Participants:
Brian T. Casey, Partner, Co-Chair, Insurance Regulatory and Transactional Practice Group, Locke Lord
James W. Maxson, Partner, EM3 Law
Laura Metzger, Partner, Orrick
Jule Rousseau, Partner, ArentFox Schiff
Understanding litigation risk is part and parcel of a life settlement investor’s day to day, and Life Risk News’ Jeffrey Davis spoke to life settlement attorneys Brian T. Casey, Partner, Co-Chair, Insurance Regulatory and Transactional Practice Group, Locke Lord; James W. Maxson, Partner, EM3 Law; Laura Metzger, Partner, Orrick; and Jule Rousseau, Partner, ArentFox Schiff to get their views on the current state of litigation in the life settlements industry and what to look for in the coming year.
JD: Are there any cases in litigation today that the industry should be paying close attention to and what might we learn from them?
JR: We had some important Delaware decisions that have been well discussed and digested. There’s the Berland decision in the Delaware Supreme Court, and the Malkin decision. They really set some new parameters in Delaware law for litigation both by insurance companies and by estates of deceased insureds. And those decisions have now led to two trial court decisions that are even more important than the Delaware Supreme Court decisions.
Berland basically handed everything – silver spoon included – to the estate, but it’s going before the Third Circuit. But the trial judge was a Third Circuit judge and we’re not optimistic that the Third Circuit’s going to reverse a decision by one of their brethren. If that case gets locked in federal court, decisions in Delaware and state cases could all go badly for the industry.
Then we have a second case that’s in Delaware State Court where the state court judge did the same thing that the federal judge did in Berland. That case we might get to take to the Delaware Supreme Court – we’re waiting for the client to give us the go ahead – so there’s likely going to be a fourth Delaware Supreme Court decision that hopefully will limit the way the courts have treated these estate cases in Delaware.
But if they don’t, it’s just an open door for litigation firms. They seem to be bringing these cases that file a lawsuit and say, “pay us money, you have no defense in the state of Delaware”. If you do get sued, in the context of the overall industry, it’s a minor blip, but nobody wants to lose a $5mn or $10mn collection that they’ve already collected and booked into their profits for the year.
The second decision, which was a carrier case, is also a major decision, and there’ll be more to come in that case as carrier cases now apply the rules from Seck. So those, those are all three important things to follow and we’re all following them.
JM: There have been knock-on effects from these cases impacting the industry as well. In particular, Wells Fargo and Wilmington Trust, which act as securities intermediaries, are requiring that fund managers effectively leave funds in the securities intermediary account to cover tail risks in litigation cases.
JR: There’s a case in California where they’re also seeking to get Wells Fargo dismissed as merely being a pass-through for the money. If we can get a couple of decisions like that, that’s going to give Computer Share and Wells Fargo a little bit more comfort that they’re not going to be on the hook. Right now, they’re looking at the fact that they could be found liable to an estate as well, particularly when their customer is an offshore fund that can’t be sued in the United States. So, that is a crucial legal issue that we’re pushing, and others representing Wells Fargo are pushing litigation too. Are the securities intermediaries going to be deemed not at risk in a state litigation?
JD: There’s a continued regulatory clamp down on so-called enhanced cash surrender value transactions. What should the life settlement industry be watching for in that area?
BC: You want to be on the lookout for maneuvers by the life insurance companies to come up with a different way of doing the same thing. They have smart lawyers and product development people, so they may come at it from a different angle but try to achieve the same goal.
There are still some life insurance policies that have onerous anti-assignment clauses designed to thwart life settlements that some of the carriers were able to get away with and filed and approved by some state insurance departments. I had one that came in recently and it might be a nice follow-on opportunity for the folks that are working with the state legislators and regulators on this enhanced cash surrender value issue to go ahead and start addressing these anti-assignment clauses that are out there while they’re up.
JD: What’s the current lay of the land regarding whether life settlements are securities?
BC: I have a new article coming out which examines the question of whether, under state blue sky securities laws, a plain vanilla tertiary life settlement trade could be a securities transaction, and the answer is it can be, in some states. Some states have exemptions, but when you weave your way through it, some states don’t.
JM: Most states have adopted that view. For instance, several years Georgia ago adopted the uniform securities act. And it just flat out says life settlements are securities, no exceptions, no exemptions, nothing. And it is pretty much universally ignored.
BC: For big life settlement investment funds, it’s not a practical issue if you’re an offshore fund and you’re selling in a tertiary transaction. However, if you were selling to a buyer that has its principal place of business in one of these ‘bad’ states, then it could be a securities transaction. But by and large the funds aren’t principally located in these states, thankfully.
LM: Right. And you would also have to look at the characteristics of the buyer to see if you can fall into exemptions there as well.
JD: Let’s talk about things that arguably could do with being undone. For example, in some states a policy owner cannot sell a policy for five years after issuance. This disadvantages policy owners in those states that don’t permit them to sell an asset that they lawfully are entitled to monetize. What are your thoughts here? And is there anything else that you’d like to flag here?
BC: Well, let’s clarify that. I mean there are exceptions of course like in any area of law. So yes, there’s a presumptive five-year ban, but then you have to look at the exemptions. There’s one for changed circumstances, becoming terminally ill, divorced, that kind of thing. And then if it’s not non-recourse, premium financed, you can do it after two years, so it’s not necessarily a flat-out five-year ban.
JM: And there’s really only a handful of states that have the five-year. Florida has the one that Brian just discussed that you can sell after two years if you can prove the policy was originated via a non-recourse premium finance program.
Something that I still encounter that is occasionally problematic are the minimum pricing rules. Those tend to be in the regulations rather than the statutes. But I still have clients call regularly and say, “hey, this person has a 30-month LE, and it says we have to give them 80% of face, do we have to give them 80% of face?” And the answer is, “yes, that’s what the regulation says”. And that sometimes results in the consumer being unable to monetize their asset because practically speaking, the policy’s not worth anything close to 80% of face. And I’ve advised clients to tell the sellers, “Call the department of insurance and see if they’re willing to tell you it’s okay since we can’t tell you it’s okay.” I’d love to see those rules revoked, but I don’t know if there’s much appetite by state regulators to revoke these regulations.
BC: If we had our druthers, there’s all kinds of other stuff that I would clean up in the model life settlement laws, particularly in the NAIC model act. For example, there’s all this securities law and investment side-isms in there because at the time the insurance regulators developed the model act, the securities regulators were really just getting up to speed on the life settlements industry.
JM: A situation happened recently where the provider sent a client a viatical settlement investment disclosure required by NAIC model act, and they were like, “what the heck is this?” And I told them to not worry about it. These aren’t burning issues, but they add to the overall friction of the industry in terms of everyone complaining about how long it takes to close deals. A big part of the problem is that the statutes are so byzantine, and they vary so much from state to state. It would be great to see more uniformity but that just isn’t going to happen.
BC: One other friction area I see fairly frequently is that state insurance regulators oftentimes don’t understand the difference between Gramm-Leach-Bliley privacy and HIPAA privacy. They’re taking the position that a HIPAA authorization has to terminate in two years. That’s just not the law. The provision in the settlement law says when you get an authorization to get information, not from a physician, but from the insurance carrier, it terminates and you have to renew it every two years or so. This creates these friction areas because either they don’t understand the law or they’re misapplying it.
JD: What are you seeing in the area of increased data privacy and security compliance obligations?
BC: Lots. You’ve got the CCPA (California Consumer Privacy Act), and acts in some follow-on states that may or may not apply to the life settlement industry depending on what data is being collected. The NAIC is revamping its Gramm-Leach-Bliley Act data privacy and security regulations, which were passed in 2000 to become more CCPA-like to give more data rights to consumers. And then you also have a species of new regulations and laws addressing artificial intelligence and machine learning, all of which ties back into to the privacy issue.
LM: I think the biggest risk to this industry right now is in these data protection acts because data is ultimately how you value the policies and restrictions on your ability to share or use that data, or requirements that make it more onerous to obtain that data, are just really bad for this industry. And I agree that it’s probably an open question as to whether or not the California law might apply to some people and it might not apply to others but at the same time, I look at this as if data is managed within these laws in the right way, it potentially is their most valuable asset. And finding a way within all this regulation to monetize that data could give a completely new life to the industry because then you’re not only relying on the underlying value of the actual asset, you’re using data in a completely different way.
BC: I agree. The reality is that the investment funds really are in the regulatory gap on privacy laws. I think they’d like to stay that way, but it may change.
JM: One of the things that I’ve always thought was interesting is a lot of these life settlement laws have explicit provisions that allow you to share information in connection with the resale of a policy. But at the same time, a lot of them have provisions that say something to the effect of ‘just because this law says you can do it doesn’t mean there’s not another law that says you can’t.’ This is just another example of how confusing and conflicting the life settlement laws can be.
LM: There are older policies in the market that get traded that could be impacted by these provisions and the restrictions on sale that don’t have the documentation necessary to permit the sales with some level of comfort around this issue. I think that’s a significant concern. I’d also be concerned if I’m trading in some of these states because if you are covered by these laws and these transactions, then when you’re doing portfolio sales or policy sales, what liability do you still have? We started being much more thoughtful about this issue several years ago, specifically with confidentiality agreements and adding provisions, especially when you’re dealing in Europe. But I think that’s going to become the norm now in the US and it might become more difficult to transact with certain counterparties that aren’t going to be complying at the level that some firms are going to need them to.
JD: Let’s talk about best interest fiduciary duty and pushing on life insurance agents to include the life settlement option to a life insurance policy, surrender or lapse. What are your thoughts here?
BC: I think it would be great for consumer policyholders and probably for our industry if there was a best-interest duty. But if the agent is not initiating a potential life settlement transaction, I don’t think that an agent who represents a carrier – and is not the agent of the customer in the legal sense – would normally have a duty to the policyholder because their duties run to the carrier, not to the client. On the other, most life insurance customers perceive “their agent” as being their advisor, and oftentimes, life insurance agents can be dual agents for both a life insurer and the life insurance customer.
JM: I agree with Brian. There was a case going back maybe 15 years out of California, where a family did sue an agent because he failed to tell them about the life settlement option, and their policy lapsed, and the parties just ended up settling. The significant thing from that case was the cause of action, which withstood a motion to dismiss by the agent, created the possibility that there could be a viable claim – that if an agent fails to disclose the life settlement option, they have been negligent, if nothing else.
JD: Finally, what is the most important thing from a regulatory perspective as we head into 2023 that you think is likely to have the biggest impact on the life settlement industry?
LM: This isn’t necessarily a regulatory issue, but I think one of the biggest issues is that life insurance policy inventory is low, and it is becoming more difficult to transact. Over the last year or two, there haven’t been as many massive transactions as there used to be. If managers want to try to acquire some of these larger portfolios, it seems that they have to be more creative and be willing to engage in lengthier and more cumbersome ways of obtaining the underlying policies, as you saw in the battle over financing the GWG portfolio. That’s a very different transaction from what we used to see two years ago, when there were 100 or 200 policies for sale, and you could buy and close them within two months. In my mind, that is both a business and legal issue for 2023. In addition, I think the GWG scenario and the allegations currently pending there does a disservice to how much the industry has cleaned up. But as a result, you might see some of the institutional investors more cautiously consider future investment.
BC: Given that the life settlements industry has been heavily regulated in about 46 states for many years, I don’t expect much new legislative or regulatory activity directly aimed at this industry. But 2023 should see more regulatory action regarding enhanced cash surrender transactions and in the data privacy and security area.
JR: I think that state regulators exercising their power over providers could become a big problem, as we saw from Florida at year end 2022. As licensees, providers must respond to market conduct and investigative inquiries and if states want to make their lives hard, they have the statutory power to require a lot of meaningless information that could create headaches and expense for providers, most of whom live on tight budgets.
JM: I tend to agree that, with the possible exception of Florida, we are not likely to see a great deal of regulatory activity in 2023. I caveat that by noting if Florida does engage in a more aggressive posture, other states might also pile on. That scenario aside, I am more concerned about the state of the economy and the impact a recession would have on the life settlements industry. In 2008-2009, in conjunction with the “Great Recession” the industry saw a significant contraction from which it has only arguably recovered in the last year or so. Having another recession knock the industry back on its heels again would be disappointing when it has provided some much-needed financial help for U.S. seniors.