1. The History of the Life Insurance Industry Provides Good Reasons for
Investor Confidence in the Secondary Market
Like the life insurance industry itself, the secondary market for life insurance is a risk
management industry, not a risk avoidance industry. While Life Settlement Investors take and
must either mitigate or become comfortable with mortality risk, headline risk, calculation risk and
viator fraud risk, there is one risk that a Life Settlement Investor must never take, and that is the
risk of not receiving the death benefit of an owned policy. A competent Life Settlement Provider
will assure that the policy is in good standing at the time of purchase by the investor and will
utilize the best tools available for projecting the cost of policy maintenance until maturity by death
of the insured. A competent Life Settlement Asset Manager will pay premiums in an amount
adequate to maintain the policy and will provide annual reviews to assure that policy funding is
maintained appropriately. But what about the one circumstance that is out of the control of the
Investor, the Provider, and the Asset Manager: insurance company insolvency?
Life insurance initially is purchased to mitigate the risk of potential financial loss at the time of
death. The two more common reasons life insurance is purchased are to replace income lost
when the earner dies and to assure that the insured‟s estate passes to beneficiaries undiluted. If
a life insurance company issued only one such policy, the risk would be that the insured would
die before the company had the opportunity to collect enough premium money and investment
income to pay the death claim. Insurance companies mitigate this risk by assessing the medical
condition of the each applicant before entering contracts and by issuing hundreds or thousands of
policies to spread that risk. Additionally, they share the risk of policies with large face amounts
(the initial death benefit displayed on the Face Page of the life insurance contract) with other
carriers. Premium income fuels the insurance company, but it is the investment income that
provides the reserves, surplus, and profit. Life company investments, like those of other financial
institutions, have suffered from the collapse of the mortgage market and the subsequent
economic downturn. As a consequence, it is important to ask, how safe is investing in the
secondary market for life insurance?
This paper will provide an assessment of the level of risk to the Life Settlement Investor of
insurance company insolvency.
The Level of Risk
There is no available record that documents that any life insurance company licensed to
do business in any of the fifty states has ever failed to pay a death claim in accordance
with the terms of a life insurance contract.
In my judgment, only the collapse of the life insurance industry would result in the failure to pay
the full death benefit of a policy upon the death of the insured while the policy is in force. The
viability of the industry is dependent upon payment of death claims, and life insurance
companies, trade organizations, and state regulators are positioned to assure payment of death
benefits.
In some cases, requests for policy loans (except automatic premium payment loans), payment of
cash or surrender values, policy surrenders, fund transfers, cash outs, and similar payments and
certain policy changes and conversions have been delayed, occasionally for several years, and,
in a few cases, settlements with policy owners requesting surrender of their policies have been
deeply discounted. This is of no concern to Life Settlement Investors who maintain cash
surrender values at the lowest possible level and who never anticipate borrowing policy values for
other than premium payments on „whole life‟ policies and never would surrender any form of
policy to an insurance company.
2. When life insurance companies are in declining financial condition or have been placed in
receivership or liquidation, the policies frequently are assumed by other carriers within a relatively
short period of time. The industry has a strong record of protecting all policy owners through
assumption of liability, merger, and acquisition. (Case studies are provided in the Appendix).
Regulation of the Life Insurance Industry
Insurance is monitored and regulated by state insurance departments, and one of their primary
objectives is protecting policyholders from the risk of a company in financial distress. When a
company enters a period of financial difficulty and is unable to meet its obligations, the insurance
commissioner in the company‟s home state initiates a process - dictated by the laws of the state -
whereby every attempt is first made to help the company regain its financial footing. This period is
known as rehabilitation.
If it is determined that the company cannot be rehabilitated, the company is declared insolvent,
and the laws of the state require the commissioner to ask the state court to order the liquidation
of the company. The insurance commissioner, either appointed by the governor or elected,
heads the state insurance department and monitors and regulates insurance activity within the
state. The commissioner also has the responsibility to determine when an insurance company
domiciled in the state should be declared insolvent and to seek authority from the state court to
seize its assets and operate the company pending rehabilitation or liquidation.
Life Insurance Company Rehabilitation or Liquidation
With only a few known exceptions, life insurance companies that have become insolvent over the
past thirty years have been financially marginal, low rated, stock insurance companies operating
on a regional basis. These companies typically have held A. M. Best ratings of C, C-, or D (Weak
to Poor) or have been non-rated, usually a sign of financial weakness, and have been no different
in financial make-up from financially weak companies in the industrial sector. Yet, death claims
made against insolvent carriers in all cases have been paid in full.
There are only two highly rated carriers licensed in all 50 states that have experienced severe
financial difficulty, Executive Life Insurance Company (ELIC) and Mutual Benefit Life Insurance
Company (unrelated to Mutual Benefits Corporation, a failed life settlement provider). See the
Appendix for Case Studies of the causes and consequences of financial difficulty in these two
companies and three others.
Reinsurance and State Guarantee Funds
The secondary market typically focuses on policies with large face amounts. It is not uncommon
for policies to have face amounts of $5 million, $10 million, or even $20 million dollars. No
insurance company can afford to take the risk of an early death claim in these amounts. Insurers
enter into reinsurance treaties with other insurers and spread the risk with a sharing of the
premium dollars. Thus, a company issuing a $10 million dollar policy may only have a $1 or $2
million dollar risk while as many as a dozen other insurers share the remaining $8 to $9 million
dollars of risk. These reinsurers must agree to the decisions to offer insurance, thereby
improving the underwriting process, and eliminating the risk of a single catastrophic loss to the
primary insurer.
Most states have guaranty funds, financed by the life and health insurance companies licensed in
the state, to help pay the claims of financially impaired insurance companies. State laws specify
the lines of insurance covered by these state guaranty insurance funds and the dollar limits
payable. The coverage of these guaranty funds is usually for individual policyholders and their
beneficiaries and not for values held in unallocated group contracts. Reliance on the availability
of these funds to cover claims against a failed insurance company is not advised; however it is
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3. unlikely that, short of collapse, the life insurance industry would allow a situation to develop in
which claims against the funds for payment of death benefits would ever occur.
There is no available record showing that a state guaranty fund ever has been utilized to recover
death benefits. In some cases, funds have been used to recover cash surrender values. The
greatest utilization of state guaranty funds has been in the area of recovery from health insurance
company failure. However, in the unlikely event of funds ever being required for the recovery of
death benefits, there are significant limits on the maximum death benefits covered by the
guaranty funds, some of which have increased in the last few years. For example, Connecticut,
Minnesota, New Jersey, New York, Utah, and Washington limit payment to $500,000, and the
other 44 states, the District of Columbia, and Puerto Rico limit payment to $300,000 (New Mexico
allows the Superintendent of Insurance to set higher amounts by regulation). Cash value
recovery, the more common use of guarantee funds, typically is limited to $100,000.
According to the National Organization of Life and Health Guaranty Associations (NOLHGA),
“State life and health insurance guaranty associations provide a safety net for their state‟s
policyholders, ensuring that they continue to receive coverage even if their insurer is declared
insolvent. Working together through NOLHGA, the guaranty associations form a national safety
net, protecting insurance consumers all across America in their time of need.” Fortunately, it is a
safety net that is unlikely ever to be needed.
Primary Carriers in the Secondary Market
There are five primary life insurance companies that issue policies that are purchased in the
secondary market. These five are among the strongest insurance companies in the world, and, in
fact, some are owned by parent organizations outside the United States. Statutorily, the
investments of the United States subsidiaries of these companies, like subsidiaries of domestic
parents, are separate and protected from use by parent companies. The portfolios of these five
carriers are sound and are representative of the life insurance industry as a whole. These
companies are:
Transamerica Life Insurance Company (owned by AEGON)
American General Life Insurance Company (owned by AIG)
John Hancock Life Insurance Company (owned by ManuLife)
Lincoln National Life Insurance Company (owned by Lincoln National Financial)
Pacific Life Insurance Company
The strength of these primary players, the fact that no death claim on an inforce policy has ever
been denied or delayed longer than the terms of the contract provides, and the commitment of
the industry to protect its viability by timely payment of death benefits and absorption of policies
issued by financially troubled companies by assumption of liability, merger, and acquisition, give
investors good reason to be confident in the safety of their investment.
Case Study Appendix
Executive Life Insurance Company – Case Study
ELIC, a California based company operating in 49 states, and its sister company, First Executive
Life of New York, were subsidiaries of First Executive Corporation. At the time of liquidation,
ELIC enjoyed an A+ rating from A. M. Best. ELIC was a large issuer of life insurance, structured
settlement annuities, group annuities, and guaranteed investment contracts (GICs) issued to
pension plans and municipalities. A conservation order was issued for ELIC on April 11, 1991,
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4. and a liquidation order was entered on December 6, 1991. Most of the company's policies were
assumed by Aurora National Life Insurance Company in 1993.
Along with First Capital Life and Fidelity Bankers Life, failed subsidiaries of First Capital Holdings,
and a number of smaller carriers, ELIC and First Executive Life of New York were actively
involved in the trading of “junk” bonds and were working closely with Drexel, Burnham and
Lambert, the investment banking firm driven into bankruptcy by its illegal activities in the junk
bond market under the direction of its employee, Michael Milken, who was indicted on 98 charges
of racketeering and securities fraud.
The policies of First Capital Life were assumed by Pacific Corinthian Life, a subsidiary of Pacific
Mutual Life Insurance Company. The policies of Fidelity Bankers were assumed by Hartford life
Insurance Company.
Mutual Benefit Life Insurance Company – Case Study
The other notable exception to the profile of a failing company is Mutual Benefit Life Insurance
Company, a large mutual company (owned by its policy owners) operating in all states. Holding
an A. M. Best rating of A+ until shortly before its failure, Mutual Benefit was placed in
rehabilitation under the supervision of the New Jersey Department of Banking and Insurance on
July 16, 1991. Policies ultimately were assumed by Anchor National Life, a company that I earlier
had served as Chief Marketing Officer. At the time of assumption, Anchor had become a wholly
owned subsidiary of SunAmerica Group, which subsequently was acquired by AIG. The policies
are now maintained by AIG SunAmerica Life Insurance Company.
Like other smaller carriers such as Monarch Life, announcement of the failure of significant
investments in commercial real estate held by Mutual Benefit led to a run on cash surrender
values by policyholders driving the company into bankruptcy. The policies of Monarch Life were
assumed by Merrill Lynch Life, which subsequently was acquired by AEGON.
New England Mutual Life Insurance Company – Case Study
Since the early 1990‟s, merger and acquisition activity in the insurance industry has been
vigorous, and it is sometimes difficult to trace the responsibility for maintaining the policies of
companies no longer in business whether because of regulatory intervention or because of
outside acquisition. An example of the latter would be New England Mutual Life Insurance
Company, an old line mutual company that had been in business for over 150 years when it was
acquired by Metropolitan Life Insurance Company (MetLife). Having been an officer of that
company in the late 1970‟s, I believe that the attempt to expand distribution beyond the General
Agency system to financial planners, stock brokers, CPA‟s, and estate planning attorneys
depleted a significant portion of the company‟s surplus, the assets above the required reserves to
meet future liabilities. While not subject to regulatory intervention, this made the company
attractive for takeover.
Kentucky Central Life Insurance Company – Case Study
A more complicated example of regulatory intervention would be Kentucky Central Life, a
Lexington, Kentucky based company that migrated from receivership to liquidation. The
Kentucky Department of Insurance took control of Kentucky Central in February 1993. The
company was declared insolvent, due in large part to bad real estate loans and consistently
questionable investment decisions. Jefferson-Pilot Life Insurance Company, the merger
company of Thomas Jefferson Life and Pilot Life, before its merger with Lincoln National Life,
assumed the policies in May of 1995 and provided $250MM of support. Additional support for
other than death claims came from the State Guaranty Funds. The balance of Kentucky Central‟s
real estate assets were liquidated under guidance and direction by the state insurance
commissioner and the courts.
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5. Shenandoah Life Insurance Company – Case Study
A Virginia domiciled mutual life and health insurance company that issued life insurance policies,
annuities, and dental insurance in 31 states and the District of Columbia, Shenandoah Life was
placed in receivership in February 2009 in the wake of losses in Freddie Mac and Fannie Mae
stock and a failed merger with Indiana based American United Mutual. A judge placed the
company in receivership and appointed the State Corporation Commission as receiver, beginning
a review designed to determine whether Shenandoah Life should be rehabilitated or liquidated.
At the time of the receivership order, Shenandoah Life enjoyed a B++ rating from A. M. Best. The
receiver began negotiating a sale of the company to Assurant, Inc. and its affiliate, Union Security
Insurance Company in 2009 and has been negotiating with Prosperity Life Insurance Group of
Austin, Texas since mid-2010. During the receivership, all death claims on inforce policies have
been paid as have health claims and continuing annuity payments. All other transactions, such
as policy loans or surrenders, have been suspended.
Jerry D. Cherrington
Senior Insurance Advisor
The Peninsula Group, LLC
March 8, 2011
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