Insurance: Policy sales, transfers under fire

Industry watchers suspect that the warning was triggered by a significant increase in STOLI activity in recent months. These transactions involve buying a life insurance policy with the intent of transferring the right to receive the death benefit to a third party – often an investor who has no insurable interest in the insured person’s life.

“It started to pick up steam about a month ago,” says Eric Wachtel, national chief compliance officer with Mississauga, Ont.-based IDC Worldsource Insurance Network Inc. “There’s a lot of buzz in the industry about it, from coast to coast.”

Viatical and life settlements have long been a topic of contentious debate within the insurance industry. A life settlement is the sale of a life insurance policy to a third party in exchange for an immediate cash settlement that is less than the face value of the policy but more than the current cash-surrender value. A viatical settlement refers to the same sort of transaction in a case in which the policyholder is terminally ill, typically with a life expectancy of less than 24 months.

At the moment, however, STOLI is of more immediate concern for regulators. Specifically, insurance companies have identified a growing number of “life premium financing arrangements.” These typically involve a person taking out an insurance policy that is assigned as collateral to secure a loan from a financing firm. The loan is used to pay the premiums on the policy and, upon death of the insured person, the financing firm collects a portion of the death benefit as repayment of the loan.

In some cases, these arrangements are being aggressively marketed to consumers as a lucrative strategy for securing “free” life insurance.

“People are taking out insurance, not because they want the insurance but because somebody is willing to pay the premiums for them,” says Daniel Kahan, president and founder of Halifax-based Canadian Life Line Ltd., which provides viaticals in the form of loans to policyholders.

However, regulators and insurance industry players are raising concerns that clients may be entering into these arrangements without fully understanding how they work – or the risks involved. In cases in which the underlying loan is capitalized, for example, Wachtel says, the portion of the death benefit ultimately paid to the policyholder’s beneficiaries could end up being far smaller than anticipated.

“These average consumers out there are thinking they have free life insurance,” Wachtel says, “and, suddenly, Mom or Dad passes away and the actual amount paid out to the family or the business partner is a fraction of what the policy contract stated.”

Several insurers have released notices in recent weeks indicating that premium-financing arrangements are in violation of industry codes of conduct – and some notices warn that advisors who help to facilitate these arrangements could have their producer contract terminated.

“There is a great risk to the advisor,” says Wachtel, “especially if it looks like they were doing this fully aware of what was going on.”

Those who provide premium-financing arrangements, however, say there’s nothing offside about them.

“There’s been a lot of negativity circulating about premium financing in Canada, but I think a lot of it is misinformation,” says Edward Anthony, founder of Toronto-based Life Premium Finance Corp. Ltd. (LPF), which provides loans to clients who need life insurance in cases in which they don’t have sufficient cash flow to pay their premiums. Such a loan, says Anthony, is secured by the collateral assignment of the insurance policy, as well as by equity in the client’s home, and the arrangement is designed to provide enough insurance coverage to pay back the loan while still covering the client’s estate planning needs.

Although some insurers have raised concerns about this arrangement, Anthony says, it doesn’t violate any rules: “Lending money to policyholders to help [them] pay their insurance premiums, which is the business we’re in, is not violating any sections of the [OIA]. Collateral-assignment agreements are done all the time with conventional, traditional lenders.”

The regulations regarding this practice vary from province to province. In most Canadian provinces, viaticals, life settlements and other transactions that fall into the category of “trafficking” in life insurance are prohibited under insurance legislation. The exceptions are Saskatchewan, New Brunswick, Nova Scotia and Quebec, which don’t have specific rules prohibiting these transactions.

However, the regulations are not black and white. FSCO’s recent warning, for example, says that STOLI arrangements, viaticals and life settlements “may not be legal,” depending on the circumstances.

This is because the trafficking rules under Section 115 of the OIA target organizations in the business of buying large quantities of life insurance policies and selling them as investments rather than targeting one-off situations in which an individual sells or transfers a policy.

“Currently, there are no legislative restrictions that prevent an individual from selling his or her life insurance policy to another individual,” explains Anatol Monid, director of the market conduct branch at FSCO.

FSCO’s warning was intended to clarify the rules on this topic, Monid says. Given the vague nature of the language in the regulations and the warning, however, many people in the insurance industry still are confused about what is and isn’t permissible.

“They’re not even clear – is this a legal product or is this an illegal product here in Ontario?” says Greg Pollock, president and CEO of Toronto-based Advocis. “I don’t find it clear.”

Even individuals who are in the business of providing viatical settlements and premium financing admit that the rules are unclear. Anthony, for example, says, “It’s a very murky area.”

Despite FSCO’s recent warning, however, Anthony doesn’t anticipate that LPF will encounter any regulatory problems. “Our program is very conventional; it’s very conservative,” he says. “I don’t foresee any issues with FSCO.”

Although the regulations may be vague, most insurers are very clear about their opposition to life settlements and other similar arrangements.

“We’ve looked at the experience in other countries – and particularly the U.S., where such activities are allowed,” says Frank Zinatelli, vice president and general counsel at the Canadian Life and Health Insurance Association Inc. “And what has generally been associated with those activities are a variety of frauds and abuses. Our industry members oppose life settlements and viatical settlements for that very reason.”

To monitor for these arrangements, most insurance applications include questions about any intention for third-party involvement in the policy. Some insurers are considering adjusting the wording of these questions to ensure they also guard against premium-financing arrangements.

However, Anthony says, his firm has been in discussions with one insurance carrier that has expressed support for LPF’s program and is exploring a possible referral arrangement.

Still, Wachtel urges advisors to be wary of these arrangements. He suggests doing extra due diligence in cases in which clients are seeking unusually large policies relative to their income.

“There is a rationality test that the advisor would be expected to adhere to and judge for,” Wachtel says. “Do a thorough job with fact-finding and needs analysis.”

Meanwhile, Pollock says, there is less activity in the viatical and life settlements market in Canada: “I don’t sense that there’s much of a market in this product today in Canada.”

That could change, however, if regulators and insurers give the green light for these transactions. Proponents argue that many Canadians would seize the opportunity to sell their insurance policies as an alternative to surrendering them. These proponents note that such transactions are very popular in the U.S. and other jurisdictions where they’re permitted.

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