United States Government Accountability Office Report to the Special Committee on GAO Aging, U.S. Senate July 2010 LIFE INSURANCE SETTLEMENTS Regulatory Inconsistencies May Pose a Number of Challenges GAO-10-775 July 2010 LIFE INSURANCE SETTLEMENTS Accountability Integrity Reliability Regulatory Inconsistencies May Pose a Number of Highlights Challenges Highlights of GAO-10-775, a report to the Special Committee on Aging, U.S. Senate Why GAO Did This Study What GAO Found Since the late 1990s, life settlements The life settlement market is organized largely as an informal network of have offered consumers benefits but intermediaries facilitating the sale of life insurance policies by owners to also exposed them to risks, giving third-party investors. Policy owners may sell policies directly to investors in rise to regulatory concerns. A policy owner with unneeded life insurance some cases, but owners and investors commonly use intermediaries. Life can surrender the policy to the settlement brokers represent policy owners for a fee or commission and may insurer for its cash surrender value. solicit bids for policies from multiple life settlement providers with the goal of Or, the owner may receive more by obtaining the best price. Life settlement providers buy life insurance policies selling the policy to a third-party for investors or for their own accounts. No comprehensive data exist on investor through a life settlement. market size, but estimates indicate it grew rapidly from its inception around These transactions have involved 1998 until the recent financial crisis. Estimates of the total face value of high-dollar-amount policies covering older persons. Despite their potential policies settled in 2008 ranged from around $9 billion to $12 billion. benefits, life settlements can have unintended consequences for policy State and federal regulators oversee various aspects of the life settlement owners, such as unexpected tax market. Life settlements typically comprise two transactions: the sale of a liabilities. Also, policy owners policy by its owner to a provider, and the sale of a policy by the provider to an commonly rely on intermediaries to investor. As of February 2010, 38 states had insurance laws specifically to help them, and some intermediaries regulate life settlements. State insurance regulators focus on regulating life may engage in abusive practices. settlements to protect policy owners by imposing licensing, disclosure, and As requested, this report addresses other requirements on brokers and providers. The Securities and Exchange how the life settlement market is Commission (SEC), where its jurisdiction permits, and state securities organized and regulated, and what regulators regulate investments in life settlements to protect investors. One challenges policy owners, investors, type of policy (variable life) is considered a security; thus, settlements and others face in connection with involving these policies are under SEC jurisdiction. SEC also asserted life settlements. GAO reviewed and analyzed studies on life settlements jurisdiction over certain investments in life settlements involving nonvariable, and applicable state and federal or traditional, life insurance policies, but their status as securities is unclear laws; surveyed insurance regulators because of conflicting circuit court decisions. All but two states regulate and life settlement providers; and investments in life settlements as securities under their securities laws. interviewed relevant market participants, state and federal Inconsistencies in the regulation of life settlements may pose challenges. regulators, trade associations, and Policy owners in some states may be afforded less protection than owners in market observers. other states and face greater challenges obtaining information to protect their interests. Twelve states and the District of Columbia do not have laws What GAO Recommends specifically governing life settlements, and disclosure requirements can differ Congress may wish to consider among the other states. Policy owners also could complete a life settlement taking steps to help ensure that without knowing how much they paid brokers or whether they received a fair policy owners involved in life settlements are provided a consistent price, unless such information was provided voluntarily. Some investors may and minimum level of protection. face challenges obtaining adequate information about life settlement SEC agreed with our matter for investments. Because of conflicting court decisions and differences in state congressional consideration, and the laws, individuals in different states with the same investments may be National Association of Insurance afforded different regulatory protections. Some life settlement brokers and Commissioners did not agree or providers may face challenges because of inconsistencies in laws across disagree with it but raised related states. GAO developed a framework for assessing proposals for modernizing concerns. the financial regulatory system, two elements of which are consistent consumer and investor protection and consistent financial oversight for View GAO-10-775 or key components. For more information, contact Orice Williams similar institutions and products. These two elements have not been fully Brown, (202) 512-8678 or achieved under the current regulatory structure of the life settlement market. [email protected]. United States Government Accountability Office Contents Letter 1 Background 3 Life Settlement Market Organized Largely as an Informal Network of Specialized Intermediaries 4 State and Federal Regulators Oversee Various Aspects of the Life Settlement Market 5 Regulatory Inconsistencies May Pose Challenges for Policy Owners, Investors, and Life Settlement Intermediaries 6 Conclusion 7 Matter for Congressional Consideration 8 Agency Comments and Our Evaluation 8 Appendix I Briefing to Congressional Staff on Life Insurance Settlements 11 Appendix II Results of GAO’s Survey of State Insurance Commissioners Regarding Their Regulation of Life Settlements 85 Appendix III Results of GAO’s Survey of Licensed Life Settlement Providers 111 Appendix IV Comments from the Securities and Exchange Commission 115 Appendix V Comments from the National Association of Insurance Commissioners 117 Appendix VI GAO Contact and Staff Acknowledgments 119 Page i GAO-10-775 Life Insurance Settlements Abbreviations ACLI American Council of Life Insurers FINRA Financial Industry Regulatory Authority ILMA Institutional Life Markets Association LISA Life Insurance Settlement Association LSI Life Settlement Institute NAIC National Association of Insurance Commissioners NASAA North American Securities Administrators Association NCOIL National Conference of Insurance Legislators SEC Securities and Exchange Commission STOLI stranger-originated life insurance This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. Page ii GAO-10-775 Life Insurance Settlements United States Government Accountability Office Washington, DC 20548 July 9, 2010 The Honorable Herb Kohl Chairman Special Committee on Aging United States Senate Emerging in the late 1990s, the life settlement market offers consumers benefits but also exposes them to risks, which have raised regulatory concerns. Policy owners with unneeded or unaffordable life insurance can surrender their policies to their insurance companies for the cash surrender value.1 However, life settlements provide policy owners with another option: in a life settlement transaction, third-party investors compete to buy an existing, or in-force, policy from its owner—potentially resulting in an offer for the policy that is higher than its cash surrender value.2 In exchange for the payment, the investor becomes the new policy owner and is responsible for paying the policy premiums but is entitled to receive the policy death benefit when the insured dies. Life settlements evolved from viatical settlements, which historically have involved insured persons who are chronically or terminally ill and expected to live 2 years or less. In contrast, life settlements traditionally have involved policies covering older persons (for example, 65 or older) who are expected to live more than 2 years.3 Importantly, life settlements are complex transactions that can take several months to complete. Policy owners commonly rely on specialized intermediaries to help them understand and complete the transactions. As 1The cash surrender value of a policy is the contractual price at which a policy owner can return the policy to the insurance company that issued it. 2Policy owners had the right to sell their life insurance policies before the emergence of the life settlement market. A Supreme Court decision in 1911 (Grigsby v. Russell, 222 U.S. 149) determined in effect that a life insurance policy is private property that can be sold at the will of the owner. 3Both life and viatical settlements involve the sale of a life insurance policy by its owner to a third-party buyer, but the life settlement industry distinguishes between life and viatical settlements based on the insured’s life expectancy. However, some state regulators define “viatical settlement” broadly