Life For Sale

Cashing in on insurance policies forms a rapidly growing industry, but not without its growing pains.

by Charles Toutant

1-30-2006

Sales of life insurance policies for cash are growing in popularity and consequently falling under greater government scrutiny.

Providers of viaticals - from the Latin viaticum, or "provision for a journey" - once limited their services to the terminally ill, such as AIDS sufferers, as a way to finance catastrophic health-care costs. But as medical advances prolonged the lives of AIDS sufferers, thereby postponing insurance payoffs, the market flattened.

Since the late 1990s, though, vendors have expanded their customer base by offering "life settlements" to healthy senior citizens: people 65 or older with a life expectancy of up to 12 years.

Making policy sales available under a broader range of criteria caused an industry spurt. Life settlements are becoming popular with the affluent, who no longer see life insurance policies as giving a sound return on investment. And another reason for keeping life insurance - the financing of federal estate taxes - has been negated by recent tax-rate cuts.

"It's growing like crazy because there are a lot of people with a net worth of $3 million who don't need estate tax protection or who have been unnecessarily oversold on life insurance," says Doug Head, executive director of the Life Insurance Settlement Association, a trade group in Orlando, Fla.

Life settlements, which totaled $13 billion nationally last year measured by policy face values, are expected to top $19 billion this year, according to Bernstein Investment Research of New York City.

The growing trade has caught the attention of the New Jersey Legislature. A new law, N.J.S.A. 17B:30B-1 et seq., effective Dec. 21, requires companies selling life settlements to register with the state. (Previously, only viatical sellers needed to register.)

The new law may expand the industry in New Jersey because it removes some restrictions on who can offer the products. It allows life insurance agents to register as brokers of viaticals and life settlements, while previously one agent could not hold both positions simultaneously.

Life settlements are essentially the same product as viaticals. The owner of a universal or whole life policy assigns it to a purchaser for a cash amount that is less than the death benefit but more than the surrender value. The assignee takes over the payment of premiums on the policy and collects the full death benefit when the seller dies.

Or, more likely, the assignee sells the policy to investors. "A lot of these policies are being bought by German mutual funds, by hedge funds," says John Mandel, vice president of The Ardan Group in Woodbridge, which offers viaticals and life settlements.

The amount of a viatical or life settlement is based on an actuarial analysis of the seller's medical history, since policies that will "mature" sooner have a greater value than those where payment will be deferred for a long time. Policyholders in extremis thus draw a higher price than healthy ones. Viaticals per se are settlements where a physician certifies that the seller's life expectancy is two years or less. The Health Insurance Portability and Accountability Act (HIPPA) generally exempts such settlements from federal income tax. By contrast, life settlements are tax-free only up to the total amount of premiums paid over the life of the policy; anything above is ordinary income.

The secondary market for life insurance policies broke the monopoly held by insurance companies when cash-strapped insureds canceled their policies, typically for predetermined surrender values that were far less percentage-wise than the life settlements now available.

Since insureds want the cash their policies can yield, there are few complaints about viaticals and life settlements, according to the state Department of Banking and Insurance.

When the funding stops

Still, the new law in New Jersey may head off problems of the type suffered by Jacob Cohn's client: a woman suing an out-of-state company in Camden County for breaching terms of a viatical contract.

"My sense is, had this regulation been in place when this transaction occurred and had they been registered and licensed, . . . this whole transaction would have been illegal," says Cohn, of Cozen O'Connor in Philadelphia.

Cohn's client, identified in pleadings as M. Smith, was diagnosed with AIDS. In 1994, she signed a contract with Life Partners Inc. of Waco, Texas, that called for the company to pick up the premiums on her life and medical insurance, which were billed jointly. For her $150,000 policy, the company paid her $84,500 and placed $5,500 into a trust to pay her life and health insurance premiums.

In 1998, Life Partners threatened to stop paying the health insurance portion of Smith's premium because the trust funds had run out. It ultimately relented but last August threatened again. The AIDS Law Project in Philadelphia hooked her up with Cohn, who took the case pro bono.

In November, Cohn filed suit, seeking specific performance, and preliminary and permanent injunctive relief. The case, Smith v. Life Partners, Inc., C-214-05, is before Superior Court Judge M. Allan Vogelson in Camden County.

"Our client continues to be bound to the viatical company and she is at their mercy," says AIDS Law Project executive director Ronda Goldfein. "She still needs something from them, but they've gotten all they could get from her, other than her quick demise."

Life Partners' lawyer, Joseph Kenney of Ballard Spahr Andrews & Ingersoll in Voorhees, moved to dismiss on jurisdictional grounds, since the Texas defendant has no offices here and Smith lives in Pennsylvania (though she lived in New Jersey when she signed the viatical contract).

Another dismissal ground is failure to state a cause of action, the defense motion states. Since all premiums due have been paid, Smith is seeking only an assurance of future payments - in essence, an advisory opinion, which the Declaratory Judgment Act does not allow, wrote Kenney, who declined to comment for this article.

Cases like Smith's are rare, says AIDS Law Project's Goldfein. Having counseled AIDS-afflicted people about viaticals, she says most have no problems. "I never felt they were being taken advantage of or that it was ghoulish," Goldfein says. Insurance "is an asset and people should be able to negotiate their assets any way they want."

Goldfein does say she advises clients to obtain offers from three viatical companies to compare terms.

Lawyers usually are not consulted on such settlements until after the fact, says Frank Demmerly Jr., a trusts and estates lawyer at Haddonfield's Archer & Greiner. "I think you should speak with an independent party about it to make sure you understand the transaction," he says.

Trouble has been more common for sellers of viatical settlements who promise investors unrealistically high gains.

In 2003, a federal judge in Toledo, Ohio, sentenced John Richard Jamieson, the head of Toledo viatical settlement company Liberte Capital Group, to 20 years in prison for defrauding investors of more than $90 million.

In another case that year, Stephen Keller, founder of Kelco Viatical in Lexington, Ky., was sentenced to 14 years in prison for a scheme in which people with AIDS were encouraged to take out small policies that did not require medical tests, and then sell the policies to Kelco.

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