A life settlement is the legal sale of an existing life insurance policy (typically of seniors) for more than its cash surrender value, but less than its net death benefit ( via Institutional investor)). There are a number of reasons that a policy owner may choose to sell his or her life insurance policy. The policy owner may no longer need or want his or her policy, he or she may wish to purchase a different kind of life insurance policy, or premium payments may no longer be affordable.
Viatical settlements are similar but not the same as life settlements. For a viatical settlement, a person who is selling his policy (viator) is terminally or chronically ill.
Life settlement history
Although the secondary market for life insurance is relatively new, the market was more than 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings and key individuals.
The U.S. Supreme Court case of Grigsby v. Russell, 222 U.S. 149 (1911) established a life insurance policy as private property, which may be assigned at the will of the owner. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner may transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property, such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policy owner.
This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
- Name the policy beneficiary
- Change the beneficiary designation (unless subject to restrictions)
- Assign the policy as collateral for a loan
- Borrow against the policy
- Sell the policy to another party
In the 1980s, the U.S. faced an AIDS epidemic. AIDS victims faced short life expectancies, and they often owned life insurance policies that they no longer needed. As a result, the viatical settlement industry emerged. A viatical settlement involves a terminally or chronically ill person (with less than two years life expectancy) who sells his or her existing life insurance policy to a third party for a lump sum. The third party becomes the new owner of the policy, pays the premiums, and receives the full death benefit when the insured dies. Because of medical advancements, people with AIDS started living longer and therefore viatical settlements became less profitable. As a result, the life settlement industry arose.
A life settlement is similar to a viatical settlement, but in a life settlement transaction, the insured is typically at least 65 years old and is not chronically or terminally ill.
In 2001, the National Association of Insurance Commissioners ("NAIC") released the Viatical Settlements Model Act, which set forth guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policy owners who no longer needed their policies.
On April 29, 2009, the United States Senate Special Committee on Aging conducted a study and came to the conclusion that life settlements, on average, yield 8x more than the cash surrender value offered by life insurance companies.
Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the client a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to third parties.
With the evolution of the life settlement industry in the United States, providers have become in many instances intermediaries between non-U.S. investors (or however investors not having a provider license) and the sellers. The stratification of intermediaries (providers and brokers) in a market that's private and illiquid, along with the substantial lack of transparency in the price-fixing process are items requiring attention from investors - a variety of incorrect behaviours may be put in place by sell-side agents, including pump and dump-like attitudes, life expectancy report shopping (to show buyers only those with shorter life expectancies implying higher present value of the policy), pulling of unfavourable medical records (to induce life expectancy underwriters to underwrite shorter life expectancies, again implying higher present value of the policy), faking high bids to inflate prices in auctions, etc. 
These issues are also preventing a full-institutionalisation of the market.
Generally, a life settlement broker is a person who, for compensation, solicits, negotiates, or offers to solicit or negotiate, a life settlement contract. In most states, a person must be licensed to act as a life settlement broker and must take continuing education courses.
A life settlement broker, in exchange for a fee, will shop a policy to multiple providers, much as a real estate broker solicits multiple offers for one's home. While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after commissions, and more.
As part of the purchase transaction the investor assumes responsibility for paying all future premiums required to keep the policy in force.
Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a broker will benefit the client.
In states that regulate life settlements, there are laws pertaining to procedure, privacy, licensing, disclosure, and reporting, which if violated, may subject the broker to penalties. For instance, the state of California provides strict regulation for the industry.
Life settlement investors are known as financing entities because they are providing the capital or financing for life settlement transactions (the purchase of a life insurance policy). Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures. The life settlement provider is the entity that enters into the transaction with the policy-owner and pays the policy-owner when the life settlement transaction closes. In most cases, the life settlement provider has a written agreement with the life settlement investor to provide the life settlement provider with the funds needed to acquire the policy. In this scenario, the life settlement investor is effectively the ultimate funder of the secondary market transaction. However, in some life settlement transactions, the life settlement provider is also the investor; the provider uses its own capital to purchase the policy for its own portfolio.
Life expectancy providers
Life expectancy providers (LEPs) are specialized independent companies that issue life expectancy reports (LERs) that estimate the life expectancy (LE) of an individual (typically the insured individual on whose life a life insurance policy involved in a life settlement is based). Life expectancies are not a prediction of how long an individual will live, but rather are the average survival time amongst a particular risk cohort. Risk cohorts are typically grouped by age, gender, smoking, and relative health/morbidity. LE is a key component in the pricing of a life settlement.
LEPs are typically made up of actuaries and medical underwriters who utilize actuarial models based on published or proprietary mortality (life) tables and medical underwriting based on various debits/credits for various morbidity characteristics similar to the medical underwriting performed by life insurance company underwriters and reinsurance underwriters. Until recently, the most commonly used mortality table was the 2001 Valuation Basic Table (VBT) published by the Society of Actuaries based on data supplied by contributing life insurance carriers. In 2008, the Society of Actuaries published a new table, the 2008 VBT, that is based on 695,000 lives representing $7.4 Trillion in death benefits which is almost 3 times more lives than the former 2001 VBT. Included with 2008 VBT are relative risk tables (RR Tables) that separate insured lives into various underwriting categories based on the health/morbidity of the insured at the time the policy was issued. Note that no impaired lives are included in any of the RR tables, but rather were designed for companies that subdivide their standard policies into more than one sub-class. Most LEPs have factored in the experience data underlying the 2008 VBT, as well as their own experience data and other factors, as a basis for their mortality tables. This resulted in a significant lengthening of average LEs in the fourth quarter of 2008 for some LEPs. All major LEPs have continued the practice of developing and using proprietary and confidential mortality tables based on extensive medical research and mortality experience. One new LEP has adopted the use of the 2008 VBT RR Tables as a replacement for proprietary multipliers, despite the fact that Relative Risk Factors are in their infancy and not designed for impaired life nor life settlement underwriting.
Stranger-Originated Life Insurance ("STOLI")
The Life Insurance Settlement Association (LISA) supports the enactment of legislation to stop STOLI and believes that the STOLI argument is frequently used to attack legitimate life settlements.
STOLI is not a life settlement. Life settlements occur long after issuance of the policy.
STOLI is any act, practice, or arrangement, at or prior to policy issuance, to initiate or facilitate the issuance of a life insurance policy for the intended benefit of a person who, at the time of policy origination, does not have an insurable interest in the life of the insured under the laws of the applicable state. This includes an arrangement or other agreement to transfer the ownership of the policy or the policy benefits to another person. The main characteristic of a STOLI arrangement is that insurance is purchased as an investment vehicle, rather than to provide for the insured's beneficiaries. STOLI arrangements also may be called "zero premium life insurance", "no cost to the insured plans", "new issue life settlements", "high-net-worth settlements", or "non-recourse premium finance transactions".
Insurers may refuse to make payments on STOLI arrangements. Such arrangements circumvent the insurable interest requirement and are illegal in most states. Such an arrangement also may constitute insurance fraud.
STOLI occurs at the point a policy is issued by a carrier or when a policy is issued through an agent under a STOLI scheme, the policyholder has no “insurable interest”. The common law in both England and the United States long-abhorred insurance without an interest as a “mischievous kind of gaming” and so developed the insurable interest doctrine i.e., that an owner of a policy must have an interest in that insured.
STOLI became so popular that many producers and insurers confused it with legitimate life settlements, which are transacted on properly originated policies with valid insurable interest at issue.
In 1993, the National Association of Insurance Commissioners (“NAIC”) passed the Viatical Settlements Model Act (the “NAIC Model”). The Viatical Settlements Model Act intended to end STOLI transactions and strengthen consumer protections in the life settlement area, while not infringing on legitimate estate planning transactions. The NAIC Model limits the most obvious form of STOLI—the sale of life insurance policies originated or manufactured solely for the purpose of third party investment and requires life settlement brokers to disclose to policy owners information regarding settlement transactions, such as broker commissions and any competing offers to purchase. The Model also recognizes a policyholder's right to sell or assign a policy but initially placed a two-year waiting period on any such sale; it was later amended to a five-year waiting period. and Viatical Settlements Model Act Legislative History (NAIC Model Regulation Service – April 2008).
The five-year waiting period, tests the insured's “good faith” purchase by imposing a holding period, during which the insured must make costly premium payments. It also tests the investors’ risk tolerance, as they cannot be certain that an insured will survive the holding period in order to assign the policy. The NAIC Model, however, is less effective in combating schemes that use trusts, financing, and beneficial interests in the trusts as a means of gambling on the lives of strangers.
The Viatical Settlement Model Act originated by the NAIC was followed by the National Conference of Insurance Legislators’ (“NCOIL”) own model act: The Life Settlements Model Act (the “NCOIL Model”).
The NCOIL Model more directly addresses the multitude of schemes that life insurers have faced since the NAIC Model's promulgation. As a result, the NCOIL Model is much broader in scope and attempts to bring within its prohibitions all manifestations of STOLI, including indirect sales of beneficial interests in trusts or policies.
STOLI is defined as a ‘Stranger-Originated Life Insurance’ or ‘STOLI’ is a practice or plan to initiate a life insurance policy for the benefit of a third party investor who, at the time of policy origination, has no insurable interest in the insured. STOLI practices include but are not limited to cases in which life insurance is purchased with resources or guarantees from or through a person, or entity, who, at the time of policy inception, could not lawfully initiate the policy himself or itself, and where, at the time of inception, there is an arrangement or agreement, whether verbal or written, to directly or indirectly transfer the ownership of the policy and/or the policy benefits to a third party. Trusts, that are created to give the appearance of insurable interest, and are used to initiate policies for investors, violate insurable interest laws and the prohibition against wagering on life. STOLI arrangements do not include those practices set forth in Section 2L(2) of this Act.
When settling a contract, a broker cannot use a provider, and vice versa, unless each knows that the other is licensed under the NCOIL Model. Licensed brokers and providers must report annually to state insurance commissioners regarding their internal controls, including their “anti-fraud plan” that must include procedures for (i) detecting possible fraudulent acts, (ii) resolving material inconsistencies between medical records and insurance applications, (iii) reporting fraudulent insurance acts, (iv) providing anti-fraud education of and training for underwriters and others, and (v) outlining personnel to investigate and report activities that may be fraudulent. 
The beginning of the end for STOLI came in December 2005, when the New York State Insurance Department released a General Counsel Opinion that STOLI-type arrangements violated insurable interest laws. This ruling had significant impact on the STOLI industry. State legislatures began passing anti-STOLI legislation that would make it easier to enforce insurable interest laws. Insurers — many of whom either ignored, supported, or were oblivious to these transactions — “got religion.” That is, they implemented underwriting procedures intended to detect and prevent STOLI transactions. Insurers also began to review previously issued policies for STOLI, and, as a result, a number of suits were filed to rescind such policies. In addition to insurable interest violations, many of these policies were thought to contain false statements, particularly with respect to the insureds’ net worth, which was overstated in order to qualify them for larger face amounts of insurance. Investors’ interest in STOLI policies waned as they realized that such policies contained considerable risk because they could be unenforceable and subject to rescission by the insurer.
Of the estimated 300 – 400 lawsuits filed by insurance companies involving illegally manufactured life insurance policies (often referred to as Stranger-Originated Life Insurance, or STOLI), none were directed at life settled policies, life settlement provider companies, or the property rights of policy owners to sell a lawfully owned policy in a regulated transaction.
Most states regulate life settlements and impose a two-year waiting period. However, New Mexico, Michigan, Massachusetts, and Delaware only regulate viatical settlements, while Wyoming, South Dakota, Missouri, Alabama, and South Carolina neither regulate viatical settlements nor life settlements.
Manager's operating funds of Life Settlements will be regulated by the financial regulator in the jurisdiction in which they reside. Managers and service providers also operate a form of self-regulation through associations such as the European Life Settlement Association (ELSA) - created to increase levels of transparency and raise standards in the market.
Major Study Findings
An academic study that showed some of the potential of the life settlement market was conducted in 2002 by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance." This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their under-performing life insurance policies, an opportunity that was not available to them just a few years before. It also has been stated by Neil A. Doherty, the professor at Wharton, that this practice drives up the cost of insurance to all other consumers purchasing life insurance.
"We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton Study, pg 6
Another study by Conning & Co. Research, "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements.
- What is a Life Settlement?, Life Insurance Settlement Association, retrieved on March 5, 2012, at http://www.lisa.org/content/13/What-is-a-Life-Settlement.aspx Archived 2015-02-06 at the Wayback Machine
- Life Settlement History, Life Insurance Settlement Association, retrieved on March 5, 2012, at http://www.lisa.org/content/51/Life-Settlement-History.aspx Archived 2015-02-06 at the Wayback Machine
- Braun, Alexander; Xu, Jiahua (2020-03-31). "Fair Value Measurement in the Life Settlement Market". The Journal of Fixed Income. 29 (4): 100–123. doi:10.3905/jfi.2020.1.084. ISSN 1059-8596.
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- Braun, Alexander; Cohen, Lauren H.; Malloy, Christopher J.; Xu, Jiahua (2018-05-01). "Ashar Group: Brokers and Co-opetition in the Life Settlement Industry". Harvard Business School Case (218–109).
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- Sheridan, Matthew. The STOLI Worm: A Practitioner's Guide to Managing Life Settlements and Micro Longevity Risk.
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- NAIC, Viatical Settlements Model Act, 697, 11A(3) (1993).
- NAIC, Viatical Settlements Model Act, 11(A) (2009)
- NCOIL, Life Settlements Model Act (2007).
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- Wharton study