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Arbitration Panel Orders AIG to Pay $86.7M in Life Insurance Dispute

Source: WSJ - Leslie Scism

Posted on 04 May 2011

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American International Group Inc. (AIG) has been ordered by an arbitration panel to pay $86.7 million to a U.S.-based subsidiary of a Belgian bank. The payout was tied to a dispute over insurance on loans that were made to an investor who purchased older people's life-insurance policies.

The arbitration award is the most recent in a string of adverse developments for AIG in this controversial corner of the investing world in which life-insurance policies taken out on the lives of older people are traded.

AIG owns life settlements totaling about $18 billion in anticipated death benefits, according to the company's financial filings, or more than a third of the estimated $45 billion traded since the secondary market revved up in the early 2000s. In the life-settlements market, investors who buy older people's policies bet the future death benefit will exceed the cash needed to buy the policy and pay for premiums while waiting for the person to die.

In addition to buying policies, AIG has sold "lender protection" insurance to other participants in this market. It is that kind of transaction that led to last month's adverse arbitration ruling, which essentially found that AIG's Lexington unit had to make good on its policies despite its arguments that its client violated some policy restrictions.

A spokesman for AIG declined to comment.

The ruling isn't likely to have a significant effect on the earnings of AIG, which is preparing a stock offering next month as the U.S. government winds down its 2008 bailout. Still, it provides a glimpse into the entrepreneurial culture of the insurance conglomerate, slimmed down from three years ago before its government bailout but still one of the largest insurers in the world.

The two-to-one ruling by the panel of the American Arbitration Association is in favor of Lonsdale LLC, a subsidiary of the U.S. financial-products business of KBC Group NV, based in Brussels. Both Lexington and Lonsdale had alleged breaches of a complex credit-insurance agreement.

Lexington agreed in 2008 to insure certain loans made by Lonsdale that enabled a borrower to purchase life-insurance policies; the borrower expected to resell those policies and use proceeds to repay Lonsdale. If the borrower was unable to repay the loans in full, Lonsdale aimed to tap the Lexington coverage, subject to certain restrictions.

Lexington in the arbitration said the older people who took out the policies had been financially induced to apply for them—in violation of Lexington's restrictions.

The two arbitrators who ruled in favor of Lonsdale wrote that Lexington failed to prove the policies were originated through a prohibited act or that Lonsdale concealed any material fact.

A dissenting arbitrator said Lexington was "misled at every step along the way."

Lonsdale's lawyer, Stephen Foresta of Orrick, Herrington & Sutcliffe LLP, called the ruling "a major victory" and said it "vindicates Lonsdale's belief that there was nothing improper in the origination of the life insurance policies at issue."

In another example of lender-protection coverage sold by AIG, its Chartis unit, parent of Lexington, provided coverage to Imperial Holdings Inc. from 2008 through Dec. 31, 2010, as previously reported. At the end of 2010, Chartis had paid Imperial more than $177.8 million, according to Imperial's regulatory filings.

Earlier this year, AIG unsuccessfully sought to obtain a rating from Standard & Poor's for a security that would be backed by life settlements.