Life 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 sells an unwanted, unaffordable, or underperforming life insurance policy to an institutional purchaser instead of letting the policy lapse. As registered representatives grapple with the go-ahead with their compliance department, they are usually confronted with mixed answers regarding 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.”

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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 product securities to be subject to firm supervision.

The NASD is the “watchdog of the SEC,” whose sole purpose is to protect the investing public. One of their preoccupations is to keep 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. However, many would conclude that the upfront 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, there is $9.4 trillion of life insurance 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 white paper, “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 redeployed 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 to adopting the 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 life settlement. Some warehouse 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 reward by redeploying 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 secondary market policy 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 concerning 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 in defining 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 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 the settlement business’s insurance regulation. 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, many Broker-Dealers have chosen to ignore the life settlement in the hopes that they can one day claim ignorance. This “stick your head in the sand” posture is a recipe for disaster because, empirically, the NASD has made it clear that it will not tolerate this kind of strategy under any circumstances.
Common sense dictates that to avoid problems, the client’s best interest should always be placed first. Thus, issues can be prevented 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, imperative 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 choice of favorite company and price-fixing. The fact that the firm has multiple offers may not be enough. Indeed, it is imperative to have more than three quotes to get the best execution due to the providers who will”take a pass” to acquire the insurance contract. Today, broker-dealers engage in life settlements that likely violate this procedure.

NASD Rule 2110:

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

NASD Rule 2310:

The NASD has clarified that we must conduct our business consistently with the customer’s objectives and corresponding suitability. Moreover, we must disclose all material facts and maintain full disclosure. Not offering a beneficial strategy when appropriate directly conflicts with the 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:

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

Licensing and Compensation Issues

The “Desk Drawer Broker-Dealer”

This strategy is simplistic and a logical alternative to partnering with a single Funder. The interested broker-dealer would create a selling agreement with a specialized broker-dealer component to conduct the life settlement transaction for a fee. All transactions would meet NASD requirements, including best execution. The broker-dealer with the unwanted policy would transact under an arm’s length arrangement.

NASD “Blue Sky” Regulations

Besides having a general securities license series seven and series 63, some guidelines should be followed. Although there is confusion by many of the Founders as to how life settlement transactions should be conducted from state to state, it is logical that the broker-dealer and its Registered Representative must maintain registrations in the state from which the compensation originates, i.e., the Funder’s home state of business transactions. However, it should be emphasized that it is a good business practice for an R.R. to become authorized in every state where they plan on conducting the business of life settlements.

Variable Policy Clearing

Although many of the policies sold in the secondary market are fixed, there is the occasion when “variable rescue” may come into play. In this situation, it is always advisable to clear through a “desk drawer” broker-dealer, as mentioned above. Moving the subaccounts to the policy’s money market is not a fixed product and, thus, is insufficient to avoid potential NASD regulation.

USAPatriot Act

USA PATRIOT Act in October 2001 settlement transactions are not excluded and should comply with all rules and regulations concerning the USA Patriot Act. Therefore, to comply with anti-money laundering (AML) laws, a normal business model of compensation payment could include the settlement broker firm notifying its contracted employee and RR/BD of the specific dollar amount of a transfer that will derive from a source Provider firm. The Registered Representative reports to the broker-dealer about the payment amount and its source to ensure Blue Sky registrations. After the broker-dealer receives the payment to the Registered Representative (in compliance with NASD guidelines), the Registered Representative will deposit the funds into his LLC bank account (in compliance with the IRS above guidelines) and provide separate invoices that meet uniform and specific identification requirements to both the agent’s broker-dealer and the life settlement broker firm. The invoices will be signed and executed by each entity and returned to the Registered Representative for inclusion in a permanent file as the compensation recipients. After pay, the Registered Representative’s LLC makes payment to the agent’s broker-dealer and the life settlement broker firm. The latter will provide the Registered Representative with an electronic copy of the specific case file the Registered Representative will keep in the same permanent file as the related invoice copies.



The 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 that 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 are 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” the past host of the Southern Most Wall Street Report on Conch FM and has authored other literary and columnist works.