes only and is not intended to be and should not be taken as legal advice.

7 Consolidated Wealth Management and John Spalding v. Rhonda Short, S.D. Texas, Houston Division, 2019 WL 548516 (October 2019) 8 In the Matter of Living Benefits Asset Management LLC v. Kestrel Aircraft Company, United States Court of Appeals for the Fifth Circuit, Case No. 18-10510, February 22, 2019

For questions or additional information, contact Brian T. Casey at [email protected] or Thomas D. Sherman at [email protected].

Locke Lord LLP disclaims all liability whatsoever in relation to any materials or information provided. This piece is provided solely for educational and informational purposes. It is not intended to constitute legal advice or to create an attorney-client relationship. If you wish to secure legal advice specific to your enterprise and circumstances in connection with any of the topics addressed, we encourage you to engage counsel of your choice. (013120)