Premium Financed Policies becoming mainstream

The current battleground in the life settlements industry, as the recent article by AM Best shows, is whether or not a carrier that refuses to pay out on a policy needs to refund premiums. The more states mandate that premiums need to be refunded, the more mainstream premium financed policies will become. Many policies that have been in issuance since the early 2000s would be too expensive for carriers to refuse paying out on - the carriers in essence become 'damned if they do, damned if they don't' pay out. If refunding of premiums as a law spreads, that would necessarily lead to a dramatic tightening of spreads for premium financed paper. And a corresponding uplift on asset values for many hedge funds and private equity firms. And possibly to some tears for Phoenix.

The article below from A.M. Best throws more light on  the same issue. 

Life Industry Battling Investment Groups Over Proposed Return of Premium Legislation

OLDWICK, N.J. - The American Council of Life Insurers is fighting efforts by hedge funds and other investors to get laws passed requiring life insurers to return the premium on a life policy to them even after a policy is voided due to fraud or determined to be a stranger-originated transaction.

Millions in premium is at stake in the battles in the states.

So far this year, South Dakota and Minnesota have introduced return of premium legislation, and bills were introduced last year in Delaware, California, Connecticut and Florida, but did not pass, Whit Cornman, a spokesman for the ACLI, told Best's News Service. "However, we anticipate proponents will try to introduce the measures again this year."

Return of premium legislation would take away the financial consequences of fraud by "encouraging strangers to fraudulently originate life insurance on the lives of vulnerable seniors and then market such policies to third parties with no financial risk at all," said Cornman. "If the policy is later deemed to be obtained without an insurable interest, the third party gets all of the premiums paid returned, with interest."

If the fraud is not detected and the policy claim is paid, the third party receives the death benefits, he said. "It’s a win-win for the third party."

Some U.S. courts have ruled an insurance company is not obliged to return the premium, Daniel Kahan, an actuarial life insurance valuation consultant in Canada, told Best's News Service. Recent court cases have allowed insurers to keep the premiums, "presumably to punish the original or current owners" for fraud, and deter hedge funds from building up life settlement portfolios, Kahan said.

In a typical life insurance settlement, a policy purchased in good faith but no longer wanted is sold to a third party. A life insurance policy is sold by its owner for an amount greater than the surrender value of the policy but lower than the face amount. In STOLI transactions, financial speculators entice senior citizens to purchase life insurance with the intent of transferring the death benefits to the speculators at a later date (Best's News Service, Oct. 23, 2008).

Legislation requiring the return of premiums in cases involving fraud will "overturn well-established laws protecting consumers against wagering on human life," Cornman said.

Jack Kelly, managing director of the Institutional Longevity Markets Association, told Best's News Service that premium return isn't related to STOLI — that's "a red herring" insurers are trying to redirect the issue. ILMA is comprised of institutional investors and intermediaries worldwide in the mortality and longevity market, and encourages the development of life settlements and premium finance.

It's a doctrine of consumer protection that when insurers void or terminate a policy, the insurers are required to return premiums to the owner, Kelly said. When a contract is voided, the parties are placed back into the position they were in at the time of the contract, Kelly said.

Gary Sanders, vice president for securities and state government relations for the National Association of Insurance and Financial Advisors, said when a life settlement provider owns a policy, the provider pays the premium but when the provider bundles thousands of policies together and sells them, whoever buys them pays the premiums.

NAIFA is opposed to bills that would provide for a return of premium when a policy is voided for fraud or STOLI, as they would facilitate STOLI, Sanders said. Investors paid a discounted amount for a policy — "pennies on the dollar," partly because they knew some policies "didn't have an insurable interest when they were sold."

It was not until recently that some certain carriers "have started trying to keep the premiums from policies owned by investors," Kelly maintains.

Gloria GreningWolk, a North Carolina-based consumer advocate, said she's opposed to legislation that encourages life insurers to abandon stringent underwriting. Many have abandoned their standards, she contends.

When courts allow insurers to keep the premiums, they "encourage the tacit conspiracy" of insurers in STOLI, Wolk maintains. If legislation is enacted to allow them to keep the premiums "it will encourage others to follow suit," she said.

Cases filed by Phoenix Cos. ask the courts to invalidate the policy and allow them to keep the premiums, Kelly said, noting Phoenix filed eight such cases in Delaware federal court over a couple of days last year.

Alice Ericson, a spokeswoman for Phoenix Cos. Inc. said "hedge funds and other life settlement market players are using aggressive tactics, including regulatory complaints and litigation as well as special interest legislation, in an attempt to maximize their own returns. Their current efforts to change state rules around return of premium for illegal or invalid policies are examples of these tactics."

For years, courts have determined whether an insurer should return premiums if a policy is rescinded or voided, Cornman said. "There can be no hard and fast rule because each situation is unique."

Attempts to get comment from Fortress, an investment and hedge fund firm, were unsuccessful. The Life Insurance Settlement Association deferred comment to a life settlement provider, which didn't return calls seeking comment.