Cashing out: Big banks and insurers are putting money into the business of buying unwanted life insurance policies, a trend that foreshadows growth for the still-new industry. (Life/Health).

Life settlements--the newest wrinkle in the secondary life market--are so new that fewer than 20 states regulate them. But in the past few months, several companies have reported the infusion of smart money--institutional capital--that they expect will power the business to fast growth and greater acceptance by regulators and the public.

Life settlements involve the purchase of life insurance contracts, for a fraction of the face amount, from healthy individuals with a life expectancy of a dozen or so years. Some $1 billion has been committed for purchases this year, according to industry players. Within four or five years, they expect to need $2.5 billion annually to buy expected face amounts of $10 billion to $15 billion. Industry experts estimate annual life settlement sales could hit $20 billion to $50 billion in face amounts within the next 10 years.

The advent of extension-risk insurance offered by Lloyd's helped to make possible institutional funding and spur its growth, according to Meir Eliav, president of Legacy Benefits Corp., New York, and a founder of the Viatical & Life Settlement Association of America. "If an insured outlives the life expectancy by more than 24 months, Lloyd's will come in and purchase the policy from us," he said. "That element opened up a great deal of possibilities, and that's when Wall Street began to look at settlements in different ways."

Life settlements are an outgrowth of the shrinking viatical business, which bought policies insuring people with life expectancies of two years or less. Viaticals were a profitable business through the mid-1990s, but the industry ran into hard times beginning in 1996, when new treatments began to prolong the lives of HIV patients. Life settlements made their debut soon afterward, but the business was hurt by scams on both private investors and insurers.

The advent of institutional funding should virtually eliminate the scams and elevate the industry's image, said Alan Buerger, chief executive officer and co-founder of Coventry First, a settlement broker in Fort Washington, Pa. Coventry has access to $250 million this year, enough to buy about $1 billion in face amounts. "All of us are dealing with sophisticated partners who understand the asset," Buerger said of the more than half-dozen companies with institutional funding. "The due diligence we go through to get the capital serves as a very strong anti-fraud program." And there's real privacy for the seller, because the institutions focus on pools of policies and understand that each pool is a complex asset, he said.

Banding Together

To address regulatory concerns, Coventry and five other settlement companies, including Living Benefits Financial Services, Minnetonka, Minn., formed the Life Settlement Institute in late January. The not-for-profit association, whose members are all institutionally funded, will work with government regulatory agencies, legislators and the life insurance industry to promote regulations and standards for life settlements. The institute, based in Washington, D.C., estimates that some $400 billion of in-force policies insures the lives of people over age 65.

"Since life settlements are directed at the senior population, we think they will be of significant interest to legislators," said Paul Moe, chief executive officer and chairman of Living Benefits. "It's something seniors should have available to them." While 36 states as of February had laws in place to regulate viaticals, only 16 have extended those laws to include life settlements, he said.

Like other settlement companies, Living Benefits pays more than the cash value for policies that owners no longer want. The sellers may no longer need to insure the covered life, or they may be hard-pressed to pay the annual premiums. On the business side, companies may want to sell key-man policies when they no longer need them.

Sellers use the money for many purposes, including investments, the purchase of income-generating annuities or long-term-care insurance or to gift it to children or grandchildren, said Ken Klein, Living Benefits' president.

Regarding legislation and regulation, Moe said a low bar to entry has allowed fraud and excesses to find their way into the fund-raising side of the business, specifically relating to individual investors. The institute plans to work state by state to set the bar higher, he said.

The institute also would like Congress to make at least some of a life settlement payment tax-free for senior citizens. The move would be similar to the action it took in 1996, when it made viatical payments tax-free under the Health Insurance Portability and Accountability Act. The institute also will promote accuracy in the industry so seniors can understand settlements as a viable financial option, Moe said.

Funding Sources

Moe, Klein and Suzanne B. Moe launched Living Benefits in early January, when the company announced it had enough funding to purchase up to $400 million of net death benefits this year. According to Steve A. Ballard of The Norseman Group, a managing general broker in Libertyville, Ill., the loan availability was arranged by Gen Re Securities, a subsidiary of General Reinsurance Corp., which is a member of the Berkshire Hathaway Insurance Group. "Berkshire Hathaway's GenRe subsidiary brings the prominence and credibility that allows Living Benefits to engage individuals and companies that before now may have elected not to participate in the life settlement business, mostly because of the uncertain nature of funding and sometimes unseemly behavior of providers," said Ballard, who has been a major broker of life settlements. The Norseman Group pulled back from the business when CNA subsidiary Viaticus ceased funding operations, because "no viable and consistent institutional source of funding and underwriting existed."

Living Benefits' business plan anticipates funding for another $700 million of purchases next year and $1.2 billion in the following year. The company estimates that the life settlements industry will buy $12 billion to $15 billion of death benefits annually five years from now, more if Congress provides tax incentives. Baby boomers, with more insurance than their parents and more two-income families, will probably add great amounts of death benefit available for life settlement purchases when members of that generation begin to turn 65 in 2011, Klein said. He estimated that settlements are a useful option for about 5% to 10% of the population.

Paul Moe and Klein point to their viatical industry experience as a strength of Living Benefits. Moe previously was chief executive officer and chief operating officer of ViatiCare Financial Services LLC, where he helped structure and negotiate $150 million in institutional funding with Cargill Financial Services Corp. Klein was president of ViatiCare. Before that, he founded and was president of the National Capital Benefits Group of Cos., which he said was the nation's first institutionally funded and publicly held viatical settlement company. It was funded by Transamerica Corp.

Buerger, a life insurance agent for more than 30 years, formed Coventry Group, a brokerage also involved in administrative service and consulting with special expertise in the corporate and high-net-worth markets, in 1982. The company became a life settlements broker in September 1998, when Buerger formed Coventry Financial. "We were the only broker that came out of the life business," he said. "That's an advantage for us. When you get into life settlements, you're moving into estate and business planning, and we know the business and the products."

Buerger formed Coventry First in early 2001 to become a principal in the settlement business. As a principal, the company actually buys policies using the institutional funding. Coventry First began buying in October after announcing a $1 billion financing facility. In the first 100 days, the company bought 100 policies with a collective face amount of $165 million, Buerger said. He expects to buy $600 million to $800 million in face amount through the first 12 months. Like all but one member of the institute, Coventry uses U.S. Bank as a trustee. Bank of New York is the other institution that serves as a trustee, Buerger said.

Coventry First achieved a fast start in purchases, because it had brought many life brokers into the market as competitors. "Since we are no longer competing with them, they felt comfortable sending us their business," Buerger said. About half of all referrals come from these brokers, he said. Coventry also has relationships with about 15 national life insurance marketing organizations in the country, including National Financial Partners, the Advantage Insurance Network and Highland Capital.

Another way Coventry differentiates itself from the competition is that it does not have to buy extension-risk insurance coverage. "One of our partners is a major insurance company, both a direct writer and a reinsurance company," said Buerger. "It assumes the extension risk as part of what it's providing. Most of our competitors use Lloyd's for coverage, which is expensive and requires a large upfront fee."

Coventry pays 20% to 25% of the face amounts of the policies, or about seven times their cash value, said Buerger. He predicts that principal players in the future will be life insurers and reinsurers "in conjunction with firms like ours.

"Many believe insurers have been underpricing the mortality component," Buerger said. "We think and hope that's right. If so, a settlement is a great hedge to what they do."

In other words, insurers issuing life policies prefer that insureds live for a long time so that the policy owners continue to pay premiums. They can hedge their bets if they buy the policies and are in a position to collect the death benefit. Buerger said insureds covered by policies Coventry First buys have an average life expectancy of 7.5 years and are typically at least 70 years old. The average face amount is $1.7 million.

Legacy Benefits was a pioneer in the viatical industry. Supported by lines of credit from Chase Manhattan Bank and Bank One, it started buying policies in 1991. Now, armed with financing from an undisclosed domestic financial institution in New York to buy about $200 million in face amounts, the company is expanding.

Legacy Benefits was one of the first to obtain a viatical settlement license in New York, has licenses in more than a dozen states, and is actively seeking licenses in states that require them.

"Competition brings awareness of products to markets," said Eliav. "People look for different options. If they learn about the industry from competitors, they'll likely call us, too. There's a totally untapped market out there, and the more we talk, the more we realize how little educated financial professionals know about this."

Marketing life settlements to both potential sellers and the financial world requires tremendous resources, Eliav said "We're trying to open doors with financial planners and advisers, and the only way you can do that is if you have enough financial backing to buy very large policies," he said. "With viaticals, the average face amount was $75,000 to $125,000. In the senior market, where wealthy individuals have something to protect, the policies are $1 million and up. The only way for this industry to grow and benefit the markets is exclusively with institutional funding."

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Is There Still Room for Viaticals?

Life settlements are on the rise as viatical purchases wane, but that hasn't deterred a new company from trying to serve both constituencies.

Atlanta-based Habersham Funding LLC began purchasing its first insurance policies in early December, and managing member M. Bryan Freeman said its consortium of financing allows it to serve "the whole spectrum of people" who can sell their policies. That includes viatical purchases of face amounts under $100,000.

"So many companies have reinsurance with Lloyd's, and Lloyd's dictates what kinds of policies they can buy," said Freeman. "So you have a lot of companies competing for the same policy. But there are policies that don't fit that model that we can purchase."

Buying low face amounts is harder because fixed costs are the same. "But frankly, those are often the ones who need the help the most," Freeman said. "Don't get me wrong; we like to do the $1 million policies, too, but buying those lower-valued policies was the reason the industry got started."

Habersham does not specialize in HIV cases, however. Instead, it buys the policies of insureds with other diseases, including cancer, amyotrophic lateral sclerosis (Lou Gehrig's disease) and liver problems, or those with multiple conditions. The company also buys from insured seniors who have shortened life expectancies clue to age and chronic health problems, Freeman said.

Unlike many companies in the viatical business, Habersham does not have capital from individuals. Most comes from Habersham's sister company, Benefits America, and some comes from banks. Habersham has considerably less than the $200 million or $400 million in financing that some life settlement companies have announced, Freeman said.

Growth of the viatical industry stalled with the introduction of protease inhibitors in late 1996. This medical treatment extended the lives of AIDS patients. Many were desperate to sell their insurance policies to get onto the regimen, said Douglas Head, executive director of the Viatical & Life Settlement Association of America, based in Orlando, Fla. "When the sellers got well, the buyers wound up holding the bag," he said.

As a result, the industry has switched to a financial-services approach. "It concerns me that an awful lot of the industry is no longer serving people with terminal illness," said Head. "I'm concerned the humanitarian nature of our business is slipping away from us. I'm afraid we'll lose one of the great ethical arguments."

As for the issue of individual vs. institutional funding, Head said the industry needs both. Institutional funders seek the long-term settlement, eight to 12 years, because it is less risky. Private buyers, looking for returns in three to five years, are "generally bigger risk takers," he said.

Head's association (www.viatical.org) had 25 members in February. They are a mix of brokers, fund raisers, service providers and settlement providers, some of whom are life settlement companies. Profitability is down for some of them, while profits have surged for others. "If you look at our membership list of five years, you'd see those that rolled with the waves of change are doing well, and those that couldn't adapt are not there anymore," said Head. "Some made bad decisions. Some were heavily into AIDS policies and couldn't adjust. Some were good at marketing to people with AIDS, and they didn't know how to reach other business. A lot of people got into the business for reasons of compassion rather than profit, and they were ill-equipped when the industry shifted to talk about rates of returns to guys with million-dollar policies."

Head said he does not view the newly formed Life Settlement Institute as a competitor, because both organizations and their members have similar legislative and regulatory goals. Two companies are members of both organizations, and Head said some companies have left the association for the institute.

Life Settlement Institute Founding Members

* Coventry First LLC, Fort Washington, Pa.

* Life Capital By, San Diego 

* Life Equity LLC, Hudson, Ohio 

* Life Settlement Corp., Boca Raton, Fla.

* Living Benefits Financial Services LLC, Minnetonka, Minn.

* Stone Street Financial Inc., Bethesda, Md.

Note: Each member of the Life Settlement Institute must have an initial financing commitment of at least $50 million from an acceptable institution.

Life Settlement Criteria

Transaction Requirements

A successful life settlement transaction typically involves a policy with these characteristics:

* Insures an individual who is at least 65 years of age or older with a life expectancy of 12 years or less and who has experienced a change in health status since the policy originated.

* Has a net death benefit of at least $250,000.

* Is beyond the contestability period-usually two years.

* Is a universal, term, variable, whole or survivorship policy.

Why a Policyholder Might Sell

Many situations can cause a policy to be unwanted or unneeded. For example:

* A client wishes to obtain money for other current wants or needs, from estate and retirement planning to long-term care or new investments.

* A client outlives his or her policy beneficiary, or adult beneficiaries no longer need protection.

* A company wishes to sell key-man policies on former employees who have either retired or left the company.

* The policy would otherwise lapse.

The Purchase Process

Usually, a policy owner learns how a life settlement can be an appropriate financial option through a financial planner or insurance agent and will submit an application through that person. Once an application is received:

* The case is reviewed by the underwriting team, and if the policy meets the criteria, it will be approved for purchase.

* The life settlement company then submits an offer on the policy, and if it is accepted, closing documents are sent.

* Once the signed closing documents are received by the life settlement company, the funds are escrowed by a financial institution.

* After the appropriate change of ownership/beneficiary forms are received by the financial institution, the funds are released.

* The entire process takes about six to eight weeks.

Source: Living Benefits Financial Services LLC