Life settlements could feel heat from new product

A product that allows policyholders to take out loans on their insurance policies while retaining the policies and without putting down collateral could hurt the life settlement industry, according to observers.

Legacy Funding Group Inc. of Malvern, Pa., next month will begin offering LegacyLoan, which will allow policyholders to maintain ownership of their policies while the company funds all premiums. No collateral is needed, as the collateral is a pledge of 90% of the policy’s death benefit.

Upon death, the death benefit is used to pay off the loan and accrued interest. The balance can never be less than 10% of the death benefit, and beneficiaries will receive that money.

Typically, life settlement companies make more money if the participants die early. However, in the case of the loans, Legacy Funding earns interest.

“We don’t want them to die too early. We make our money on the spread of the loan,” said Larry Fondren, the company’s founder and president. The loans carry a guaranteed, fixed interest rate.

The LegacyLoan product will be available through both the company and financial advisers.

“The policyholder retains ownership of the policy and takes a loan instead. That’s not a settlement,” said Joseph M. Belth, professor emeritus of insurance at Indiana University’s Kelley School of Business in Bloomington.

“I consider these to be in the public’s interest,” he said. “If people understood that they could get more money and still keep the policy, I can’t imagine why anyone would want to go through a life settlement.”

In a life settlement, a policyholder can sell a life insurance contract for a percentage of its face value rather than surrendering the policy for its cash value or letting the policy lapse. When a person sells the policy, they no longer receive any death benefits from the policy and they lose ownership entirely.

DISAGREEMENT ON DEFINITION

Doug Head, executive director of the Life Insurance Settlement Association in Orlando, Fla., questions whether the LegacyLoan product is just another way to describe a life settlement.

“I think these are still settlements,” he said.

“Settlements have always included loans against the policy,” Mr. Head said. “My view is if insurers are making loans against policies, then they are in the business of settlements, [and] they ought to get settlement licenses.”

But New York Life Insurance Co., which offers Access Plus, a similar product to LegacyLoan, begs to differ.

“It is absolutely not a settlement — the key differences being that under our program, the policy ownership does not change, the beneficiary receives the death benefit net of the outstanding loan, and the policyholder can undo the transaction simply by repaying the loan and interest,” company spokesman William Werfelman wrote in an e-mail.

He declined to quantify sales of the product since it was introduced in December 2006.

Access Plus, which is sold through the company, allows a policyholder access to cash in a loan, in excess of the cash value, while preserving the death benefit and allowing the policyholder to retain its ownership.

Only certain individuals are eligible — those whose life expectancy is more than one year but less than 10 years. Access Plus loans occur outside the terms of the policy and are made available after a policy’s cash value is used.

Although insurance companies have typically allowed policyholders to take out loans on their policies, Access Plus is different because the loans are made outside the traditional terms of the policy.

In the past, loans have been made available, but traditionally, collateral has had to be offered up.

TRANSPARENT PRICING?

The new loans offer more-transparent pricing than life settlements do, said Lewis Schiff, senior managing principal of New York-based Advanced Planning Group.

“The life settlement market is a very inefficient, opaque market; it’s a very gray market,” he said.

The life settlement industry has been controversial since its inception in the early 1980s. More than a dozen states are considering legislation that would set stiffer standards on life settlements.

In recent years, a number of lawsuits have been filed against the life settlement industry. In October, for instance, television talk show host Larry King filed a lawsuit against an insurance brokerage firm, saying he was swindled when he sold two policies totaling $15 million for $1.4 million.

There is no question that the new products will diminish the value of life settlement policies, said Emmanuel Modu, managing director and global head of structured finance at A.M. Best Co. Inc. in Oldwick, N.J. He rates life settlements products.

“Generally, I think that anything that increases the cash beyond the surrender value that policyholders can get will diminish the attractiveness of the life settlement industry,” Mr. Modu said.

The biggest problem with life settlements is that there is an intermediary between the seller of the policy and the buyer of the policy, said James D. Kaplan, president of Karr Barth Private Client Group LLC in Princeton, N.J. His company manages about $300 million in assets.

“It’s a mess. I don’t even like it when we have to sell a policy,” Mr. Kaplan said.

“I don’t really trust the process, and I don’t trust the intermediary.”

Mr. Kaplan is impressed with LegacyLoan.

“I think it addresses the problems head-on,” he said. “There’s no sale of the policy.”

Lisa Shidler can be reached at [email protected].