Rising Compliance Risks Of NOT Discussing Life Settlements

In An Age Of Regulatory Harmonization, Financial Advisors Face New Pressures To Weigh Pros And Cons Of Life Settlements For Clients

Sander Ressler, Expert Columnist, Compliance & Regulatory Affairs, WSR

Life settlements might be making a comeback.  Commonly defined as the sale to a third-party investor of an existing life insurance policy for more than its cash surrender value but less than the net death benefit. The use of this alternative solution when canceling a policy is experiencing something of a revival of interest.

But while changing demographic, regulatory and economic trends might be bringing life settlements back into focus, a quick trip down memory lane could be helpful in better setting the stage. Having a better understanding of the good, the bad and the ugly, in terms of the attributes of the life settlement solution, is appropriate at this time.

Be Kind, Rewind

Life settlements developed a bad reputation in the 90s

Back in the 1990s during the AIDS epidemic, life settlements – also known as viaticals – were an investment solution that had little regulatory structure and developed a bad reputation due in part to the premise of the investment.

To be fair, you probably don’t need the benefits of hindsight to appreciate how maybe, just maybe, an investment that bets on the truncated lifespan of terminally ill persons would elicit hesitation from many financial professionals and their clients.

And it didn’t help that, for many years and far too often, the product was promoted by shady middlemen with no standard of care or responsibility to either the buyer or the seller.

Indeed, viatical settlement abuses that were prevalent in the 1990s and early 2000s put a heavy reputational stain on the entire settlement industry.  Following that, most independent broker-dealers took a decidedly hands-off approach to life settlements.

It’s taken more than a decade to start getting over the intense stigma that life settlements are under, and rehabilitating the image of these solutions is well under way.

What’s Changed?

But with the advent of regulatory harmonization across the RIA and broker-dealer segments of the industry, the renewed interest in life settlements could very well accelerate in the coming months and years.

Jamie L. Mendelsohn, Executive Vice President, Ashar Group

According to Jamie L. Mendelsohn, Executive Vice President of the Ashar Group, a nationally licensed life settlement firm that acts as a fiduciary to protect the best interests of policyholders, regulatory harmonization that emphasizes a best interest approach to client services could potentially be a game changer for the life settlements market.

Mendelsohn said, “When you consider the fact that 87% of life settlement (source: Ashar Group statistics) transactions involve seniors ages 70 to 100, it highlights a population of vulnerable seniors who know little to nothing about life settlements other than what they see on television commercials and social media. It’s our responsibility as a compliance-centric life settlement brokerage firm to make sure that their best interests are protected. We have a fiduciary responsibility to do so.”

What’s The Right Way To Use Life Settlements?

Of course, reputation and education are just two of the challenges that life settlements face.  But even if the specific product passes the due diligence smell test – by itself a major hurdle to supersede – there is a third and arguably most important criteria to weigh:  Is the option to sell one’s policy or receive a buyout of one’s policy a clear fit within a broader holistic financial plan?

One attorney with extensive experience in the life settlements space, speaking on condition of anonymity, said, “There’s always a risk that any complex financial product will blow up.  Life settlements, non-traded REITs, master limited partnerships and BDCs are all examples of commonly used investment solutions that have each suffered from a reputational cloud at one time or another.”

“One of the key differentiating factors when it comes to legal and regulatory liability for financial advisors when a product implodes is this:  Was the investment solution in question recommended as a one-off transaction, versus as part of a holistic financial plan?”

Elevated Liability Risks For Not Raising The Issue

Life settlements may be part of the plan

In this Reg BI new normal, for many financial advisors the development of a comprehensive financial plan should at least include consideration of life settlements for their clients – At least as sellers of life insurance policies, if not as buyers.

Indeed, from a liability standpoint for financial advisors to clients who own longstanding life insurance policies, there’s arguably at least as much risk in not disclosing the life settlement option as there is in raising it.

In Mendelsohn’s view, “When financial advisors meet with clients, they are often asked for their opinion about life insurance policies their family or business owns. This is a slippery slope without the in-house expertise of valuing a policy for its fair market value, or having a database of comps that can be relied upon. We see situations daily when policies are surrendered for a fraction of the life settlement value. On average clients can receive five times more than the cash surrender value, sometimes even higher.”

“Unfortunately, many clients do not know the market exists or their advisors are prohibited from disclosing the life settlement option, resulting in the clients receiving less than the policy was truly worth. Many advisors wonder if there could be liability for not documenting that the life settlement option was explored, along with other non-forfeiture options. Time will tell.”

Broker-dealers may consider oversight related to suitability, recommendations and use of funds for the recently liquidated policy involved in the life settlement. How does the advisor reallocate the proceeds or place them in investments that pay the advisor a fee, for a product that may not be in the client’s best interest? For these reasons, it is imperative that broker dealers have a compliance-centric life settlement resource and workflow. Can they demonstrate price discovery and document competitive offers? A conflict of interests could inherently exist in this transaction like all financial transactions.

In other words, not having the resources to properly analyze insurance liquidation options or creating the perception that recommendations on such steps were driven by self-interested financial incentives – as opposed to a much more well-informed process where the pros and cons of such potential moves are presented – could be damaging to a financial advisor’s career.

Views From Compliance Officers

Over time, compliance officers have also come to recognize that life settlements can be in the client’s best interests, especially in terms of policy sellers, but only when done for the right reasons.

As with any other product or solution specialist, compliance officers look for some very specific factors when considering a life settlement broker. First and foremost, they look for a partner that has a fiduciary responsibility to protect the client’s best interest throughout the settlement process. Only a licensed life settlement broker will meet that criterion.

Other requirements are that the licensed broker is a national firm that is operating in all 50 states and licensed in all states that require settlement licensing and be able to demonstrate the ability to manage a transparent policy auction forcing providers (independent buyers) to compete to secure the best offer for the client.

They also must have strong financials, a long-standing positive reputation and wide-ranging experience in the market. They must exhibit the expertise and staffing requirements to provide ongoing education and training for registered representatives to ensure best practices and best execution.  And of course, they have an obligation to partner with the BD using the proper forms, processes and reporting requirements.

Mendelsohn added, “Our firm has received a significant uptick of broker-dealer inquiries related to adding a life settlement broker as a resource to their advisors. It also provides an arm’s distance that minimizes transactional liability. The drivers behind these requests have been best interest regulations, as well as the desire to retain their current advisors and recruit new advisors that feel the obligation to disclose the life settlement option.”

When a survey was recently completed by the Institute of Insurance Studies, 90% of seniors said that if their advisor had told them about the life settlement option, they would have wanted to explore it.  The cost for fiduciaries who do not discuss all potential options with their clients, including life settlements, could not be greater than it is in the current advisory landscape.

Sander Ressler, WSR’s Expert Columnist, Compliance & Regulatory Affairs, can be reached via ContributingEd@wealthsolutionsreport.com.

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