The Meaning Of Life Settlements: Are They Securities Or Not?
"Life settlements" are financial transactions in which the original owner of a life insurance policy sells it to a third party for an up front, lump sum payment. The amount paid for the policy is less than the death benefit on the policy, yet greater than the amount the policyholder would otherwise receive from an insurance company if the policyholder were to surrender the policy for its cash value. For the life settlement investor that buys the policy, the anticipated return is the difference between the death benefit and the purchase price plus the amount paid in premiums to keep the policy in force until the death benefit is payable.
Some commentators have deemed life settlements as essentially a "bet" on the life of the insured. The longer the insured lives, the lower the rate of return on the investment. Critics of life settlements are quick to point out that investors have a financial interest in the early demise of the insured person. The life settlement industry has been subject to extensive litigation for several years.
An important and as yet unsettled question is whether life settlements are "securities" as defined under federal and state securities law. This basic question has important ramifications for how life settlement contracts will be treated by courts and regulators.
The SEC's position on this important issue has been clear for several years. An SEC task force released a staff report in 2010 recommending that life settlements be defined as securities. The report noted that 48 states treat life settlements as "securities" under state securities laws, although some states have exceptions for the initial sale of a life insurance policy to a licensed life settlement provider. Federal courts, however, have split over this issue, creating uncertainty among those in the life settlements industry and the lawyers who represent them.
Recent cases in Texas, which is one of the two states yet to resolve this issue, shows the different schools of thought that have resulted in divergent federal opinions on whether life settlements are securities under the federal securities laws.
Last month, the Dallas Texas Court of Appeals, in Arnold v. Life Partners, Inc., 05-12-00092-CV, 2013 WL 4553379 (Tex. App. Aug. 28, 2013), held that life settlements are securities falling under the Texas Securities Act ("TSA"). In reaching this conclusion, the Court applied the U.S. Supreme Court's seminal "Howey test" which, as adopted by the Texas Supreme...
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