existence insurance Settlements

Life insurance settlements have caused much confusion for broker-dealers in the last 24 months. More and more registered representatives are becoming aware of this controversial wealth management strategy. The life settlement is the sale of an unwanted, unaffordable, or underperforming life insurance policy to an institutional purchaser instead of letting the policy lapse. As Registered Representatives grapple with their compliance department for the go-ahead, they are usually confronted with mixed answers about its viability. To be sure, this strategy is an area of concern for broker-dealers and NASD members alike. Mary Schapiro, Vice Chairman of the NASD, spoke at the Chicago NASD Conference on May 25th, 2005. She addressed, in part, three central issues:

1.“The first risk is to assume that baby boomers have a level of financial acumen that eliminates the need for proper suitability analysis.”

2. “A second risk comes from the product innovation that has generally served your customers so well.”

3. “A third risk is failing to analyze the status of these new products under the federal securities laws.”

Chairman Schapiro says that equity-indexed annuities are securities and life settlements and may constitute a “selling away” problem, amongst other concerns. She explains: “Equity-indexed annuities are only one example of a financial product that a firm might erroneously treat as a non-security. Other examples include tenants-in-common exchanges and life settlements. NASD considers all of these products securities subject to firm supervision.

The NASD is the “watchdog of the SEC,” Its sole existence is to protect the investing public. One of their preoccupations is keeping in check the “egregious overcharging” of fees generated by manufactured investment products. There seems to be a correlation between the NASD and their concern with the nature and size of fees generated by the life settlement transaction.

The question remains: are life settlement transactions securities? The question of whether life insurance settlements are to be treated as deposits is divided into two parts whether we are discussing the back-end sales activity, i.e., the distribution of interests in a policy or pool of policies, or the front-end activity, i.e., the solicitation and facilitation of the sale of an approach to a life settlement company. Once the policy has been sold into the secondary market, one could conclude that the “transfer for value rule” has been applied, and the insurance contract could be construed as security. Many, however, would conclude that the up-front transaction of a life settlement would not be subjected to securities law and jurisdiction.

Why all the Fuss?

Does the life settlement market deserve such attention? According to the 2004 Life Insurers Fact Book, compiled by the American Council of Life Insurers, $9.4 trillion of life insurance is in force on 167 million policies. Coupled with the fact that emerging demographics show our beloved “Baby Boomers” are hitting retirement, you can see that the life settlement market is getting on everyone’s radar screen.

Moreover, according to the Conning Research and Consulting whitepaper, “Life Settlements, The Concept Catches On,” 2006, the average life settlement offer approximates 25% and 30% of the face amount.” Suppose it is true that approximately 35% of all settlement proceeds will be re-deployed into new investment vehicles for growth or income. In that case, one can conclude that broker-dealers should have a vested interest. This rings particularly true where there is competition for registered representative recruiting, where they can potentially increase their gross commissions.

This article will examine the potential NASD issues and possible solutions for adopting a life insurance settlement program. It is not intended to support the notion that a life settlement is a security but to understand better if a broker-dealer wishes to add the strategy as a new profit center. The first consideration from a compliance perspective is how to treat the settlement of life. Some wirehouse compliance departments, for example, have treated life settlements as passive referrals and do not accept compensation.

The common thought is that they can reap the compensation by re-deploying the proceeds towards a traditional product such as a stock, bond, or mutual fund. In that way, as the reasoning goes, they did not complete a securities transaction and, therefore, did not violate the NASD procedure. Moreover, many of these firms use the life settlement strategy to replace underperforming or outmoded insurance.

For example, Client Clara has a $1,000,000 life insurance policy and pays $60,000 yearly premiums. Broker Bob tells her she can sell the policy in the secondary market and use the proceeds to pay for new coverage with a unique no-lapse guarantee. She sells the policy for $300,000 and uses the money to buy a new $1,500,000 with less than her original premium.

Many broker-dealers have adopted this passive non-compensation approach to life settlements. Other broker-dealers see the product to offset lagging markets and infuse new revenue streams for the firm. We must become more educated about addressing complex compliance issues about life settlements. Many factors influence how the life settlement program should be installed into a B.D. System. For example, should the B.D. Consider the program security or strictly outside business activity. Few firms can answer these complex questions and will provide consulting concerning life settlements.

Involving the notion that a life settlement is a security, it is critical to understand what a security is to determine if it applies to life settlements. The keystone case on the definition of securities is SEC v. W.J. Howey.1 In Howey, the Supreme Court was asked to define the term “investment contract” since the term is used to define a security under the Securities Act of 1933. In its decision, the Court defined investment security as any transaction that involves the investment of money in a common enterprise with an expectation of profit and which occurs solely from the efforts of others.

It is immaterial if the enterprise is evidenced by formal certificates or nominal interests in physical assets. In SEC v. Mutual Benefits Corp., the Eleventh Circuit affirmed a U.S. District Court finding that Mutual Benefits was involved in a viatical settlement contract that qualified as an “investment contract” under the Securities Act of 1933 and 1934. Before the Mutual benefits case, the settlement industry consistently cited a district court decision, SEC v. Life Partners Inc., as the basis for insurance regulation of the settlement business. Despite losing, the SEC has insisted that investment in settlements is securities. The precedent set by SEC v. Mutual Benefits has created a cavalcade of potential securities issues that should be looked at by a seasoned expert in the settlement/NASD industry.

Just as important is that many Broker-Dealers have chosen to ignore the life settlement, hoping they can take one day to claim ignorance. This “stick your head in the sand” posture is a recipe for disaster because, empirically, the NASD has made it clear that they will not tolerate this kind of strategy under any circumstances. Common sense dictates that to avoid problems, the client’s best interest is always placed first, thus preventing issues by not being compliant.

Many rules, regulations, and strategies would apply to life settlements under NASD guidelines. This article will only examine some very pertinent issues. It is important to note that any prudent compliance department must adopt written procedures for processing life settlements.


In offering life settlement services in a prudent SEC and NASD-compliant manner, we must understand how the strategy must apply NASD procedures. Thus far, the SEC and the NASD have not definitively become the official SROs of the life settlement industry, although they have prosecuted and taken punitive actions on R.R.s. The NASD has declared that the back-end of the transaction is a security and has made it clear that “fractionalization “is a dangerous product area. The program has gained popularity, and the regulation above body will likely lead the regulatory charge. It is therefore essential to understand written procedures concerning: While there are over 20 identifiable issues and strategies that may influence NASD procedures, here are seven that should apply immediately:

1. NASD Rule 2320 (g) (1) (Best Execution)
2. NASD Rule 2110 “Standards of Commercial Honor and Principles of Trade.”
3. NASD Rule 2310 “Recommendations to Customers” (Suitability)
4. NASD Rule 2430 “Charges for Services Performed.”
5. NASD Rule 3030 “Outside Business Activities of an Associated Person.”
6. NASD Rule 3040 “Private Securities Transactions of an Associated Person.”
7. NASD Procedures (*should be Written and Consistent)

NASD Rule 2320:

Best execution via the “3 Quote Rule” is applicable anytime there is an offering to the general public. That is to say, we as professionals are held to the highest of standards and have a fiduciary to get the best pricing for our clients. This due diligence process ensures against improper favorite company choices and price-fixing. The fact that the firm has multiple offers may not be enough. Indeed, it is essential to have more than three quotes to get the best execution because the providers will”take a pass” at acquiring the insurance contract. Today, broker-dealers are currently engaging in life settlements that are likely violating this procedure.

NASD Rule 2110:

High Standards of Commercial Honor and Principles of Trade are paramount to stay compliant. The NASD has ruled and punished broker-dealers and registered representatives, combining rules 2110/ 3030 & 3040 about life settlements. It is important to note that there may be “failure to supervise” issues selling away, and private placements are conducted.

NASD Rule 2310:

The NASD has clarified that we must conduct our business according to the customer’s objectives and corresponding suitability. Moreover, we must disclose all material facts and maintain full disclosure. When appropriate, not offering a beneficial strategy directly conflicts with NASD Rule 2310 (b) (4). (B.D. Beware)

NASD Rule 2430:

Charges, if any, for services performed, including miscellaneous services such as a collection of money due for principal, dividends, or interest; exchange or transfer of securities; appraisals, safekeeping or custody of protection, and other services, shall be reasonable and not unfairly discriminatory between customers. States that regulate excessive fees must be adhered to appropriately. Empirically speaking, the NASD sees exorbitant fees to be anything over 5-6%. Since life settlements create value over the insurance policies’ cash surrender value, a payout grid can be established to comply with NASD rule 2430. One should seek out professional consultation concerning this very paramount issue.

NASD Rule 3030:

No person associated with a member in any registered capacity shall be employed by, or accept compensation from, any other person as a result of any business activity, other than a passive investment, outside the scope of his relationship with his employer firm unless he has provided prompt written notice to the member. As previously stated, the NASD has clarified that life settlements are included in their interpretation of “selling away.” It is a paramount area of concern where improper supervision exists.

NASD Rule 3040:

Provides, among other things, that before participating in a securities transaction outside the course or scope of their employment, a person associated with a member firm must give that firm prior written notification. In addition, if the firm is notified that the associated person may receive selling compensation, it is required to issue written approval or disapproval.

How to Live Within Your Means

“Always live inside your approach: If you’re making it an addiction to live within your means each day, you’re much less likely to go into client debt when gas or meal charges increase and more likely to regulate your spending in other areas to compensate. Debt begets extra debt while you can’t pay it off right away – if you think fuel charges are high, wait until you’re paying 29.99% annual percentage price (APR) on them. To take this precept to the next degree, when you have a partner and a two-profit family, see how close you may get to residing off the simplest one partner’s profits.

Inappropriate times, this tactic will help you save amazing amounts of money – how quickly ought you repay your mortgage, or how much in advance could you retire if you had an additional $40,000 a year to keep? In awful instances, if one partner gets laid off, you may be OK because you’ll already be used to living on one income. Your savings behavior will be forestalled briefly. However, your daily spending can remain ordinary.”

A manner of dwelling of individuals, households (households), and societies, which they manifest in handling their bodily, mental, social, and financial environments on a day-to-day foundation. Lifestyle is expressed in each work and enjoyment behavior pattern and (on a person’s foundation) in activities, attitudes, pursuits, reviews, values, and allocation of profits. It also reflects human beings’ self-photograph or self-idea, how they see themselves and accept as true how they are seen with the aid of others. Lifestyle is a composite of motivations, needs, and wishes and is prompted by lifestyle, family, reference groups, and social class.


Life Insurance Settlement is an emerging and often misunderstood industry. While the idea of selling an insurance policy has been around for over a century, we are now entering an era where it may become commonplace. While still in its infancy, the secondary market seems to have “turned the corner” and is quickly becoming a permanent part of our financial and wealth management planning. As the industry expands and matures, we will see more and more seniors benefit from the strategy. Moreover, we will see Registered Representatives enjoy creating new sources of funds for their clients, which they, in turn, will place in a more suitable and appropriate investment.

Today, more than ever, broker-dealers and wirehouses are putting into effect “written procedures” or learning the potential benefits of the secondary market for life insurance. If conducted with prudence and strict adherence to NASD rules and regulations, life settlements should become a major component of mainstream wealth management for the broker-dealer and wirehouse community.

Jonathan H. Proby, CSA, MBA, is a South Florida native born and raised in Coral Gables, Florida. He is the author of “The Seven Most Costly Financial Mistakes Made By Seniors,” “The Ten Most Essential Things That You Must Know When Selling Your Insurance Policy,” and “Life Insurance Settlements and the NASD… A Study in Compliance”, is the past host of the Southern Most Wall Street Report on Conch FM and has authored other literary and columnist works.

Sandy Ryan
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