Sale of Existing Variable Life Insurance Policies
to Third Parties

The NASD has recently focused on another potential area for trade practice abuse, that being "life settlements". Over the last few years, a secondary market has developed for the sale of existing life insurance policies to third parties at a price between the net death benefit and the cash surrender value. This type of a transaction is known in the market as a life settlement. This secondary market has developed as an alternative for the holder of an existing life insurance policy, rather than to let the policy lapse or to surrender the policy to the issuer for the cash surrender value. From a regulatory perspective, life settlements represent the sale of variable life insurance policies (to wit, in the secondary market), and as such, they are considered a security. Therefore, NASD and State rules and regulations apply.

The NASD believes this is an area of potential abuse for a number of reasons. With respect to the primary target market, an insured may contact the life settlement broker directly, or through a financial adviser or use a life settlement broker. It is perceived to be more common for life settlement providers and brokers to look for people who can no longer afford the policy or no longer need the policy. Providers and brokers also solicit financial institutions, including broker/dealers to find customers who might be willing to sell their policies. To further exacerbate the situation, the payouts can be as high as 30%. Thus, the NASD believes that members need to be reminded of their duties as to a customer's privacy, and their obligation to perform a suitability analysis.

Suitability relates to both the transaction and the product. As with all other products, suitability analysis requires an associated person to understand the products and transactions they recommend to customers. In the case of a life settlement, a representative must also know that it is a suitable transaction for the client. Thus, it would be appropriate to inquire if the customer intends to replace the coverage, the cost of comparable coverage and the tax implications of the transaction.

To this end, the NASD states that NASD members must inquire into the privacy policies of the providers they are working with (medical records), and to ascertain if the providers are going to require ongoing information on the customer's changes in health. Members must also determine if providers and brokers are properly licensed where required. They may further establish a list of acceptable providers or brokers. The NASD also believes that the members' obligation to obtain best execution needs to be addressed, and as such, members must obtain the best price for their customers (best execution). Thus, an exclusive arrangement with one provider may not be appropriate, and it's recommended that bids from multiple licensed providers be obtained and recorded on a memorandum of record.

Life settlements can also affect NASD Rule 3040. To that end, associated persons wanting to participate in the sale of life settlements outside the scope of their employment must obtain prior written permission in accordance with NASD Rule 3040. Members may also have to record the transaction on their books and records.

Finally, to the extent that life settlements are considered a new product, the NASD has recommended that members should perform a thorough formal review of the product. The review should be completed by members of the executive team, compliance and legal department, sales department and the FINOP prior to permitting sale of the product. Registered personnel involved in the sale of the product should also be appropriately trained in the features of life settlements prior to engaging in sales.