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Poignant words indeed, but it may surprise you to know that in fact the law has had its say over life insurance settlements for almost 100 years. In 1911, the U.S. Supreme Court laid the foundation for settlements with its interpretation of life insurance in the now famous Grigsby v. Russell case. The case involved an insurance carrier questioning whether a life insurance policy insuring one John C. Burchard should be permitted to pay its benefits to administrators or an assignee. Burchard was in serious financial distress and wanted to sell his life insurance policy to finance a surgical operation. He sold the policy to his doctor, a Dr. Grigsby, for $100, equivalent to about $10,000 today. Grigsby agreed to assume complete responsibility for making the premium payments.
In a unanimous decision, Justice Oliver Wendell Holmes, Jr., wrote on behalf of the court:
On the other hand, life insurance has become in our days one of the best recognized forms of investment and self-compelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property ... To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner's hands.
The court's opinion established the all-important underlying premise that a life insurance policy is freely transferable like any other asset. It was not until the 1990s, however, that the market "caught up with the law" through the advent of viatical settlements -- viatical being a Latin word that the industry adopted to describe terminally or chronically ill patients.
Some of you may recall the so-called HIV bonanza, when patients at risk for Acquired Immune Deficiency Syndrome (AIDS) and requiring costly medical treatments began to sell their life insurance policies. Investors who believed they had captured a significant amount of arbitrage paid handsomely. With the development of advanced medicines and treatment programs for HIV-positive people like basketball star Magic Johnson, however, these individuals now literally have a new lease on life. With more than a tinge of irony, that spelled doom for the viatical market.
Later in the 1990s, life settlements as we know them today appeared on the market, primarily from senior clients age 65 and older. The competition for these policies in the secondary market is spurred by such financial giants as Credit Suisse, UBS, Deutche Bank, Goldman Sachs, and Berkshire Hathaway, as well as a myriad of European and American hedge funds bidding against one another. The resulting settlements typically yield 300% or more of the policy's cash surrender value.
Thanks to Grigsby, we can state confidently that a life settlement in and of itself is a bona fide and legal transaction. It is extremely unlikely that such a legal precedent would be overturned, because it deals with a fundamental constitutional right to transfer or sell personal property unhindered. So why are trial attorneys, insurance regulators, and even attorneys general so concerned about settlement transactions? It's all about the money.
By most objective estimates, about 75% of life insurance policies do not end in a death claim. Three out of four policies end in cash surrender or lapse. It can safely be assumed that in these cases, the policies no longer served their original purpose, and/or the premiums became unaffordable or at least financially burdensome. The settlement market unites a working policy with a willing premium payor in anticipation of an ultimate death claim. The lapse ratios on these policies, by all objective accounts, have not changed appreciably. The transfer of policy ownership to large financial entities, who regard the asset as an investment, is bound to attract the attention of regulators.
It's important to draw a clear distinction between settlements and "stranger owned" life insurance, or SOLI. We all know that insurable interest is a fundamental requirement in any life insurance transaction, although the legal definition of the term differs from state to state. SOLI transactions, from inception, are financed by parties and investors not related by blood or law to the insured, and SOLI policies generally lack any connection between the policy owner, beneficiary, and insured.
Carriers claim that such arrangements defeat insurable interest and the very intentions Congress had in granting favorable tax treatment to life insurance. There is still no clear-cut, all-encompassing rule to apply to these cases. What remains indisputable, however, is that a policy in which insurable interest clearly was present at its inception and creation is, by anyone's definition -- including all insurance carriers -- a legal and bona fide candidate for a life settlement. No one has or will attempt to change this so long as Grigsby remains valid law.
In fact, Grigsby is an even more powerful decision than one assumes at first glance. In his opinion, Justice Holmes addressed insurable interest and how it was unaffected by the Grigsby transaction:
Of course, the ground suggested for denying the validity of an assignment to a person having no interest in the life insured is the public policy that refuses to allow insurance to be taken out by such persons in the first place. A contract of insurance upon a life in which the insured has no interest is a pure wager that gives the insured a sinister counter interest in having the life come to an end ... But when the question arises upon an assignment, it is assumed that the objection to the insurance as a wager is out of the case. In the present instance the policy was perfectly good.
The Burchard policy had "perfectly good" insurable interest from inception and creation and thus, with the Supreme Court's blessing, was permitted to be sold to Dr. Grigsby. Justice Holmes went further and actually stated as such: "No question as to the character of that contract is before us."
A life settlement, in the right circumstances and handled by an experienced professional, presents a terrific financial solution for unwanted, unnecessary, and costly life insurance. The law, all the way up to the Supreme Court, certainly agrees. It is incumbent on you as an insurance agent, in a fiduciary and advisory capacity with your clients, to ascertain the validity of a policy and be prepared to recommend a settlement if circumstances warrant. When you encounter a client who no longer needs or wants his or her policy, or can no longer afford it, you can present the settlement option confidently and proudly, knowing that almost 100 years of established law is behind it.
Grant Phillips, Esq., is a managing partner and the general counsel at Supreme Life Solutions, LLC, a life settlement company. He is an attorney licensed in New York, New Jersey, and Florida, and has authored several articles on life settlements, premium financing, and life insurance.
