NEW YORK - Premium financing for policies destined to be sold in life settlements is either a legitimate service for the cash-strapped elderly or a wily scheme that should be taxed to death, depending on which trade group you believe.
In these transactions, finance companies loan money to the elderly to buy life insurance. If the insured dies within two years, their beneficiaries get the death benefits.
But after a policy has been in force for two years, the insured must either sell it or repay the loan - with interest rates that often are in the 20% range. Older Americans almost always sell the policies, as they can't afford the loan payoffs or subsequent premiums.
This month, the American Council of Life Insurers in Washington, a life-insurance-company trade group, proposed a 100% excise tax for such policies and is lobbying for it in Congress.
"The tax is designed to stop these contrived transactions," said Greg Jenner, executive vice president for taxes and retirement policy for the ACLI. "Their leaving the market is exactly what we are hoping for."
He noted that the ACLI's proposal would apply to life settlements entered into before a policy has been in effect for five years.
But "in practice, no excise taxes would be paid, because policyholders would leave the market," said Larry Simon, president of the Life Insurance Finance Association in Atlanta, a life settlement premium-finance trade group.
"I can't believe that insurance companies would go and ask Congress to tax a product that they sell," said Bryan Freeman, vice president of government relations for the Life Insurance Settlement Association in Orlando, Fla. "[Life settlement firms] are such a small part of the overall insurance industry, we really shouldn't be causing any real problems."
One thing the ACLI and LIFA do agree upon is that the excise tax proposal now on the table would destroy this type of premium financing, as no one in their right mind would pay such a high tax.
Lapse rate worries
Mr. Simon contends that the ACLI isn't worried about protecting elderly policyholders but rather about how the life settlements will affect the lapse-rate assumptions of their member companies.
Policies purchased in premium-financed deals don't lapse; the financing firm buys back the policy, because the policyholder can't afford to keep it. That can increase insurer expenses, because they have to maintain higher loss reserves to pay the inevitable death claims.
But according to Mr. Jenner, this type of premium financing is a way to get around insurable-interest requirements that were intended to prevent investors from speculating on human lives.
States mandate that an insurable interest exist at the time a life insurance policy is purchased by the applicant but not at the time the applicant dies.
"We are not talking here about legitimate life settlements but about financing schemes to circumvent state insurable interest laws. A lot of hedge funds have money chasing these deals," Mr. Jenner said.
"By making loans under these terms, the financing companies are making people hope that they will die within two years," he said. "That is what I call an unsavory transaction."
Generating tax revenue
Mr. Jenner added that insurers aren't as worried about lapse rates as LIFA claims they are, because they eventually can build revised lapse assumptions into their rates.
Premium finance transactions shouldn't be subject to an excise tax at all, because that would limit available options for elderly people who want life insurance, according to Mr. Simon. Senior citizens would be denied the right to sell a valuable asset at a time in their lives when they may no longer need life insurance but instead require cash for long-term care or other reasons.
"The tax would prevent people from exercising their property rights," Mr. Simon said. "Life insurance policies are assets, and people should have the ability to finance or sell them."
Car dealers and real estate agents don't mind if clients borrow money to buy what they are selling, so why should insurers mind? Mr. Simon asked.
LIFA also noted that life settlements already generate up to $2 billion in tax revenue annually, as the sale proceeds, premium payments and death benefits may generate taxable events.
The excise tax threat isn't the only current assault on the life settlements industry. The National Association of Insurance Commissioners in Kansas City, Mo., is considering recommending to states that they impose a moratorium on life insurance policy sales during the first five years that the policy is in force.