The Financial Services Consumer Alliance’s purpose is to promote and defend the rights of consumers in the financial industry. This organization will be launched and be fully operational by September 2014. It’s CEO, Richard Proteau, in an interview soon to be published stated: “this organization will be unlike any others. First, it will be a social organization intent on leveraging every single social media to promote the rights of consumers in the financial industry… Our tools to achieve our goals come from my 20+ years experience in this industry… such tools are unique and innovative and will forever change the face of this industry such as the Financial Services National Database of Consumer’s Complaints which will allow us to identify past and future problems through data mining of registered complaints made by consumers, allowing us to decide on the right legal action to address the issue…
What is a life settlement? First let’s start with the word settlement as its meaning is extremely important
Settlement: is a business process whereby an interest in an asset is delivered in part or in full in exchange for a payment of money either through the surrender, transfer or assignment of the asset to another party.
In this context, what is the definition of a life settlement which would enclose all forms and categories of life settlement?
Life settlement involves the delivery of an interest in a life insurance policy, through the surrender, transfer or assignment of the policy, in part or in full, from one party to another against a settlement payment which takes principally the form of cash payment or loan.
There are now many categories of life settlements and each type of life settlement comes with its own set of variables and issues.
However, insurers have always tried to make life settlements the synonym of only one of its subcategory which is the viatical settlements. Viatical settlements have been abused and have a bad reputation. By making all life settlements synonym to viatical settlements, automatically all life settlements by association become tainted and are perceived to be bad. It is a very effective way for insurers to close the door on any opportunities to discuss life settlements in order to preserve the status quo which is very profitable for them.
For the first time we will categorize the different forms of life settlements from a consumer perspective:
1. Surrender Settlement: This type of settlement is the full or partial surrender of the death benefit interest in a life policy in exchange for a) nothing for the death benefit and b) a return of part of the excess of the invested premium + interest which is represented by part or the full cash value which is paid by the insurer in accordance with the provisions of the policy contract.
Issues with this type of settlement:
a) The policy owner is misinformed and believes that he receives the cash value in exchange for the surrender of the death benefit. This is wrong. The cash value is a representation of the excess premium invested and has nothing to do with the value of the death benefit.
b) Upon surrender, the policy owner transfers back his interest in the death benefit for nothing to the insurer. However this death benefit can have a lot of value which the insurer takes in as profit. This is not disclosed to the client. The more the policy owner is unaware or uneducated about the value of his death benefit, the more this is profitable to the insurer.
c) This explains why insurers have done so little in educating their agents on the concept of the Fair Market Value of life insurance. Insurers want policy owner to surrender their life policies at cash value so that they make a lot of profit on the transfer of the interest in the death benefit at a value of ZERO when that value can be quite significant.
2. Loan Settlement: This type of settlement is the full or partial transfer of an interest in a life policy to another party named the lender through an assignment of this interest in order to secure a loan. There are 3 types of leveraged settlement.
The first settlement is a loan contractual settlement where the lender is the insurer and the term of the loans are dictated by the policy contract. This type of settlement is called policy loans.
The second settlement is a leveraged settlement which is the transfer of an interest in a life insurance policy to a third party which is not an insurer through the assignment of the policy where the cash value is used as a guarantee to secure a loan or series or loan.
The third type of loan settlement is a reverse mortgage settlement which is the transfer of an interest in a life insurance policy to a third party which is not an insurer through the assignment of the policy where the Fair Market Value instead of the cash value of the policy is used as a guarantee to secure a loan or series or loan.
FSCA Issues with loan settlements:
a) The issue here is with the position of the insurers who have stated that they have the right to oppose a transaction between the policy owner and a third party when they are not a party to the transaction (loan transaction) and when no provisions in the policy contract give them this right.
b) The position of the insurers and therefore the insurance industry is that it is ok to leverage the policy based on cash value but it is not ok to leverage it based on Fair Market Value. FSCA believes there is no legal basis for this position. For example, let’s take the situation of a policy owner taking a leverage loan on his policy. Suddenly the client gets terminally ill and is unable to pay interest on the loan. The loan becomes greater than the maximum allowable loan determined by the cash value. There is a margin call from the lender. The policy owner cannot meet the margin call. Normally the policy would have to be surrendered which would have grave taxable consequences for the policy owner. However the lender after being informed that the policy owner is terminally ill decides to waive the margin call realizing that the Fair Market Value of the policy is far greater than the cash value because of the value of the death benefit considering the terminal illness of the client. Based on Fair Market Value, the leveraged loan is not offside and no margin call is needed. Based on the position of the insurance industry, the lender would have no right to do this and use the FMV as the security for the existing loan.
In this case, we could see that it is to the advantage of the insurers that the terminally ill policy owner is forced to surrender his policy even if it is financially catastrophic for him. The insurers would profit highly from restricting transactions to the cash value of a policy.
3. Contractual Benefit Settlement: is the transfer of an interest in a life policy from the policy owner to the insurer following a “triggering” event which is identified in the contractual provisions of the life insurance policy which also specifies the terms and conditions of this transfer.
There are two types of Contractual Benefit Settlement. First there is a Cash Value Contractual Benefit Settlement where the triggering event is a critical illness, total disability or long term care and where the insurer allows the payment of the cash value. Usually the benefit for the policy owner is that they can receive the cash value as a non taxable benefit where it would have been taxed as a surrender or withdrawal.
The second type of contractual settlement is a Face value (or Fair Market Value) Contractual Benefit Settlement. In this case, the benefit paid is determined by the death benefit of the policy. This type of benefit is often referred as an Accelerated Death Benefit and the triggering event is a terminal illness where the life expectancy of the policy owner has fallen below 2 years.
Issues: FSCA issues are with Accelerated Death Benefits
a) We have found that insurers are in a conflict of interest when providing Accelerated Death Benefits. These insurers have speculated in the pricing of their policy that terminally ill patients who experience financial difficulties would lapse their policies in order to access the cash value of the policy (opting for a surrender settlement).
b) There is tremendous profit for the insurer to deny a request for an Accelerated Death Benefit forcing terminally ill policy owners into a surrender settlement and this explains why a study by the Ontario Insurance Commission has found that consumers had a lot of difficulties in accessing Accelerated Death Benefits:
“This study found that because the insurance industry has not developed and promoted a strong living benefits program, a gap has been created which for-profit viatical companies are eager to fill. A “living benefit” is a cash payment on a life insurance policy made by the company to a policyholder who is terminally ill while that person is still alive. The cash payment is then deducted from the face value of the policy when the person dies.
Although the Ontario Insurance Commission has developed “recommended practices” regarding living benefits programs, these practices are not mandated, and most insurance companies fall well below the standards set out by this document. For example, the maximum cash payouts tend to be very low (maximum $25,000 regardless of the face value of the policy) and many insurance companies do so little to publicize to policy holders the option of living benefits as to appear to be discouraging it. The inability of the insurance industry to regulate practice regarding living benefits has created a climate favorable to viatical companies.”
c) FSCA representing consumers finds the exploitation of terminally ill policy owners by the insurers to be extremely abhorrent, repugnant and disgusting. For FSCA redressing this situation will be its first order of priority. FSCA believes as per the study made for the Ontario Insurance Commission, the only viable solution to protect terminally ill policy owners is to allow third parties (non insurers) to offer Accelerated Death Benefits and therefore compete with insurers and through this competition, ending this speculation and trafficking done by insurers on the back of terminally ill policy owners.
4. Viatical settlement is the sale of a policy owner’s existing life insurance policy to a third party for more than its cash surrender value, but less than its net death benefit. As far as FSCA is concerned there are two types of viatical settlement. We could use the term legal and illegal viatical settlement but this would be wrong. FSCA does not make laws or apply the laws. We will use the term ethical and unethical viatical settlements.
Ethical Viatical Settlement involve the sale of life policies which originally had a valid insurable interest but this insurable interest has changed and does not hold the same value anymore for the policy holder and beneficiary. Usually the policy owner would opt for a surrender settlement; giving away the value of his death benefit to the insurer. However the policy owner could instead get something for the value of his death benefit by selling his death benefit interest to a third party.
Please note that giving a life policy to a charity in exchange for a charitable receipt equal to FMV of policy is an Ethical Viatical Settlement.
Unethical Viatical Settlement involves the trafficking and speculating on life insurance where either life insurance is issued with no valid insurable interest as part of a scheme to speculate on insurance or by influencing policy owner to sell their life policies when the insurable interest is still relevant depriving the beneficiaries of the protection offered by the death benefit of these policies.
Please note that for FSCA any viatical settlement which would deprive a beneficiary of a death benefit that is still relevant and needed without his written consent is considered an unethical viatical settlement.
Issues with viatical settlements:
a) FSCA representing consumers finds the exploitation of any consumers through the use of unethical viatical settlements to be extremely abhorrent, repugnant and disgusting. We will oppose such schemes when informed of them.
b) Despite antiquated legislation in many provinces that prohibit viatical settlement, viatical settlements have taken place and are taken place in these provinces. In fact looking at section 115 of the Ontario insurance Act:
115. Any person, other than an insurer or its duly authorized agent, who advertises or holds himself, herself or itself out as a purchaser of life insurance policies or of benefits thereunder, or who trafficks or trades in life insurance policies for the purpose of procuring the sale, surrender, transfer, assignment, pledge or hypothecation thereof to himself, herself or itself or any other person, is guilty of an offence.
First as you can see there are no dispensations for charities. Charities looking for the gifting or buying policies are breaking the law. They are trading in life policies.
c) It is clear that the law must be updated and the question is not whether viatical settlement must be legalized as it already done. The question is what kind of viatical settlemts must be permitted and what are the regulations needed to ensure the protection of policy owners not only from the third party profiting from the viatical settlement but also from the insurer who would profit greatly from the non existence of viatical settlements.
Divide and conquer has been the strategy used by insurers in dealing with life settlements. I am certain that many people will not agree with me with the redefinition of what is a life settlement. By keeping the different types of settlements apart, the industry is able to keep the consumer in the dark ensuring that is unaware of all of his options and of the whole picture.
By identifying the common thread to all life settlements, this ensures that the consumer can make the best decision in regards to his needs. This is the only viable starting point for any future discussions on life settlements.