In the early days of the life settlement industry, when it focused more on viaticals than life settlements, talk of pitfalls and scams was more relevant than it is today. At that time, there were some bad actors who preyed on the general lack of knowledge about the industry and relied on lax or nonexistent regulations.
Fortunately, the industry has become increasingly mainstream and now focuses almost exclusively on life settlements rather than viatical settlements (where much of the negative perceptions originated). Thirty-nine states now regulate some aspect of the viatical or life settlement market, and these regulations have brought stability and confidence to policy owners and the companies and individuals who constitute what is known as the secondary market for life insurance.
Practically speaking, most of the problems one might encounter in today's settlement market are parallel to those found in many other industries and can readily be avoided. In fact, it is not difficult today to avoid potential pitfalls in a life settlement transaction as long as advisors partner with credible, knowledgeable, and licensed life settlement providers. Such partnerships, along with sound due diligence practices, should ensure that consumers and advisors have a positive life settlement experience.
Avoid the pitfalls
o Insurance and financial advisors who assist clients with life settlements should ensure that they are dealing with licensed settlement provider entities in states that require licensing. If a settlement company says it can purchase a policy in a regulated state but that the company itself does not have to be licensed, beware. Even if the purchasing company is based outside of the U.S., it is still bound by U.S. laws in states in which the owner of the policy is domiciled.
o If your state does not regulate settlements, a good way to ensure the legitimacy of a settlement company is to verify that it is licensed in states that require licensing. Check with the insurance department in those states as well as your own to see if there have been complaints against the company. Dealing with an unlicensed settlement provider in a state that requires licensing could jeopardize the privacy and confidentiality of parties involved in the transaction. Likewise, it could lead to legal action and actually undo the deal -- which could cause a chain reaction of problems for the insured, the policy owner, heirs of the policy, the agent, and so on.
o Similarly, an agent who deals with an unlicensed provider could face their own difficulties, from a cease-and-desist order to suspension or revocation of their life license. The agent might be sued for punitive damages and have to give up fees associated with this transaction and subsequent transactions.
o It could also be problematic if there are not enough licensed settlement providers in your state because that reduces competition. In such cases, it is especially important to deal with a reputable settlement company that will not take advantage of that lack of competition.
o It would be a mistake to undertake a life settlement if the insured and their advisors have not first determined whether the insured can obtain additional or replacement coverage -- assuming new coverage is needed, as it is in most cases.
There are practical concerns too that can't really be considered pitfalls and are not confined to the settlement industry. For instance, receiving a large lump sum of cash may affect someone's ability to receive certain means-based benefits; or, if you have a client who has a judgment against them or an agreement that enables others to access their income (such as custody or divorce agreements). The windfall received from a settlement could be seized for those purposes.
And there are certainly tax implications from a settlement. You should consult a qualified tax advisor before you undertake a settlement to ensure you understand the tax treatment of your client's individual circumstances. (See page 47 for more on the tax consequences of a life settlement.)
Dealing with reputable, licensed settlement companies helps ensure that those small yet crucial details of the transaction will be tended to. For instance, settlement industry leaders make clear any terms for the potential resale of a policy. They use proven escrow agents, they comply with HIPAA and other regulations, their contracts include appropriate rescission periods when required, and more.
A huge increase in the number of settlements in recent years serves as evidence that familiarity, standardization, and, above all, regulation have vastly reduced the potential risks of undertaking a life settlement transaction.
As you can see, there are aspects you need to take care of when working with a client toward a potential life settlement. Even so, as in most industries, if you learn the basics and partner with a reputable settlement firm that has a proven record, potential pitfalls can be anticipated, minimized, and even avoided altogether.
M. Bryan Freeman has been a licensed insurance agent for 26 years and is now in his fourth term as president of the Life Insurance Settlement Association (LISA). He is president of Habersham Funding LLC, a life settlement provider. He can be reached at bryanfreeman@habershamfunding.com.
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