Life Insurance Settlements Viewed Through the Eye of the NASD – A Study in Compliance


Life coverage settlements have brought about a tremendous deal of confusion for broker-sellers within the last 24 months as increasingly registered representatives have become privy to this arguable wealth management method. The existence settlement is the sale of an undesirable, unaffordable or underperforming lifestyles insurance policy. This is bought to an institutional patron instead of letting the policy lapse. As Registered Representatives grapple for the go-ahead with their compliance branch, they’re usually faced with mixed answers as to its viability. To make sure, this method is an area of subject for dealer sellers and NASD participants alike. Mary Schapiro, Vice Chairman of the NASD, spoke at the Chicago NASD Conference on May 25th, 2005. She addressed, in component, 3 significant issues:


1. “The first risk is to count on that infant boomers have a level of monetary acumen that gets rid of the want for correct suitability evaluation.”

2. “A 2nd hazard comes from the very product innovation that has normally served your clients so properly”.

3. “A 1/3 risk is a failure to research the fame of these new products underneath the federal securities legal guidelines.”

Chairman Schapiro says that equity-indexed annuities are securities in addition to lifestyles settlements and might constitute a “selling away” problem among different concerns. She explains: “Equity-listed annuities are most effective one example of a monetary product that a firm would possibly erroneously treat as a non-security. Other examples consist of tenants-in-not unusual exchanges and life settlements. NASD considers all of this merchandise to be securities, a problem to company supervision.

The NASD is the “watchdog of the SEC,” whose sole lifestyle is to shield the funding public. One of their preoccupations is to hold in check the “egregious overcharging” of expenses which might be generated with the aid of synthetic funding products. There appears to be a correlation via the NASD as to their concern with the nature and size of fees that have been generated by way of the life settlement transaction.

The question remains; are existence settlement transactions securities? The question of whether or not life insurance settlements are to be treated as securities is split into two parts whether or not we are discussing the returned cease income interest, i.E. The distribution of hobbies in coverage or pool of guidelines or the front gives up a hobby, i.E—the solicitation and facilitation of the sale of a policy to a life settlement agency. Once the coverage has been bought into the secondary marketplace, one could conclude that the “transfer for cost rule” has been carried out, and the insurance agreement may be construed as a safety. Many, however, might conclude that the up-the-front transaction of a life settlement would now not be subjected to securities law and jurisdiction.


Why all the Fuss?

Does the existing agreement market deserve such interest? According to the 2004 Life Insurers Fact Book, compiled using the American Council of Life Insurers, there is $nine.4 trillion of existence coverage in pressure on 167 million rules. Coupled with the reality that rising demographics display, our loved “Baby Boomers” are hitting retirement, and you could truely see that the lifestyles settlement marketplace is getting on everyone’s radar screen.

Moreover, in step with the Conning Research and Consulting whitepaper, “Life Settlements, The Concept Catches On” 2006, they explain that the average life settlement provides 25% and 30% of face quantity.” If it’s miles genuine that approximately 35% of all settlement proceeds will be re-deployed into new funding vehicles for boom or earnings, then you could draw the realization that broking-sellers should have a vested hobby. This rings particularly authentic where there’s opposition to registered consultant recruiting in which they will doubtlessly boom their gross commissions.

This article will look at the ability of NASD troubles and possible solutions closer to the adoption of existing insurance agreement applications. It isn’t supposed to assist the belief that a life agreement is safe but to give higher expertise if a dealer-provider wishes to add the strategy as a brand new earnings center. The first consideration from a compliance attitude is how to treat the existing settlement. Some cord-residence compliance departments, as an instance, have treated life settlements as passive referral and do now not accept repayment. The commonplace concept is that they could acquire the compensation by re-deploying the proceeds toward a conventional product consisting of an inventory, bond, or mutual fund. In that way, because the reasoning goes, they did now not complete a securities transaction and consequently did no longer violate the NASD technique. Moreover, many of those firms use the existing settlement method closer to the alternative of underperforming or superseded coverage.

 Insurance Settlements

For example, Client Clara has a $a million lifestyle insurance coverage and pays $60,000 12 months in rates. Broker Bob tells her that she will promote the policy within the secondary marketplace and use the proceeds to pay for new coverage with a new no-lapse guarantee. She sells the coverage for $300,000 and uses the cash to buy a new $1,500,000 with much less than her original premium expenses.

Many broking dealers have adopted this passive non-compensation method to existing settlements. Other broker-sellers see the product to offset lagging markets and infuse new streams of revenue for the company. We need to end up extra knowledgeable towards the expertise of a way to deal with complicated compliance problems related to lifestyles settlements. Many factors cross into how the existence settlement program has to be established into a BD gadget. For example: Should the BD examine the program as safe or strictly as an outdoor business pastime. Few firms may provide answers to those complex questions to offer to consult as it issues lifestyles settlements.

Involving the notion that a lifestyles agreement is a protection, it is critical to recognize what safety is to decide if it applies to lifestyles settlements. The keystone case at the definition of securities is SEC v. W.J. Howey.1 In Howey, the Supreme Court changed into asked to outline the term “funding settlement” because that term is used within the definition of security underneath the Securities Act of 1933. In its choice, the Court described investment protection as any transaction that: Involves the funding of cash, in a common employer, with an expectation of earnings, and which happens completely from the efforts of others. It is immaterial if the corporation is evidenced using formal certificates or nominal hobbies in physical belongings. In SEC v. Mutual Benefits Corp. The Eleventh Circuit affirmed a U.S. District Court locating that Mutual Benefits was involved in a viatical agreement contract certified as “investment contracts” below the securities act of 1933 and 1934. Before the case of the Mutual blessing, the agreement industry constantly noted a district court docket choice, SEC v. Life Partners Inc., As the idea for insurance law of the agreement commercial enterprise. Despite losing, the SEC has persevered in its opinion that investments in settlements are securities. The precedent set by SEC v. Mutual Benefits has created a cavalcade of potential securities issues that must be looked at by using a seasoned expert in the agreement/NASD industry.

Just as essential is the truth that many Broker-Dealers have chosen to ignore the existing settlement in the hopes that they can take one-day claim lack of expertise. Common feel dictates that so that you can avoid issues, continually area the client’s high-quality hobby first, consequently preventing issues with the aid of now not being compliant. This “stick your head in the sand” posture is a recipe for catastrophe because, empirically, the NASD has made it pretty clear that they may not tolerate this type of approach in many instances.

There are many policies, policies, and strategies that might practice to existence settlements below NASD pointers. This article will only have a look at some very germane issues. It is vital to note that any prudent compliance branch will want to adopt written approaches on processing lifestyles settlements.


Life Insurance

In presenting life settlement offerings in a prudent SEC and NASD compliant way, we must apprehend how the approach has to practice NASD tactics. Thus some distance, the SEC and the NASD have now not definitively emerge as the reliable SROs of the existing agreement industry. However, they’ve prosecuted and brought punitive movements on RRs. To make sure, the NASD has declared that the lower back-stop of the transaction is protected and has made it clear that “fractionalization “is a risky area of the product. The program has won in reputation, and the aforementioned law body will probably lead the regulatory rate. It is consequently extremely critical to recognize written techniques regarding: While there are over 20 identifiable problems and strategies that could have an impact on NASD methods, right here are 7 that should practice without delay:

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 (*must be Written and Consistent)

NASD Rule 2320: Best execution through the “3 Quote Rule” is applicable whenever there is an offering to most people. That is to say, we, as specialists, are held to the highest of standards and feature a fiduciary to get the best pricing for our customers. This due diligence procedure is to make sure towards mistaken favored business enterprise preference and charge solving. The reality that the firm has more than one won’t be sufficient. Indeed, it’s extremely critical to have more than 3 rates to get first-class execution because the carriers to”take a pass” at acquiring the coverage agreement. Today, there are broking-sellers presently accomplishing life settlements which can be likely in violation of this procedure.

NASD Rule 2110: High Standards of Commercial Honor and Principles of Trade are paramount to stay compliant. The NASD has dominated and punished each broking-sellers and registered representative combining rule 2110/ 3030 & 3040 related to life settlements. It is important to note that there can be “failure to oversee” issues where promoting away and personal placements are conducted.

NASD Rule 2310: The NASD has made it clear that all of us must conduct our business regularly with the patron’s objectives and corresponding suitability. Moreover, we have to reveal all cloth data and hold complete disclosure. By now, not offering a beneficial method while suitable is in direct struggle with NASD Rule 2310 (b) (four). (B.D. Beware)

NASD Rule 2430: Charges, if any, for services done, which includes miscellaneous services along with a collection of money due for predominant, dividends, or interest; exchange or switch of securities; value determinations, secure-keeping or custody of securities, and different offerings, will be affordable and no longer unfairly discriminatory among customers. States that adjust high costs have to be adhered to correctly. Empirically speaking, the NASD sees immoderate expenses to be anything over five-6%. Since lifestyles settlements create costs over the coverage regulations, coins give up value; thenn, a payout grid may be mounted to comply with NASD rule 2430. One must are seeking for out expert consultation regarding this very paramount trouble.

NASD Rule 3030: No individual related to a member of any registered potential shall be employed by using, or receive reimbursement from, any other person as a result of any commercial enterprise interest, other than passive funding, outside the scope of his dating with his enterprise company, except he has provided set off written observe to the member. As previously said, the NASD has made it clean that lifestyles settlements are included in their interpretation of “promoting away,” and it’s miles a paramount location of a problem in which wrong supervision exists.

NASD Rule 3040: Provides, amongst different things, that previous to taking part in a securities transaction out of doors the course or scope of their employment, a person associated with a member company should deliver that company earlier written notification. In addition, if the firm is notified that the associated individual might also acquire selling compensation, it’s miles required to problem written approval or disapproval.

Licensing and Compensation Issues

The “Desk Drawer Broker-Dealer”

This approach may be very simplistic in nature and is a logical alternative to partnering with an unmarried Funder. The interested dealer-dealer might create a promoting agreement with the specialized broking-provider factor to behave the lifestyles agreement transaction for a charge. All transactions could meet NASD requirements, such as high-quality execution. The broker-provider with the undesirable coverage would transact underneath an arm’s length association.

NASD “Blue Sky” Regulations

Aside from having a trendy securities license series 7 and collection 63, a few hints should be adhered to. Although there is confusion among the Funders as to how existing settlement transactions need to be performed from state to state, it is logical that the dealer-provider and its Registered Representative need to preserve registrations inside the nation from which the reimbursement originates, i.E., the Funder’s domestic country of enterprise transactions. It has to be emphasized but that it is ideal commercial enterprise practice via an RR to be authorized in every kingdom that they plan on undertaking the business of life settlements.

Variable Policy Clearing

Although most of the regulations bought within the secondary marketplace are constant, there is the occasion when “variable rescue” may also come into play. In this case, it is constantly beneficial to clean thru a “desk drawer” broking dealer, as noted above. Needless to say, transferring the sub-money owed to the policy’s money market does now not represent a fixed product and, as a result, isn’t sufficient to keep away from potential NASD law.

USAPatriot Act

USA PATRIOT Act in October 2001Life settlement transactions aren’t excluded and ought to observe all policies and guidelines regarding us Patriot Act. Therefore, if you want to follow anti-cash laundering (AML) legal guidelines, it follows that an everyday enterprise version of reimbursement charge should consist of the settlement dealer firm notifies its shriveled worker and RR/BD of the unique dollar quantity of a switch a good way to derive from a supply Provider company. The Registered Representative notifies the broking-dealer about the price amount and its source to make certain Blue Sky registrations. After the broking provider receives the payment to the Registered Representative (in compliance with NASD recommendations), the Registered Representative will deposit the finances into his LLC bank account (in compliance with the aforementioned IRS tips) and offer separate invoices that meet uniform and precise identity necessities to both the agent’s dealer-supplier and the lifestyles settlement broker company. The invoices may be signature performed by way of each entity and again to the Registered Representative for inclusion in a permanent file because of the repayment recipients. After payment is made through the Registered Representative’s LLC to the agent’s broking-supplier and the existing settlement dealer firm, the latter will offer a digital copy of the particular case record that the Registered Representative will preserve inside the identical permanent file because the associated invoice copies.


Life Insurance Settlement is an emerging and regularly misunderstood industry. While the idea of selling coverage has been around for over a century, we are now entering a generation in which it can become not unusual. The secondary market, even as nonetheless in its infancy, seems to have “became the corner” and is quickly becoming a permanent part of our economic and wealth management making plans. As the industry expands and matures, we can see more and more seniors benefit from the strategy. Moreover, we can see Registered Representatives revel in creating a brand new source of the price range for their customers, which they will location in a more appropriate and extra appropriate investment. Today, more than ever, broking-dealers and wire-houses are placing “written techniques” into effect or getting to know the potential advantages of the secondary marketplace for existence coverage. If conducted with prudence and strict adherence to NASD guidelines and policies, life settlements have to grow to be a chief aspect of mainstream wealth management for the broking-provider and wire-residence community.