Nov. 9--National insurance regulators plan to crack down on companies that pay elderly people to buy life insurance with the intention of selling their policies to investment groups.

The practice is an unsavory variation on "life settlements," which are a legitimate way for people to get fair payment for insurance policies they no longer need.

But rather than simply waiting for policyholders to decide to sell existing policies, some financial companies seek out people who are insurable but have short life expectancies and who agree ahead of time to sell their policies for a fee.

That's the "dark side" of the life settlement business, said Nebraska Insurance Commissioner Tim Wagner, a member of the National Association of Insurance Commissioners.

When the commissioners' group meets next month in San Antonio, it is expected to act to control what is known as "stranger-originated life insurance," or STOLI.

The commissioners say the practice undermines a basic premise behind life insurance: that a policy's beneficiary has a legitimate, insurable interest in the insured person's well-being.

Those in the insurance and life settlement industries fear that high-dollar investments in STOLI may encourage Congress to reconsider the tax advantages that life insurance enjoys and may threaten legitimate life settlements.

"There are all sorts of principles involved," Wagner said. "I am not concerned about the buying and selling of insurance policies as a regulator, except that I don't want speculation associated with new policies. I don't think that's fair to anybody.

"We want clear disclosure of this information to all parties," he said.

This week, Wagner said, the McCook Police Department forwarded him a printed advertisement offering senior citizens a profit for buying and then selling insurance policies. The solicitation may not be illegal, Wagner said, but it's the first case he has seen of a clear abuse of the life settlement process aimed directly at Nebraskans.

Wagner and those in the insurance business don't have a quarrel with legitimate life settlements, which have created a secondary market for life insurance policies and unlocked value that many consumers didn't realize they had.

Even Berkshire Hathaway Inc., the investment company headed by Omahan Warren Buffett, invested nearly $300 million in life settlements in 2004 and 2005, predicting "satisfactory earnings."

"It's a very hot topic within the entire industry right now," said Ernie Rongish, a vice president and actuary with Mutual of Omaha.

Mutual has no dispute with legitimate life settlements, which fewer than 100 of its policyholders enter into each year, he said.

But prearranged, stranger-owned life insurance poses "a very significant risk for the industry and something that we really have to aggressively address and weed out," Rongish said.

Michelle Olmstead, national sales director for Quantum Insurance Design in Omaha, said abuses threaten a legitimate service to consumers who have value in their life policies. Quantum's customers include financial advisers whose clients may want life settlements.

"It's time for some more regulation," she said.

The regulators' quarrel is with companies that seek out people -- usually those age 65 or older who can buy insurance policies with death benefits of $250,000 or more -- who agree in advance to sell their policies as soon as they can.

In most states, including Nebraska and Iowa, there is a two-year period during which insurers can contest the legitimacy of a policy. James Poolman, North Dakota's insurance commissioner and head of a committee on life insurance, has proposed extending that period to five years.

But some in the industry say a five-year limit would deprive many consumers of a legitimate chance to sell policies, especially because many policies lapse within five years of purchase.

Switching to five years "won't work" and is "an effort to address the problem with a meat ax . . . . It's much too harsh," said Douglas Head, executive director of the Life Insurance Settlement Association in Orlando, Fla.

Head said regulators can control abuses by requiring that people who buy insurance disclose any prearranged sales, allowing insurers to make informed decisions on whether to issue policies.

Rongish, the Mutual of Omaha executive, agreed that a five-year limit may prohibit too many legitimate settlements.

Although it's difficult to design rules without loopholes, he said, a compromise that would soften the impact of the five-year limit might be best.

For example, a person should be able to sell a policy after three or four years if some life-changing event has happened, such as a divorce, the sale of a business, or a death in the family.

North Dakota's Poolman said that disclosure rules would be "namby-pamby" and wouldn't do the job, according to National Underwriter, an insurance trade journal.

Robert Nelson, vice president and manager of the life and estate planning division for the Grace-Mayer insurance agency in Omaha, said luring senior citizens into purchasing policies is a "clear abuse" that distorts the purpose of life settlements.

"If we start bending and twisting this for schemes, that's where I draw the line."

If policy applicants are required to disclose any pre-arranged sales, Nelson said, then companies can decide whether they want to issue a policy or not.

"We don't need a heavy-handed approach like a five-year prohibition."

Life settlements trace their history to AIDS patients in the 1990s who had life insurance policies but wanted cash while they were living.

A third party paid the insured person a portion of the face value of the policy, knowing that an AIDS diagnosis at that time meant an early death. The buyer paid the premiums and collected the benefit when the person died.

Those transactions, done for health reasons, are known as viatical settlements, from the Latin word viaticum, or provisions for a journey.

After medical treatments helped AIDS patients live longer, companies in the viaticals business realized they could purchase policies from healthy people, and the life settlement industry took off.

A recent change in accounting rules allows policy owners to count a policy as an asset. That has attracted investors, including investment banks, hedge funds and other institutions.

Not every policy is eligible for a life settlement, but some sources estimate that as much as 20 percent -- including some term-life policies -- may qualify.

Michael Lovendusky, senior counsel for the American Council of Life Insurers, said regulation is difficult because "STOLI purveyors" find ways to circumvent the rules.

Groups working with the council on proposed regulations are the Association of Advanced Life Underwriters, the National Association of Insurance and Financial Advisors, and the National Association of Independent Life Brokers and Agents.

If the state insurance commissioners adopt changes in the model legislation they recommend to states, Lovendusky said, he expects many states to act quickly.

"There seems to be an appetite to address this in 2007," he said.

Changes in the law aren't a sure thing because some companies will try to confuse the issue by claiming that regulations would hurt consumers, he said.

"Our beef is not with the settlement industry or legitimate life settlements," Lovendusky said. "Our beef is with stranger-originated life insurance, something quite different."

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Copyright (c) 2006, Omaha World-Herald, Neb.

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