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Ruling Clamps Down on “Natural Person Exemption”

Texas court unwinds life settlement sale by unlicensed buyer.

Interest in the life settlement asset class, the purchase of an unwanted and unneeded life insurance policy for a lump sum payment, has continued to grow steadily over the course of the last two decades because of potential double-digit returns uncorrelated to the capital markets. The foundation for investors’ confidence in the asset class is that the policies purchased are legally originated and won’t be subject to challenge by the policies’ former owners or beneficiaries. A recent decision from a federal court in Texas calls into question the viability of an often used exemption from licensure and emphasizes how important it is that investors carefully investigate the policies they purchase or risk losing their entire investment.

Need for Provider’s License

Stakeholders and investors in the life settlements market know that to purchase a life insurance policy from a non-terminally ill owner, it’s necessary to have a “provider’s” license in 43 of the 50 states. These licenses are time consuming and expensive to obtain, and their maintenance entails significant on-going compliance obligations. Thus, it’s no surprise that providers who’ve invested years and tens of thousands of dollars in time and money into procuring and maintaining these licenses take umbrage with individuals and companies who regularly rely on the so-called “natural person” exemption from licensure to purchase policies.

Natural Person Exemption

This exemption, which is found in both the National Association of Insurance Commissioners’ (NAIC) and  National Council of Insurance Legislators’ (NCOIL) model acts, typically reads along the lines of the following:

“Settlement provider” doesn’t include: A natural person who enters into or effectuates no more than one agreement in a calendar year for the transfer of life insurance policies.

According to the Proceedings of the NAIC, when it adopted its model settlement act in 1993, the intent  of including the “natural person” exemption was “to exclude from the Act a friend or family member of the policyholder who wanted to enter into an agreement with a [policy owner][,]”  because, “it would create a hardship to subject family and friends to the model act.” 1993 Proc. 3rd Quarter 439. Hence, the intent of the NAIC in adopting the exemption is clear – to exclude a person with a close relationship to a policy owner from the burdensome obligations associated with provider licensure.

In contravention of the explicit intent of the NAIC, some participants in the life settlements industry have taken this exemption for use by a friend or family member and turned it into a business model, allowing them to act as a provider without having to shoulder the burden and expense of obtaining providers’ licenses. This is the fact pattern that the court confronted recently in Consolidated Wealth Management, LLC v. Short, 414 F.Supp.3d 1011 (S.D. Tex. 2019).

Court Unwinds Transaction

In January 2014, James Short, a resident of West Virginia, entered into a Senior Facilitation Agreement (SFA) with an individual employee of Montage Financial Group (Montage). Montage played no role in the transaction with James and wasn’t a party to the SFA.  Under the terms of the SFA, James agreed to assign his interest interests in the policy for a payment of $25,016. Three days after entering the SFA with James, the individual assigned his entire interest in the policy to Consolidated Wealth Management (CWM) for a payment of $37,700.

On June 22, 2018, James passed away.  His wife, Rhonda Short, thereafter filed a claim for the death benefit under the policy, and CWM made a competing claim. As a result, the carrier filed an interpleader action.

 The parties’ arguments were straightforward. Rhonda contended that the sale of her husband’s policy violated West Virginia’s viatical settlement law, and was, therefore, unlawful and void.  Whereas, CWM argued that under the “natural person” exemption in West Virginia’s law, the individual who purchased the policy wasn’t a “viatical settlement provider” when he entered into the SFA and therefore the SFA is not a “viatical settlement contract” under West Virginia law.

Even though the court found that the individual who purchased James’ policy had only entered into a single settlement contract in the pertinent year, it nevertheless ruled in favor of Rhonda.  The court’s reasoning was founded on a common sense interpretation of the language of the statute.

It was the uncontroverted testimony of the individual that he, through Montage, had been involved in approximately 75 viatical settlements in 2014 and a “bit less” in 2013.  The court noted that the “statute excepts from coverage persons who neither enter into more than one viatical settlement contract nor effectuate more than one such contract in a year. A person must meet both conditions to be excluded from the Act’s scope.”  414 F.Supp.3d at 1018-19.  The court rejected the argument that the only operative language was “enters into” and ruled that the individual had clearly “effectuated” far more than one contract in his work at Montage.

The court also rejected CWM’s argument that the exception applies to persons who regularly effectuate settlement contracts so long as they contract with only a single West Virginia resident in a calendar year, finding that the “exception only covers ‘an individual who enters into or effectuates no more than one viatical settlement contract in a calendar year,’ without regard to the viator’s state of residence.” 

As a result, the court effectively unwound the sale transaction and awarded the entire death benefit to Rhonda.

Use Licensed Providers

While this appears to be a case of first impression, it’s ossible other courts faced with similar facts will reach the same conclusion. Therefore, investors in the life settlements asset class would be wise to deal only with licensed life settlement providers and not individuals who improperly usethe natural person exemption from licensing to purchase policies.

Finally, it’s worth noting that state insurance departments currently don’t appear to be aware of the extent to which individuals use this exemption to skirt the  licensing rule or otherwise licensed providers use this exemtion to purchase policies in states where they’re not licensed.  If state regulators do become aware of the extensive use, and arguable abuse, of the exemption it’s likely regulatory consequences will follow.


James Maxson has practiced law for over 25 years, including practicing in the life settlements space for almost two decades, and is a founding partner at Edwards Maxson Mago & Macaulay, LLP.

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