The Texas Life Settlements Act Alert No. 2: New Protection for Consumers

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1 July 19, 2011 Government Enforcement The Texas Life Settlements Act Alert No. 2: New Protection The recently enacted Texas Life Settlements Act promises to provide additional protection for policy owners who engage in life settlement transactions. It requires that participants in the life settlement business be licensed and that they adhere to certain minimum standards of conduct. As with previous Texas law on life settlements, however, the Act focuses on the sale of life insurance policies from the original owner to a life settlement provider. The Act does not directly address the resale or fractionalization of policies. Application of the Act As a general matter, the Act regulates the conduct of the three major participants in life settlement contracts: Brokers, who are defined as persons who (i) offer or attempt to negotiate a life settlement contract on behalf of a policy owner; or (ii) estimate life expectancies for a life settlement contract; Insurers, the issuers of the life insurance contracts to be settled Providers, defined generally as persons who enter into life settlement contracts with owners. The Act primarily regulates the conduct of brokers, insurers and providers in order to protect owners of life insurance policies who are looking to settle their policies. It applies to life settlement contracts involving owners residing in Texas. Thus, the application of the Act turns on three questions. 1. Is it a life settlement contract? A life settlement contract is a written agreement between a provider and an owner under which the owner agrees to transfer a legal or beneficial interest in or the death benefit of an insurance policy. In a departure from the National Conference of Insurance Legislators model (the NCOIL Model ), the Act also includes certain loans secured by a life insurance policy and certain premium finance loans within the definition of life settlement contract. Loans secured by life insurance policies are life settlement contracts unless the loan is made by a licensed financial institution, or the insurer issuing the policy. Premium finance loans made in accordance with existing laws regulating the financing of insurance premiums (Tex. Ins. Code et seq.) are not considered life settlement contracts unless the loan proceeds are used for something other than for premiums or other costs related to the policy; the owner receives a written guarantee of the future life settlement value of the contract; or the owner, when the loan is made, agrees to sell all or any portion of the policy. 2. Does the life settlement transaction involve an owner? The Act specifically excludes providers and certain sophisticated purchasers from the definition of an owner. Accordingly, the Act does not attempt to regulate either the resale of policies once settled or investments based on such policies. Once a settled policy is in the hands of a provider or sophisticated purchaser, further transfers of the policy are not covered by the Act. The Act does not include sections 10 and 13 of the NCOIL Model, which contain various provisions designed to protect purchasers of and investors in life settlement contracts. In addition, the Act specifically prohibits the Insurance Commissioner from adopting rules regarding investments in life settlements. Thus, the resale of and investment in life settlement contracts will continue to be regulated under state law by the State Securities Board under the Texas Securities Act and the Attorney General under the Deceptive Trade Practices Act.

2 3. Does the owner reside in Texas? If the policy is owned by more than one owner, the law of the state where the owner of the largest percentage of the policy resides applies to the life settlement transaction. If the owners own an equal percentage, the owners may unanimously agree to apply the law of one of the states in which an owner resides. If the owners cannot agree, then the law of the state in which the insured resides governs. In the event that the state in which the owner resides does not regulate life settlement transactions, providers licensed in Texas must provide notice to the owner that neither Texas nor the owner s home state regulates the settlement transaction. The provider must also maintain the records required by the Act if the settlement involved an owner residing in Texas. Other than that, the Act simply does not apply to transactions involving policy owners who reside out of state. Protection of Policy Owners The Act protects owners by (i) requiring the licensure of life settlement providers and brokers; (ii) mandating that providers, brokers and insurers adhere to standards of conduct; and (iii) requiring that providers and brokers disclose the risks and costs of the life settlement contract. The Insurance Commissioner is granted the authority to adopt rules implementing the Act. Licensing Requirements Before beginning work as a life settlement provider or broker, a person must be licensed by the Insurance Commissioner. Existing license holders may continue to operate but are required to submit a new application within 30 days of the publication by the Commissioner of an application form and instructions. The existing license will remain valid during the pendency of the application filed under the Act. To obtain a license as either a broker or a provider, an applicant must file an application and pay a fee. The Commissioner is required to investigate each applicant and may issue a license if the Commissioner determines, among other things, that the applicant is competent, trustworthy and enjoys a good business reputation. Providers are required to provide a detailed plan of operation and a detailed antifraud plan. The Commissioner may also require an applicant to disclose its shareholders, partners, officers and employees, and may refuse to issue a license if the Commissioner believes that any person who may materially influence an applicant s conduct does not meet the standards imposed by the Act. Notably, the Commissioner has discretion not to issue a license to be a provider or a broker even if all of the statutory requirements are met. The Insurance Commissioner is in the process of writing regulations to implement this portion of the Act and the details of the application process are not yet known. The Act does, however, allow persons holding licenses to sell life insurance for more than a year to act as brokers so long as they file a notice with the Commissioner that they intend to do so. Life insurance agents acting as brokers are required to comply with all other requirements of the Act. Standards of Conduct The Act requires that providers, brokers and insurers adhere to a basic set of rules governing the life settlements industry in Texas. Among other things, the Act provides that: Brokers only represent owners and owe owners a fiduciary duty. All forms of life settlement contracts and disclosures must be approved by the Commission before they may be used. An owner has the right to rescind a life settlement contract within 15 days of the date the contract is executed by all parties. If the insured dies during the rescission period, the settlement contract is automatically rescinded. Life settlement contracts must disclose the expected date and transmitter of payment. If the provider fails to tender the purchase price to the owner by the date set forth in the contract, the contract is voidable at the election of the owner. Page 2

3 Providers are required to escrow the purchase price within three days of receiving documents effecting the change of ownership. The escrow agent is to pay the owner within three days of receiving acknowledgment of transfer from the insurer. Insurers may not unreasonably delay effecting the change of ownership or beneficiary or require the execution of any form not approved by the Commissioner in connection with a life settlement contract. Insurers must respond to requests for verification of coverage within 30 days and, at the time of verifying coverage, the insurer must give notice as to whether it intends to investigate the validity of the policy. Subject to certain exceptions, no one may enter into a life settlement contract either before or within two years of issuance of a policy. In addition to the basic rules of conduct, the Act also describes certain conduct which it deems to be fraudulent life settlement acts. This conduct includes acting fraudulently, structuring transactions to evade the Act, entering into life settlement contracts regarding policies of insurance the participants know or reasonably should know were procured by fraud and issuing or soliciting policies for the purpose of or with an emphasis on settling the policy. Using forms not approved by the Commissioner is also a fraudulent life settlement act. Knowingly, recklessly or intentionally committing a fraudulent life settlement act is a criminal offense. Providers and brokers also are required to maintain the confidentiality of medical and financial information of insureds as well as nonpublic personal information solicited or collected in connection with a life settlement transaction. The protection of information regarding insureds is copied directly from the NCOIL Model. As a result, providers and brokers operating in other states adopting the NCOIL Model should have no issues complying with this provision of the Act; although we note that the regulations adopted in Texas to effectuate the Act may differ from those in other NCOIL states. In a departure from the NCOIL Model, however, the Act expressly requires that anyone involved in a life settlement transaction treat nonpublic information they solicit or collect in accordance with the provisions applicable to financial institutions for the protection of nonpublic personal information under the Gramm- Leach-Bliley Act and other unidentified state and federal laws relating to the confidentiality of nonpublic personal information. Providers and brokers operating in Texas should therefore confirm that their procedures for handling and protecting nonpublic personal information comply with Gramm-Leach-Bliley and other privacy laws. Presumably, the regulations adopted by the Commissioner will shed greater light on exactly what other privacy laws are applicable to those in the life settlement business in Texas. To enforce the requirements of the Act, life settlement providers and brokers are required, to a certain extent, to police each other. Among other things, holders of life settlement licenses in Texas are required to verify the licensing of everyone else involved in a life settlement transaction. Under the Act, a broker may not allow any person to perform the functions of a provider without holding a proper license. The converse is true for providers. In addition, providers and brokers must report all fraudulent life settlement acts of which they become aware to the Commissioner. All license holders under the Act are required to develop and maintain antifraud initiatives that are reasonably calculated to detect, prosecute and prevent fraud. These initiatives must include retaining designated fraud investigators employed by or under contract to the provider and formulating a detailed antifraud plan. The antifraud plan must include procedures for detecting and investigating fraud; for resolving inconsistencies between medical records and insurance applications; for reporting fraudulent acts to the Commissioner and for educating the provider s employees regarding the detection and prevention of fraud. In addition, the antifraud plan must include an organizational chart identifying the persons responsible for the antifraud initiative. Each license holder must submit its plan to the Commissioner. The plans submitted to the Commissioner are exempt from disclosure under the Public Information Act as well as from discovery in a civil action. Page 3

4 The combination of the duty to report and requirement that license holders maintain antifraud initiatives means that providers and brokers must be proactive in their approach to fraud prevention. Not asking questions and ignoring red flags will likely have consequences if a provider or broker is unwittingly swept up into a fraudulent scheme. They must conduct reasonable due diligence to insure that the transactions they enter into do not violate the Act. Mandatory Disclosure The Act requires three separate sets of disclosure by life settlement providers or brokers to the owners. At the time that the owner applies to settle a policy and at the time the contract is signed, the provider or broker must disclose a variety of facts relating to the proposed transactions. These include: that possible alternatives to life settlement contracts exist, particularly accelerated benefits from the insurer; that the proceeds from the life settlement contract may be taxable or subject to claims by creditors and may affect the recipient s eligibility for public assistance or other government benefits; that the owner s medical, financial, personal information and identity may be revealed as part of the contract and the owner may be required to renew their consent to disclosure every two years; and that the life settlement contract may impact the owner s ability to purchase additional insurance in the future because there is a limit to how much insurance is available on one life. In addition, the broker must disclose to the owner and the provider at the time the contract is executed: the broker s name, business address and telephone numbers; all offers, counteroffers, acceptances and rejections related to the life settlement contract; any affiliations between the broker and any person making an offer in connection with the life settlement contract; the name of each broker receiving compensation and the amount of compensation received by each; and a complete reconciliation of the gross offer or bid by the provider to the net amount received by the owner. These disclosures must be included either in the life settlement contract or in a separate document signed by the owner. To effectuate the disclosure requirements, the Act requires that the forms of life settlement contracts and disclosures be submitted to and approved by the Commissioner before they can be used. The Texas Life Settlements Act provides broad-ranging protections for Texas owners of life insurance policies looking to settle their policies. It also imposes numerous requirements on providers, insurers and brokers. All should review their procedures to ensure that their activities in Texas comply with the Act. Author: Michael D. Napoli michael.napoli@klgates.com Page 4

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