Documents filed in an Ontario court show that the creditors of a defunct life-settlements company, Universal Settlements International Inc., are inching toward receiving compensation.

According to a report from Ernst & Young Inc. — the court-appointed monitor for USI’s assets — E&Y has received more than $10 million in income following the death of several policyholders, leaving the benefits to E&Y and its trustee.

According to court documents dated in January 2011: “During the reporting period, there were six policies that matured totalling approximately $10.2 million in death benefits, which have been collected.”

E&Y says the money, which is being held in a trust account, cannot yet be distributed to the more than 3,500 creditors, which include investors from North America, Latin America, Europe and Asia, because it is needed to pay off various policy loans, policy premiums, taxes, and legal and administrative costs.

The E&Y documents note that creditors can expect compensation when the monitor’s trust account sees further income of about $13 million, for a total of slightly more than $23 million.

USI had owned an additional 147 policies with a notional benefit value of $175 million. E&Y, which is now effectively overseeing the operations of USI, includes in its report a table detailing the ages of all USI policyholders and the dollar value of the benefits E&Y could receive to compensate creditors.

“As of Sept. 30, 2010,” the report says, “44% of the insured are at least 80 years old and represent policies that have death benefits totalling approximately $146 million, or 83% of the portfolio.”

The table in the E&Y report shows that 15 of these policies are for policyholders aged 90 to 95 with death benefits of more than $19 million.

Life settlements are legal in all but a few U.S. states; in Canada, where the insurance industry is regulated provincially, the resale of policies is restricted in most provinces and territories, except Quebec, Nova Scotia, New Brunswick and Saskatchewan.

A life-settlements firm continues to pay premiums on the policies it has purchased from the original policyholder until: the insured person dies, at which point the life-settlements firm collects the death benefit; or the policy matures, at which point the life-settlements firm takes the guarantee. In either case, the proceeds are then distributed to the life-settlements firm’s investors.

The timing of cash flow is critical to this business model; premium payments must be met with income from death benefits or guarantees from other policies.

Previous court documents indicate that, for USI, policyholders didn’t die according to projected mortality tables. As no benefits were paid out to USI, it was left short of cash. USI started running out of money and its financial troubles were compounded when the Italy-based bond agency it had paid to reinsure its premium payments went out of business.@page_break@More than two years ago, USI agreed to sell some of its assets — a portfolio of 567 life insurance policies with a face value of $36 million, which had been previously owned by persons infected by the HIV — to SDM Holdings LLC for $2.5 million.

In fact, USI’s troubled history goes back some time. In 2001, the Ontario superintendent of financial services issued a “notice of proposed cease-and-desist order” against USI, alleging the company was in contravention of Section 115 of the Insurance Act, which essentially prohibits the sale of life insurance policies unless the seller is a licensed insurance agent. But a Financial Services Commission of Ontario tribunal found that USI’s business did not constitute “insurance undertaken in Ontario” because the policies were foreign.

USI had bought portfolios of U.S.-origin life settlement insurance policies to sell to Canadians and other international clients; policies such as these can be sold legally in Ontario as securities.

These policies are marketed as investments in an asset class unrelated to fixed-income or equities. But, as it turns out, they can be just as unpredictable.

USI obtained bankruptcy protection from the Ontario Superior Court of Justice in December 2008; that’s when E&Y was named monitor.

Legal counsel for the Canadian Life and Health Insurance Asso-ciation Inc. has said the CLHIA would like to see life-settlements activity banned across Canada but doesn’t lobby against it because there’s virtually no life-settlements business in this country anyway.

Numerous cases of fraud by both life-settlements companies and policyholders in the U.S. make the practice unsavoury, the CLHIA says. Moreover, it argues, advance benefit features in many products today give consumers the same benefit as a life settlement.

Life insurers don’t like life settlements, say financial analysts, because the practice cuts into profits. Insurers make money when policyholders pay premiums for years and then stop paying because they can’t afford it, through neglect or have decided they don’t need the policy. Premiums are paid to the insurer, but benefits aren’t paid out. This so-called “lapse rate” is an important variable in product profitability.

Coincidentally, another life-settlements firm had landed in Ontario courts around the same time as USI. New Life Capital Corp. and its subsidiaries were shut down by the Ontario Secur-ities Commission in 2008, when the regulator charged that NLC had sold securities to unqualified investors without proper registration and without a preliminary prospectus. Since then, KPMG Inc., appointed receiver for NLC, has been working to unravel the business — NLC also had been dealing in U.S.-based life insurance policies — and pay off its creditors and investors.

Earlier this year, the OSC ordered $22.5 million to be disgorged from KPMG as part of the process. IE