It may be easy to view a secondary market for life insurance as a purely American creation; just one extreme example of what a modern market economy can produce.
Yet the practice of selling one�s life insurance to strangers has its origins across the ocean in England, where economically poor individuals who suffered from serious illnesses could auction off their life insurance policies to the highest bidder at least as early as the 19th century. U.S. authorities who knew about these auctions and considered them despicable aimed to keep them out of our country by promoting nonforfeiture laws on a state level beginning in the 1860s.
Between that time and the 1980s, Americans with life insurance to their name were left in an odd position. As policy owners, they technically had the right to renounce policy benefits and put them in another person�s hands. But beyond offering their policy as collateral to a creditor or surrendering it to the insurance company, they lacked formal ways of selling their policy for necessary cash.
When they look back on the state of life insurance as it was 20 years ago, multiple industry experts note that a person who wanted to sell an in-force yet unwanted policy usually had to deal with a �monopsony,� an environment in which people who market their goods and services can only do business with one buyer. That lone potential purchaser in those days was effectively the same company that issued the policy, and the �take or leave it� offer from that buyer was never greater than the policy�s cash surrender value.
Although the option of canceling a policy for its cash surrender value was certainly better than having no options at all, it was far from a financial life saver for someone with a need to create immediate income from a policy. Then, as now, the cash surrender value often amounted to a very small amount if the owner had not yet paid significant premiums on the policy. At that time, insurance companies made no changes to surrender values for clients who had developed life-threatening conditions.
Of course, the needy policyholder with a permanent life insurance policy also had the ability to receive a speedy delivery of dollars from the insurer by requesting a loan against the contract�s cash value. But the amount available to the individual via a loan was sometimes very small compared to the policy�s death benefit.
Meanwhile, critically ill people with term coverage could neither apply for a policy loan nor surrender their policies for cash. They received nothing positive from their insurance, other than the guarantee that a named beneficiary would receive some money when they passed away.
None of this boded well for people who were dying of AIDS during the late 1980s. As the disease attacked their immune system and made them too sick to remain in the workforce, many AIDS patients lost their income and employer-sponsored health insurance and struggled to pay for medical treatment that could have prolonged their lives. Those who were fortunate enough to hang onto their health coverage often found that their medical plans would not pay for the latest experimental drugs and therapies that scientists were developing to combat the new health crisis. Rather than being able to concentrate on enjoying their last days as much as possible, the terminally ill often spent their time worrying about how they were going to pay for medical attention and still have enough money for such essentials as housing, food and utilities.
Typical AIDS patients�young and unmarried men�sometimes owned inexpensive term life insurance policies that had been made available years earlier through an employer. But with death catching up to them and no dependent spouses or children to think about, they began to question the practical value of such coverage and had no way of receiving any personal benefits from what, in some cases, was the largest item in their estate.
The AIDS community�s financial dilemmas caught the attention of a few insurance veterans, financial planners and entrepreneurs who had watched well-insured close friends or family members die of AIDS or cancer with little or no money left in their pockets. Searching for ways to turn life insurance into a greater financial asset for the terminally ill, these businesspersons developed a secondary market for life insurance in the United States by promoting what have become known as �viatical settlements.�
The word �viatical� comes from the Latin term �viaticum,� which was used first to describe a bundle of provisions given to Roman officers as they headed out on long, dangerous missions and was later associated with the religious sacrament of last rights administered to dying Catholics. In theory, viatical settlements and the companies that provide them take that old terminology and apply it to modern circumstances.
In exchange for receiving the eventual death benefits created through a terminally ill person�s life insurance policy, a viatical organization pays a major portion of the policy�s face value to the dying individual, thereby giving the terminally ill policyholder funds to help with their medical bills or other needs.
For the purpose of a hypothetical example, suppose that a person with a $100,000 life insurance policy has been diagnosed with terminal cancer and is expected to die in roughly one year. By selling the policy to a viatical company�effectively making the company the beneficiary of death benefits�the person might receive a lump-sum payment of $80,000 from the organization.
During his or her remaining lifetime, the terminally ill person would be able to spend the $80,000 as he or she sees fit. After the insured dies, the viatical organization would file a claim with the life insurance company for the full $100,000 death benefit and would expect to earn a $20,000 profit from its investment.
Multiple sources name Living Benefits, Inc.�a business begun in Albuquerque, New Mexico in 1988�as the first major viatical company in this country. After spreading to portions of the South and Midwest, the young industry made its way to such metropolitan areas as New York City and San Francisco, where a high prevalence of AIDS cases suggested there might be a potentially fruitful market for viatical settlements.
By the 1990s, the viatical business was growing and trying to find a place within mainstream America. Despite still being linked to the AIDS epidemic, viaticals were increasingly targeted at people with other serious illnesses, and funding for the settlements was coming from individual and institutional investors in big cities and small towns.
At least for a brief period, some advocates for the terminally ill praised viatical companies for creating financial opportunities for the sick. Meanwhile, many investors were won over by marketers who claimed that giving money to a viatical company was practically a charitable act; a good deed that would help the less fortunate among us enjoy their last days and pass away with an enhanced sense of dignity.
The promised yields on investments probably did not hurt either. Many companies sold the idea of these transactions as an allegedly safe way for people to make at least 15 percent on their principal investment. That advertised yield greatly outpaced interest rates on certificates of deposit, and the basically nonexistent relationship between viaticals and the economy appealed to risk-averse investors who were fearful of market fluctuations.
In time, demand for viatical settlements and similar services helped transform the secondary life insurance market from a million-dollar industry in the early 1990s into a billion-dollar industry near the beginning of the new millennium.
How Do Viatical Settlements Work?
If you consider that viatical settlements involve such delicate matters as dollars and death, you will hardly be surprised to learn that these transactions are extremely complex and often packed with safeguards that protect the original policy owner, the ill person�s loved ones and the viatical investor.
The viatical process involves a front end (in which ownership of a policy is transferred from the original policyholder to a viatical company) and a back end (in which the viatical company usually resells all or a portion of the purchased policy to a third-party investor).
At this point in our course, we will study the viatical transaction in a roughly chronologically fashion, beginning with front-end activity.
A policy owner who seeks out a viatical settlement is known as a �viator.� In most cases, the viator and the person covered by the life insurance contract are the same person. However, as long as proper permission is obtained from the insured individual, a policy owner can �viaticate� (or sell) an insurance contract that covers someone else�s life. Such leniency makes it possible for trusts and corporations to qualify as potential viators.
A viator can sell nearly any kind of individual or group life insurance policy, including but not limited to a whole life, universal life, variable life or term life contract. Even federal employees with group life insurance have been known to viaticate their coverage.
Still, some life insurance products are easier to viaticate than others. Among the more challenging types are term life and group life insurance.
Term life insurance creates problems because the coverage is temporary and could run its course before the terminally ill person dies. Suppose a viatical company purchases a term life policy from a terminally ill man who is expected to die within two years and has five years of coverage left on his contract. If the man dies within the remaining five years of the policy, the viatical company will still be able to collect a death benefit from the insurer. But, if the company�s estimate of the man�s life expectancy is wrong and the man lives for another six years, the company might never receive any death benefits from the insurance company.
Viatical companies will usually only purchase term life policies if the policies can be converted to permanent coverage. In general, insurance companies will allow their term life customers to convert to a whole life or universal life policy at least until insured persons reach the age of 65.
When the policy that is up for sale involves group coverage, the viatical company will want a guarantee that the group�s administrator will not cancel the coverage for any reason. As protection against this risk, the viatical company might force the viator to leave the group plan and convert the coverage to an individual policy.
Along with these cancellation concerns, viatical companies will be interested in the group insurer�s attitude toward beneficiaries. In order for any settlement to be feasible, the viatical company must have the ability to become the insured�s irrevocable beneficiary. Yet some group contracts do not grant irrevocable beneficiary status to any party, do not allow for transfer of ownership and do not even permit a corporation to be listed as a revocable beneficiary.
It is worth noting, however, that these obstacles are not necessarily insurmountable. Human resource professionals have noted that group life insurers are occasionally sympathetic and flexible when they learn that an insured wishes to sell his or her coverage to a viatical company.
Before potential viators can start actively shopping their life insurance policies around the secondary market, they must understand the differences between �viatical brokerage companies� and �viatical settlement companies.� These two kinds of organizations perform separate duties and ultimately serve separate audiences.
A viatical brokerage company should operate with the viator�s best interests in mind. Brokerage employees usually help viators fill out applications for settlements, collect and deliver paperwork, solicit bids for viators� life insurance policies from settlement companies and analyze the pros and cons of any offers received.
A viatical settlement company, to a certain degree, operates with its own or its investors� best interests in mind. Settlement companies evaluate the life insurance policies that are up for sale in the secondary market, use underwriting techniques to estimate insured persons� remaining life expectancies, make settlement offers to desirable clients and either gather or directly provide the money that is used to purchase a viator�s policy.
Viators have the option of either using a broker to handle a viatical transaction or contacting settlement companies on their own. Many viators choose to utilize brokerage services, not only to avoid the work of negotiating with settlement companies but also because an experienced broker will at least have a general idea of which settlement companies might be most likely to show an interest in purchasing a particular policy.
A broker is entitled to a commission when a viatical settlement has been finalized. This commission can reduce the amount of money the viator would otherwise receive from a settlement company. Commissions for viatical brokers are paid by settlement companies and typically run as high as 6 percent of the sold policy�s death benefit. In rarer instances, the broker may receive a commission equal to a portion of the settlement amount, usually no more than 30 percent of the total given to the viator.
Doctors, lawyers and financial advisers have been known to occasionally receive finders� fees from brokerage and settlement organizations when they refer people to viatical companies, but public concerns over conflicts of interest have caused some states to prohibit these fees.
Whether the viator utilizes a broker or opts to handle the sale of a policy alone, he or she must grant and obtain various types of consent and provide various bits of personal information to settlement companies in order for the bidding process to commence.
To protect themselves from litigation, viatical companies will not purchase a life insurance policy in the secondary market unless the policy owner agrees to a settlement. This means, for example, that a terminally ill individual who has transferred policy ownership to a trust cannot enter into a viatical settlement without the trustee�s signed permission.
A viatical company will also refuse to buy a policy if the person covered by the insurance contract fails to give written consent. Therefore, a business that owns a life insurance policy on a terminally ill employee cannot viaticate the ill person�s coverage without obtaining permission from the individual.
This consent requirement serves legal, ethical and practical purposes. It ensures that insured persons will not unknowingly end up in a situation in which a complete stranger has a financial interest in their death. It also helps settlement companies obtain the kind of private medical information that is essential to proper underwriting in the viatical industry.
In some states, terminally ill persons cannot enter into a viatical agreement unless they acknowledge that they are doing so through their own free will and unless an attending physician concludes that they are in a sound state of mind.
Because viatical settlement companies ultimately become irrevocable beneficiaries on the policies that they purchase, any pre-existing irrevocable beneficiaries must actively renounce their policy rights in order for a settlement to be valid. Though not legally required to do so, most companies will also refuse to bid on policies unless revocable beneficiaries consent to a potential sale.
This standard practice exists as a deterrent to possible legal action that might otherwise be brought by an insured�s angry family members or other interested parties. To date, this legalistic safeguard seems to have worked well enough. Research conducted during the development of this course found no major lawsuits filed by preexisting beneficiaries against viatical companies.
As obvious as it may sound, a settlement company must be able to verify that a policy being shopped in the secondary market actually exists and is configured as advertised by a broker or viator. When applying for a viatical settlement, the viator will likely need to disclose the policy�s face value, list the policy number and give the settlement company copies of the insurance contract and the policy application form.
The viatical company will need permission to contact the insurer that issued the policy so that it can confirm this information and investigate any possible barriers to a smooth transfer of ownership. Although the insurance company may charge a fee for verifying this information, the National Association of Insurance Commissioners (NAIC) has proposed standard legislation that would forbid insurance companies from charging higher verification fees to viatical companies than to other inquirers. The NAIC has also supported giving insurers 30 days to respond to inquiries in order to investigate possible fraud.
A basic questionnaire submitted by the viatical company to the insurer will likely address the following issues:
� The policy�s face value
� The identity of all current policy owners
The importance of life expectancy to proper viatical underwriting makes medical analysis an essential part of the transaction process. No matter a life insurance policy�s face amount, the viator or other covered individual will usually not need to submit to a medical examination in order to qualify for a viatical settlement. But applicants are not exempt from having to fill out health-related questionnaires and will usually need to give settlement companies access to their medical history over the past two years. The forms used by viatical companies to access an applicant�s medical records are similar to those given to life insurance applicants and should comply with standards set forth in the Health Insurance Portability and Accountability Act (HIPAA).
Upon becoming authorized to view an applicant�s medical records, the settlement company will put its own underwriting team to work in order to come up with a settlement offer. Alternatively, it may outsource the job to experts who specialize in underwriting for viaticals.
Once the settlement company receives and analyzes the insured�s medical records and verifies coverage with the insurance company, the viator may receive a settlement offer for the life insurance policy. Competition in the viatical industry and differing investment objectives among settlement companies make it unlikely that a viator will receive exactly the same offer from multiple viatical organizations. But there are several variables that nearly all viatical companies take into account before they make any offer to a viator.
The main consideration among these variables is the insured person�s remaining life expectancy. As morbid as it may seem, neither settlement companies nor their investors are keen on working with applicants who have several years left to live. Long life expectancies diminish investment returns for settlement companies and their investors because the people who fund the viatical settlement need to pay a longer stream of premiums to the insurer to keep the policy active. Overly healthy applicants might also tie up investors� money for an unacceptably long time, since no one in the viatical business gets a return on an investment until insured people die.
As a general rule, viatical settlements are made available to terminally ill individuals who have a remaining life expectancy of two years or less. All else being equal, applicants with longer life expectancies can anticipate receiving a smaller percentage of their policy�s death benefit than applicants with shorter life expectancies. Someone with an estimated two years left to live might only be offered 50 percent or less of a policy�s death benefit from a settlement company. Someone who is expected to live for just a few months might be able to sell a life insurance policy for as much as 90 percent of the death benefit.
The responsibility for careful underwriting for life expectancies rests with the settlement company and its risk management consultants. The viator will suffer no penalty if the insured lives longer than expected.
As a previous paragraph briefly pointed out, policy premiums influence the size of a viatical settlement. Applicants who own inexpensive policies (relative to the death benefit) or who have a waiver of premium clause in their policies can expect to receive higher settlement offers than the average viator.
When the viatical industry began, some settlement companies required the viator to pay premiums on a viaticated life insurance policy for at least one year after the settlement date. However, it is now standard industry practice for settlement companies and their investors to handle payment of all premiums until the insured person dies. According to the Atlanta Journal-Constitution, a settlement company will reserve enough money to fund a viaticated policy for a period of time equal to the insured�s life expectancy multiplied by 1.5.
Like any savvy insurance customer, a viatical settlement company wants to ensure that the life insurer that issued a policy will be financially strong enough to honor eventual death claims. Devastating occurrences, such as natural disasters and terrorists attacks, not to mention poor business planning, have been known to place some insurers into insolvency, thereby preventing policyholders from receiving benefits in full and in a timely manner. State guaranty funds may help a failed insurer�s clients receive some policy benefits, but these funds usually cap the amount available to policy owners at $100,000 or so.
Many settlement companies are hesitant to buy policies issued by life insurance companies that have not received decent marks from insurance rating organizations, such as Standard & Poor�s, A.M. Best and Weiss Ratings. If an applicant wants to viaticate a policy that was purchased from a lowly rated insurer, the settlement company may make a lower offer to the viator.
Drafts of the NAIC�s Viatical Settlement Model Regulation have suggested that settlement companies be allowed to reduce a viator�s payout if the viaticated policy comes from a company that has not received one of the four highest ratings from A.M. Best or a similarly high grade from another rating company.
At times, the age of the life insurance policy can mean the difference between receiving a high offer from a settlement company, a low offer from a settlement company or no offer at all. Life insurance policies typically contain suicide clauses and incontestable clauses that allow the issuing company to void coverage within two years of the purchase date if the insured takes his or her own life or if the insurer discovers that an applicant obtained insurance through fraudulent means. Successful cancellation by the insurer would leave the settlement company and its investors empty-handed at claim time, and even unsuccessful attempts by the insurer to cancel a viaticated policy could cost the settlement company thousands of dollars in legal fees.
Most companies in the secondary market will not purchase a policy that is less than two years old or that is still subject to any type of contestability period. Among the companies that do not boycott these young policies, settlement offers for contestable coverage are usually very tiny. It is not uncommon for a viator with a contestable policy to receive less than 10 percent of the contract�s death benefit.
Potential viators should not forget about any outstanding loans they have on their life insurance policy. Policy loan provisions are an important and attractive feature of permanent life insurance, but the insurer�s ability to subtract the amount of outstanding loans from the death benefit makes them an undesirable element in a viatical transaction.
Because interest on policy loans can further decrease the death benefit if the loan is left unpaid, a settlement company will want to satisfy the terms of any existing lending agreement between the insurer and the insured immediately after buying someone�s coverage. When bidding for a policy that has an unpaid loan attached to it, the company will look at all other underwriting factors first, come up with a specific settlement amount, deduct the unpaid balance on the loan from that settlement amount and offer the result to the viator.
Despite their distance from major market risks, viatical settlements can be influenced by the national economy in subtle ways. This is demonstrated, in some cases, by the bids settlement companies make on people�s policies. If a settlement company wants to purchase a policy in the secondary market and needs to borrow money to fund the settlement, current interest rates will factor into the amount of money that will be offered to the viator.
Soon after accepting a final bid from a settlement company, the viator receives the settlement contract. The settlement contract is a legal document that spells out the rights of the viator and the settlement company. It explains, ideally in a clear manner, the following information:
Before the contract becomes a binding agreement, the viatical settlement company must typically make several important disclosures to the viator and remind the seller of various important facts. Though far from uniform across the country, the following reminders and disclosures have been suggested, endorsed or implemented by various states, the NAIC and/or viatical trade groups:
Along with the settlement contract, the viator often receives important supplementary documents, including transfer-of-ownership forms and a copy of an escrow agreement.
The transfer-of-ownership forms must be completed by the viator and submitted to the insurer in order for the settlement company to legally obtain all policy rights. Though viatical companies generally prefer to become owners of the policies they buy, insurable interest laws in some states may prohibit a transfer of ownership between an individual and a viatical organization. When faced with this potential legal hurdle, the viatical company might still be able to gain the right to a policy�s full death benefit as an irrevocable beneficiary.
When the transfer-of-ownership forms are sent to the viator for completion, the settlement company is often required to move all money intended for the viator into an escrow account that is administered by an escrow agent. The settlement company usually picks the escrow agent, but it must limit its choice to a properly licensed entity that has nothing to gain from the sale of the viator�s policy.
In addition to holding onto the money meant for a viatical settlement, the escrow agent may be asked to keep various documents safe while the viatical transaction is underway. Assuming the insurer approves the transfer of ownership from the viator to the settlement company, the escrow agent releases the settlement amount to the viator through a wire transfer, a certified check or a cashier�s check.
The viator can expect to receive settlement funds no later than the date specified in the viatical contract. If the viator receives the money at a later date, the settlement may be considered null and void, and regulators might take legal action against the settlement company. NAIC model legislation calls for viators to receive their money from escrow agents no later than three business days after the settlement company becomes aware of a successful transfer of ownership.
Some viators have the option of receiving settlement proceeds in a few periodic installments or in long-term pieces, as if the settlement were a modified kind of annuity. But many people who have monitored the viatical industry since its inception have warned potential viators that agreeing to anything other than a lump-sum settlement could lead to problems if a settlement company ever closes its doors.
Some states� insurance and securities laws require that all viatical settlements in the area involve lump-sum payments to sellers. Though the viator�s federal tax obligations may depend on the manner in which the settlement proceeds are spent, viators are not required to use their settlement money to fund any medical care.
If viators develop strong second thoughts about having sold their life insurance policy to a viatical company, they may be able to cancel the transaction in accordance with the settlement contract�s �regret provision� or �rescission clause.� A regret provision or rescission clause is similar to the free-look provision found in life insurance policies and allows the viator to void the settlement agreement and retain policy ownership for any reason.
A common rescission period lets a viator cancel a viatical settlement within 30 days of signing a settlement contract or within 15 days of receiving settlement proceeds, whichever date is earlier. In unregulated parts of the country, the length of the rescission period will differ among settlement companies.
If the viator has already received money from the viatical company as part of a settlement, the amount must be paid back in full for the agreement to be rescinded. Likewise, a viator who wants to utilize a regret provision must reimburse the settlement company for any money it used to eradicate outstanding loans on the policy.
If the viator dies during the settlement�s rescission period, the viatical company relinquishes its ownership rights, and the insurance company pays death benefits to the insured�s chosen beneficiaries, as if the transaction had never occurred.
The relationship between the viator and the settlement company will continue, in some way, for as long as the insured individual remains alive. While finalizing the details of a viatical settlement, the viator must give his or her contact information to the settlement company. After the settlement has been legally completed, the company uses this contact information to periodically check up on the insured individual. In an arguably gruesome yet true reality of the viatical business, these regularly scheduled peeks into the insured�s life essentially involve the settlement company asking if the person is either dead or at least close to death.
In the early days of viatical settlements, insureds complained of being harassed by antsy settlement investors who could barely wait to gain access to a policy�s death benefits. In response to insureds� concerns about potential invasions of privacy, the NAIC has proposed (and many states have implemented) limits on the amount of contact a settlement company can have with a viator.
In general, viatical companies can contact viators no more than once every three months when the insured�s remaining life expectancy is greater than one year. The NAIC has said companies should not be allowed to contact viators more often than once every month when the insured�s remaining life expectancy is one year or less.
For reasons of privacy or convenience, a viator can decline to serve as the main point of contact for the settlement company during this stage of the viatical process. Instead, the viator can bestow this role upon another person, such as a physician, family member or friend, who is at least 18 years old.
The responsibility for keeping tabs on the insured belongs to the settlement company rather than to a settlement company�s investors. The settlement company can employ its own staff to conduct these checkups, or it can hire an independent third party to handle this aspect of its business. The company or the third party may conduct these periodic inquiries through the mail, over the telephone or over the internet. In addition to or in place of these inquiries, many established companies use Social Security databases to confirm an insured person�s death.
Upon being able to verify that the insured has died, the settlement company is responsible for filing a timely death claim with the insurance company and distributing proper shares of the resulting death benefits to investors.
The Back-End Viatical Process
Much of what occurs on the back end of a viatical transaction is probably more relevant to financial planners and investment strategists than to insurance professionals. But we cannot adequately understand the successes, failures and controversies within the secondary market unless we know at least some general information about how settlement companies deal with investors.
A few settlement companies have significant financial backing and purchase unwanted life insurance policies in the secondary market for their own portfolios. However, most settlement companies repackage viaticated insurance policies in some way and market them to third-party investors.
The young viatical market featured a lot of individual investors who funded all or part of a single viator�s settlement. A retiree from Florida, for example, might have chosen to give $100,000 to a viatical company in order to fund a settlement designed for an unnamed male across the country with AIDS and a remaining life expectancy of nine months.
Over time, many of these individual investors lost money in the secondary insurance market, either because a viatical company had engaged in unethical business practices or because the people insured by the viaticated contracts were simply living much longer than expected. Meanwhile, critics of viatical companies continued pointing out that giving individual investors a stake in another person�s life insurance policy could create some uncomfortable, let alone dangerous, situations for the sick.
That occasionally perilous investment environment evolved for the better into the secondary market we have today, in which reputable foreign and domestic institutional investors (such as banks and insurance companies) purchase interests in a diverse collection of viaticated policies in order to minimize their investment risk. Each settlement company might have a small group of institutional investors, all of whom have their own idea of what kind of policies the company ought to buy.
Viatical investors, be they individuals or financial institutions, need to collectively contribute more than the settlement amount offered to a viator. They must help the settlement company pay the remaining life insurance premiums, fund commissions for brokers and cover general operating expenses.
More often than not, these investors technically do not become the owners of a viaticated policy, but they do earn themselves a piece of the policy�s death benefit when the insured person passes away. Barring some grossly inadequate underwriting by the settlement company, they receive a return of principal plus interest.
It is important to note here that, unlike many traditional investment vehicles, viatical investments offer simple, total interest rather than compounded, annual interest. It should also be noted that this simple, total interest is almost never guaranteed. Returns on viatical investments will depend almost entirely on the insured�s date of death, with yields getting smaller and smaller the longer the person lives.
Since arriving in the United States a few decades ago, viatical settlements have continued to be one of the most divisive issues in the insurance and financial worlds. Regardless of the potentially positive monetary opportunities for investors in the secondary market, many critics have always viewed the term �viatical settlement� as a euphemism for something that threatens and sometimes takes advantage of sick people during a time when they are arguably at their most vulnerable. A quick inquiry on a popular search engine at the time of this writing revealed that there were more than 800 items on the Web that linked viaticals to the word �ghoulish.�
People�s occasionally questionable feelings toward the viatical industry are understandable, if not entirely warranted. After all, viatical companies and investors do not make any money until an insured person dies, and they make more money the sooner a person expires. Investors might indeed hope that viators experience some dignity and some relief from financial stress as a result of a settlement, but one has to wonder how those investors would react if medical professionals developed a cure for a terminal disease.
Would their humanity cause them to be happy for affected viators and rejoice over the fact that the viators, their friends and their family would be spared from the grief that is associated with death? Or would their first instinct lead them to worry primarily about the substantial sum of money that they will end up losing as a result of the cure?
With many investors having locked their retirement nest eggs in viaticals, some critics believe that the latter is the more likely response and that the industry is merely a corporate-built arena in which investors can gather and root for people�s deaths.
For some observers, their objection to viaticals relates as much to safety as to ethical principles. Back when viatical investment opportunities were being marketed to individuals rather than to financial institutions, naysayers were worried that a viaticated policy would wind up in the wrong hands and that the terminally ill could answer their doors someday and be greeted unceremoniously by an assassin who might take matters into his own hands if the insured happened to be living too long.
These worries were probably not reduced when it was revealed that a viatical businessman in Texas had served prison time for hiring a hit man to kill people for insurance money. It was perhaps just a matter of time before the seedy potential in viaticals captured the attention of fiction writers, including author Richard Dooling, who incorporated viatical settlements into the fraud-focused plot of his 2002 novel �Bet Your Life.�
The ethical issues involved with viatical settlements are related to the way these transactions treat a highly valued concept known as insurable interest. In order for applicants to secure any kind of insurance policy, they must demonstrate that they have an insurable interest in whatever person or thing is set to be covered by the contract. This means that the owner of the policy must have an economic or emotional reason for wanting the insured individual or item to remain unharmed.
Life insurers have consistently recognized that an individual most likely wants to remain unharmed and have therefore allowed a person to own a life insurance policy on his or her own life. Insurers have also recognized that a person�s spouse, parents, employers and business partners often have financial and emotional reasons for wanting him or her to remain unharmed. Therefore, the parties in a familial or business relationship are sometimes permitted to own insurance policies on one another�s lives.
Viatical settlements always involve a viator and at least one party who lacks an insurable interest in the person covered by a life insurance policy. Yet viatical settlements are permissible in spite of an absence of insurable interest because many insurers� internal operating policies, as well as many state laws, only require that insurable interest exists at the time the policy is issued.
Requirements pertaining to insurable interest often do not apply to transfers of policy ownership because the person insured by the policy either is the one actively pursuing the transfer or has the right to reject a transfer of ownership between the original owner and a third party. In other words, viatical settlements are permitted because the settlements usually require the insured�s consent.
In a few cases from the viatical settlement�s early days, the worries over seemingly elastic definitions of insurable interest involved more than the relationship between insureds and investors. Finders� fees, now illegal in various forms in some states, caused some observers to be additionally concerned when they thought of these settlements.
Of particular concern were those fees payable to legal professionals, financial consultants and physicians. A few consumer advocates feared that the terminally ill, in a desperate search for advice, would pursue any plan proposed by their trusted advisers, even if that plan involved venturing out into the relatively fresh and untested waters of viatical settlements, and even if those trusted advisers had a financial interest in seeing sick people flock to a particular viatical company.
Even more disturbing to some were cases in which doctors received money for referring their patients to viatical companies and instances in which AIDS clinics were paid to advertise the services of specific viatical companies. Though the AIDS clinics in particular claimed that introducing their clients to the idea of viatical settlements was merely yet another opportunity to help the sick, some people seemed to imply that any individual or organization that was in the business of providing medical treatment and counseling to the terminally ill should have had no links to an industry that made its money from death benefits.
Legislation proposed by the NAIC would make it illegal for viatical companies to knowingly pursue funding for a settlement from anyone who is in any way responsible for the insured�s health.
Beyond the issues of insurable interest and the potential for foul play, a few people who claim to be looking out for the interests of viators have suggested that the viatical industry might jeopardize its clients� privacy, particularly in regard to health.
When viatical companies first arrived in the United States, AIDS was considered a problem of potentially epidemic-level proportions and was still a disease that had several social stigmas attached to it. Out of fear of professional or social backlash, several patients felt it necessary to keep their condition hidden, even from family and close friends.
Of course, those social stigmas probably still exist today to a degree, but the ethical issue of privacy in the secondary market has arguably become less specific as settlement companies have broadened their target market to include people other than AIDS patients. Rather than being concerned about insureds being identified as people with specific terminal illnesses, privacy advocates seem to have shifted their efforts to a general argument that basically says, �No matter if you are dying of cancer, feeling pain in your lower back or experiencing absolutely no ill health at all, your medical history should only be shared with people on a need-to-know basis.�
Like a life insurance company, settlement companies must have access to pertinent medical records in order to underwrite an applicant properly. But the line between necessary and unnecessary sharing of personal information sometimes gets blurry when a company engages in back-end activity. Any sale of the policy from one viatical company to another increases the number of people who have knowledge of the insured�s condition.
Settlement companies that sell interests in policies to investors have sometimes divulged more information to prospective financial clients than viators may have expected. One of the industry�s pioneering companies was criticized in the early 1990s for allowing investors to pick their own viator and for making investors aware of the viator�s initials, the viator�s life expectancy, the viaticated policy�s cash value and the insurer�s rating.
As much as this assortment of information may have helped investors make sound financial decisions, it was feared that a little detective work could have pulled the curtain away from the viators and made their identities visible to the very people whose financial prosperity was dependent upon their deaths.
The NAIC has addressed the privacy issue by encouraging states to adopt legislation that would prohibit the sharing of insured�s personal, financial or medical information. Exceptions to this prohibition would include, but would not be limited to, the following circumstances:
Another criticism of viaticals involves the size of settlements. Some people wonder if, in spite of their proposed mission to help insureds get fair market value for their unwanted policies, viatical companies might try to exploit the terminally ill by betting that a sick person will accept any offer from a settlement company, no matter how paltry the amount might be. Early media reports on the viatical industry suggested that a few companies were threatening to take settlement offers off the table if the viator did not agree to terms within a few days.
Standard pricing for viatical settlements was one of the first issues tackled by the NAIC when it began crafting its Viatical Settlements Model Act in the 1990s. Mirroring industry practice, the association�s recommendations linked the size of a fair viatical settlement to the insured�s life expectancy, with sicker people set to receive more money than healthier applicants.
A 2007 version of the model law called for viators to receive no less than the following portions of a life insurance policy�s death benefit, unless a low-rated insurer or policy loans factor into the settlement:
The NAIC has also said any viatical company that chooses to include the potential size of a settlement within its marketing material should have to use the average settlement for all its customers within the past six months.
It should be stressed that the contents of the NAIC�s model regulation and model law, as summarized in parts of this material, are merely guidelines that lay the basic framework for the viatical laws in the individual states. Each state is free to adopt all or none of the NAIC�s models.
Local governments have been especially hesitant to include the NAIC�s minimum settlement amounts in their insurance codes. A survey of viatical-specific statutes in four states (California, Florida, Illinois and Indiana) showed that none of the four had instituted mandatory minimum amounts for settlements by the time of this writing.
In recent years, the secondary market has faced tough questions about the manner in which viatical brokers receive their cut of settlements. With many brokers� commissions coming out of the viaticated policy�s death benefit rather than out of the settlement amount, some people wonder if there is a big enough incentive for brokers to shop policies aggressively and bring back the highest possible offers to their clients. In 2006, New York�s attorney general accused some companies in the secondary market of paying �co-brokering� fees to brokers in an attempt to keep competitors� bids hidden from viators.
Brokers should understand that, depending on the state where they conduct business, they may have a legally imposed fiduciary duty to viators, meaning that they are required to pursue bids that are in the viator�s best interest. They should also be aware that they may need to disclose the size and source of their commissions to the viator.
At this point, it is perhaps worth stressing that, in spite of the somewhat negative tone that the reader might have detected in the previous paragraphs, a significant portion of people who have criticized the viatical industry have not been viators themselves. Documented feedback from the terminally ill has often been positive, with viators telling reporters about how a settlement helped them pay off debts, fund a dream vacation, treat their loved ones to extravagant gifts or spend their last days in a state of reduced stress.
When the U.S. House of Representatives Committee on Financial Services conducted a day-long hearing on alleged fraud in the viatical industry, hardly any of the attention was focused on the plights of wronged sellers. Rep. Sue Kelly even said, �The industry began, in large measure, as a noble means of allowing AIDS patients to pay their steep medical bills before death,� and Ohio Director of Insurance Lee Covington said, �While the nature of viatical transactions is dependent on the death of the viator, the social benefit of viaticals are extremely valuable for some terminally ill persons and some senior citizens.�
Before turning his attention to frauds committed against investors, Rep. Michael Oxley conceded that, �A properly conducted viatical settlement can benefit all parties involved.�
Only Rep. Luis Gutierrez talked at length about the alleged mistreatment of viators, saying, �(Viators) are so desperate for this cash that they act quickly�without information, without guidance � As a result, viators often settle for unreasonably low offers.�
Tax Breaks, Fraud and Life Settlements
Triumphs and Setbacks for Viaticals
The viatical industry appeared ready to break out into the mainstream in 1996 when Congress passed the Health Insurance Portability and Accountability Act (HIPAA). Until that point, a viatical settlement�s tax treatment was extremely uncertain, with some alleged experts insisting that the Internal Revenue Service viewed settlement proceeds as taxable income, others claiming the transactions were subject to capital gains taxes and a third group professing that one portion of a settlement was taxable income and that another portion was a capital gain.
A few viatical companies did nothing to ease all this confusion. Some of them made it a point to tell prospective viators that settlement proceeds would not need to be reported on a specific tax form, such as a 1099, and perhaps led their clients to believe that they could get away with paying no taxes at all on their settlements.
HIPAA made it possible for many viatical settlements (excluding those involving a business relationship between the viator and the insured) to be treated like the tax-free death benefit paid to a life insurance beneficiary. However, in order for the viator to receive settlement proceeds without needing to pay capital gains or income tax on the money, several conditions must be met.
In order for any of its viators to receive the federal tax breaks made possible through HIPAA, the settlement company must be properly licensed in the state where the viator resides. If the settlement is executed in a state that has no licensing requirements for viatical companies, the tax breaks are available to the viator only if the company adheres to various sections of the NAIC�s Viatical Settlement Model Act and the Viatical Settlement Model Regulation.
Assuming the company offering the settlement meets those requirements, viators can receive a tax-free viatical settlement if the person insured by the viaticated policy is a �terminally ill individual.� For tax purposes, the federal government defines �terminally ill individual� as �an individual who has been certified by a physician as having an illness or physical condition which can reasonably be expected to result in death in 24 months or less after the date of the certification.� As clarification, the government defines the term �physician� as �a doctor of medicine or osteopathy legally authorized to practice medicine and surgery by the State in which he performs such function or action.�
HIPAA does not provide full tax breaks to viators when the person insured by a viaticated life insurance policy is expected to live longer than two years, but the legislation does not completely ignore people in these situations. A limited tax break is available to viators if the insured qualifies as a �chronically ill individual.� According to Title 26 of the U.S. Code, a �chronically ill individual� is defined as follows:
[DS2]The term �chronically ill individual� means any individual who has been certified by a licensed health care practitioner as�
(i) being unable to perform (without substantial assistance from another individual) at least 2 activities of daily living for a period of at least 90 days due to a loss of functional capacity,
(ii) having a level of disability similar (as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services) to the level of disability described in clause (i), or
(iii) requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.
Such term shall not include any individual otherwise meeting the requirements of the preceding sentence unless within the preceding 12-month period a licensed health care practitioner has certified that such individual meets such requirements.
Within the above excerpt, the reader probably noticed the term �activities of daily living.� These activities come from the long-term care (LTC) insurance industry. An insured�s inability to perform multiple activities of daily living is a standard benefit trigger for LTC policies.
Most LTC insurers in the United States incorporate at least the following six activities of daily living into their benefit triggers:
When the insured person in a viatical settlement is deemed a chronically ill individual, the viator only avoids tax obligations on the portions of the proceeds that are considered a return of premium and on the portions of the proceeds that are used to pay for �qualified long-term care services.� The U.S. Code defines these services in the following manner:
The term �qualified long-term care services� means necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services, which�
(A) are required by a chronically ill individual, and
(B) are provided pursuant to a plan of care prescribed by a licensed health care practitioner.
To many viatical companies and legislators, the federal tax breaks available as a result of HIPAA seemed destined to breed positive results for businesses and government. In an ideal world, formerly hesitant policyholders were expected to hear about HIPAA�s effect on viaticals, determine that this new and somewhat mysterious industry was legitimate and sell their unwanted insurance contracts for the kind of cash that would significantly reduce people�s dependence on such cash-strapped social programs as Medicaid. But several developments combined to dash those high hopes.
A few factors were perhaps beyond most of the industry�s control and revealed some of the weaknesses in the general concept of viaticals. Others were attributable to a few discouraging companies that were less than truthful with their investors.
Throughout the first few years of the viatical business, settlement companies and their financial associates had little reason to be concerned about their decision to target AIDS patients as potential viators. In the absence of a small medical miracle, people who had progressed from being HIV-positive to having AIDS were expected to live no longer than a few more years. Even when viatical companies underestimated an AIDS patient�s remaining life expectancy, the miscalculation was not likely to cause tremendous liquidity problems for investors or cause the settlement company to pay too many unforeseen premiums.
That changed when, in 1995, the Food and Drug Administration started approving the use of �protease inhibitors,� drugs that have proven to be effective in slowing or preventing the spread of the AIDS virus in the body. Though hardly a cure for the disease, protease inhibitors, along with other medicines, have made it possible for someone who contracts the AIDS virus today to live an additional 20 years or more. In a relatively quick fashion, these drugs managed to turn a terminal condition into a potentially chronic one.
This was all good news for the AIDS community, of course, but was hardly a welcome medical advancement from the perspective of investors who had spent thousands of dollars on viaticated policies. Within a few years, the media were busy telling stories of people who were waiting twice as long for a return on their viatical investments as settlement companies had promised. Handfuls of investors became incredulous when they received notices from viatical companies, informing them that the amount of money that had been set aside to pay premiums was running out and that, if they wanted to maintain their claim to any portion of eventual death benefits, they would need to reach into their wallets and pull out some additional cash. A few retirees wondered out loud if the ill people in whom they had invested their nest egg might actually outlive them.
It was not just the productive work of scientists and drug companies who were spoiling investors� chances of netting big yields from viaticals. In a somewhat ironic twist, some of the same safeguards that the industry had instituted in order to protect the privacy of viators ended up making it easier for unethical companies to abuse and defraud innocent investors. Without access to insureds� medical records, investors had no way of knowing how well the settlement companies were underwriting policies and estimating life expectancies. Without the insured�s personal information, an investor could not even verify that an insured individual actually existed.
In numerous lawsuits, state regulators, the Securities and Exchange Commission (SEC) and individual investors accused viatical companies of various frauds. In some cases, money received from fresh investors was allegedly being used to pay off old investors, and no new policies were ever purchased. Sometimes, according to prosecutors, settlement companies did in fact purchase viaticated policies, but they employed doctors who would purposely downgrade an insured�s projected life expectancy in order to make the person�s policy more attractive to investors.
In a practice known as �clean-sheeting,� some viatical companies encouraged terminal patients to apply for several small life insurance policies from multiple providers, lie about their health and viaticate the policies in exchange for a small settlement. This brand of fraud either hurt insurers, who had to pay death benefits when the fraud went undetected, or hurt investors, who lost their principal when an insurer spotted a fraud and cancelled a dishonestly obtained policy.
On occasion, individuals were duped by misleading advertisements that appeared in the pages of obscure trade magazines and major financial newspapers. Marketers sometimes stressed the alleged safety of investing in viaticals, saying that viatical investments were on par with certificates of deposit but not bothering to mention that, unlike CDs, viatical investments have no firm maturity date and are not insured by the Federal Deposit Insurance Corporation. A few ads took people�s public comments out of context and made it seem as though nationally recognized financial advisers and even members of the Supreme Court were endorsing viatical investment strategies.
This collection of dishonest deeds and outright frauds resulted in a lot of bad press for the industry and caused regulators in some states to warn residents about the risks involved with viatical settlements. State efforts were particularly strong in Florida, where, according to the SEC, one company had misrepresented or misjudged the life expectancy of 90 percent of its viators and where, in the summer of 1999, five of the state�s eight licensed viatical settlement companies were being investigated by the local insurance department. In 2000, a Florida grand jury estimated that roughly half of viatical investments were linked to insurance fraud.
By 2002, the North American Securities Administrators Association had listed viaticals near the middle of the pack on its annual list of the top ten investment scams in the continent, and multiple trade groups had removed the word �viatical� from their names, perhaps as a way of distancing themselves from the embarrassing scandals.
One common complaint about the regulation of viatical companies in this country has been that the laws enacted in various states, while giving adequate protection to viators, do not shield individual investors well enough from unethical opportunists. Drafts of NAIC model laws and regulations say investors should be made aware of the following things before their money can be used to fund a settlement:
NAIC documents also propose the following rules for advertisements:
Yet not every state has adopted the NAIC models in their entirety or even at all. In 2007, more than 10 years after the NAIC approved its first edition of the Viatical Settlements Model Act, the trade publication Best�s Review said some 12 states had neither enacted the proposed legislation nor passed similar laws. In fact, a debate has raged for at least a decade as to whether viatical companies should be regulated by the individual states or the federal government.
Regulation of Viatical Settlements
Because few investors had enough money to fully fund a viatical settlement on their own, early members of the viatical community began letting people buy �fractional interests� in viaticated policies. With a fractional interest, an investor funds only a portion of a settlement and shares any death benefits with other investors. A person might have a fractional interest in a single life insurance policy or in several policies.
Upon hearing about the buying and selling of fractional interests, the federal government claimed settlement companies had ventured into the marketing of securities and should therefore be subjected to federal regulation by the SEC. For the most part, the viatical industry disagreed, saying that the sale of life insurance policies in the secondary market�no matter the method�was comparable to selling a piece of real estate or other kind of personal property. The industry was not against all forms of regulation, but it generally believed that designating viatical transactions as securities would overcomplicate matters for buyers, sellers and middlemen.
On an admittedly basic level, securities involve investment contracts, must be registered with federal authorities, may not be sold unless accompanied by prospectuses and may not be sold by anyone who lacks an appropriate securities license. Some viatical companies claimed that the cost of satisfying many of those requirements would be too much for some brokerage and settlement organizations to handle and that the licensing requirements would prevent a significant portion of front-end and back-end workers from conducting business.
The regulatory issue was confronted in court when the SEC charged Living Benefits, Inc. with allegedly marketing unregistered securities. A U.S. district court ruled in the government�s favor, but an appeals court eventually overturned a portion of the ruling and concluded that the company was selling neither securities nor insurance contracts.
That court ruling against the SEC has made it important for viatical professionals to be aware of the unique laws and regulations in their respective states. The majority of states that regulate viatical companies have taken it upon themselves to classify interests in viaticated policies as securities, but this does not necessarily mean that state securities departments have the final say in all viatical matters.
A state may give its insurance department full authority to regulate viatical transactions. Or it may divide regulatory responsibilities by letting the insurance department handle all issues related to dealings between viators and viatical companies and letting the securities department handle all issues related to dealings between viatical companies and investors.
At the time of this writing, a few states had still not chosen to enact specific regulations for local viatical companies. The Life Insurance Settlement Association maintains a database of the applicable viatical laws and regulations in each state on its website, http://www.lisassociation.org.
Faced with a souring public reputation and advances in AIDS treatment, the viatical companies of the late 1990s and early 21st century had to find a new way to survive. At first, a few companies merely stopped buying policies from AIDS patients and shifted their focus toward potential viators with terminal cancer or other life-ending illnesses. But this strategy equated to a temporary patch for the industry�s problems instead of a permanent fix. A groundbreaking cancer drug would have sent the industry back to the drawing board.
Gradually, the industry took note of the growing number of senior citizens in this country and recognized that, like terminally ill policyholders, many older Americans had purchased life insurance that no longer served much of a purpose for them. Many seniors who had originally bought life insurance for their children�s sake no longer needed to worry about their grown son or daughter�s financial stability. Many who purchased a policy years ago in order to provide for a spouse had gotten divorced or had been widowed. Businesses that had bought key person policies on the lives of valued employees were watching those workers retire and wondered if it was economically prudent to keep paying premiums for the coverage. Other individuals had initially bought life insurance as part of a tax-sensitive estate plan but had later learned that changes in the tax code had granted their estate a tax exemption.
Assuming that many of these seniors would be intrigued by the chance to get more from their unwanted life insurance policies than their cash surrender values, the secondary life insurance market left most of its viatical business behind and began fiercely promoting a similar kind of financial arrangement known as a �life settlement,� �senior settlement� or �high net-worth settlement.�
Life settlements work like viatical settlements with a few important exceptions. The biggest difference between the two is that life settlements do not involve viators who are terminally ill. Instead, the typical viator in a life settlement is 65 or older with a remaining life expectancy of 15 years or less. To qualify for this kind of settlement, the insured must have experienced some moderately significant health problems since applying for the coverage.
Unlike viatical settlements, which may apply to policies big and small, most life settlements must involve an unwanted policy with a minimum face amount, usually somewhere near $100,000 or $250,000.
For various reasons (including life expectancy and the generally higher cost of insuring the elderly), a viator in a life settlement transaction receives a much smaller settlement than a viator in a viatical transaction. Life settlement amounts can range from 10 percent to 40 percent or more of the death benefit. Some settlement companies advertise that their average viator receives at least the viaticated policy�s cash surrender value multiplied by three.
As with a viatical settlement, money received as part of a life settlement may be used by the viator as he or she pleases. Portions of life settlements that are considered a return of premium are tax-free to the viator. Portions that are not considered a return of premium but are not greater than the policy�s cash surrender value are taxed as income. All additional proceeds are taxed as capital gains.
The back end of the life settlement process is also very similar to a traditional viatical setup, with settlement companies either holding onto viaticated policies for their own portfolios or, more commonly, selling interests in several policies to groups of investors.
The young industry�s reliance on institutional investors, rather than on individual investors, might be a major reason why some of the ethical concerns and instances of fraud that were prevalent in the viatical market have not been as problematic in the life settlement industry. At least on a privacy level, viators seem more comfortable with banks, insurance companies and other impersonal business entities having an interest in their life insurance policies than with unknown individuals having that same sort of interest.
Some states have regulated life settlements through their insurance and securities departments. In states that regulate viatical settlements as well as life settlements, an individual may or may not need to obtain separate licenses to market or facilitate both kinds of settlements.
Insurers� Reaction to the Secondary Market
As a professional insurance producer, you might be more than a little bit curious about how insurance companies have been affected by viatical and life settlement businesses and about how people working in the competing primary and secondary life insurance markets view one another.
At alternating points in time, the relationship between life insurance companies and viatical companies has been helpful or hostile on both sides. Viatical companies initially promoted themselves by criticizing life insurance companies for forcing unhappy policyholders to either hang onto their coverage or accept allegedly unfair settlements in the form of cash surrender values. Yet viatical companies have also admitted that life insurance agents are the average person�s most likely source for information about potential opportunities in the secondary market.
For years, settlement companies have complained about insurers that refuse to employ people who have held jobs with viatical organizations and that allegedly do not let their agents discuss viatical-related options with clients. Some viatical companies have even claimed that insurance agents expose themselves to potential lawsuits when they know a client is interested in canceling a policy but do not mention the option of viaticating the coverage.
When pressed about this issue, insurance professionals sometimes say they lack enough personal expertise to advise clients in regard to the secondary market or that they have legal or ethical reasons of their own for avoiding the subject. With viaticated contracts often occupying a gray area between insurance policies and securities, some agents and their employers have worried about mentioning viaticals and finding themselves in a licensing dispute with regulators. Other insurance workers have heard about the instances of fraud in the secondary market and claim they want to protect their clients from possible abuse.
In spite of insurers� stated reasons for avoiding mentions of viatical settlements in conversations with their clients, one can easily make the case that the main conflict between insurers and settlement companies boils down to dollars and cents. Once viaticals became an option for millions of Americans, industry observers predicted that insurance companies would lose money as a result of falling �lapse rates.�
Lapse rates represent the number of people who discontinue their coverage before their life insurance policy matures. These rates are significant indicators of expected profits for a life insurance company. When a policy lapses, an insurance company is no longer obligated to pay a death benefit to beneficiaries and often makes money on the policy as a result. A healthy amount of lapses can reduce the insurer�s reinsurance costs because the corresponding reinsurance company will need to back up fewer death claims. This reduction in cost might be passed down to new policyholders in the form of lower premiums.
Conversely, when few policies lapse, the insurer makes less money, the reinsurance company tends to charge more for its services, and premiums are likely to rise.
Prior to the debut of viaticals and life settlement companies, it seemed nearly certain that a large percentage of terminally ill people and senior citizens would eventually let their policies lapse. But once settlement companies and their investors started stockpiling these policies with no intention of ever letting them lapse, insurance companies had to accept that more of their policies would end up reaching the claims stage.
The prospect of having to pay out more death benefits than originally planned did not sit well with insurers during the viatical era, and the secondary market�s shift toward life settlements has done little to alter that displeasure.
It also should go without saying that the insurance community could not have been pleased by the instances of clean-sheeting in the viatical market. In some cases, as we have already noted, insurance companies spotted these frauds promptly and saved themselves from losing thousands of dollars in death benefits. In other cases, insurers recognized the scams too late and were forced to honor fraudulent claims.
Insurers have also frowned upon the life settlement industry�s involvement with �wet paper,� �wet ink� or �stranger-originated life insurance� (SOLI) policies.
Similar to clean-sheeting but generally free of blatant fraud, SOLI is life insurance that is bought by an individual at the suggestion of a life settlement company in exchange for money or gifts. When a policy becomes incontestable, the insured transfers ownership rights to the settlement company in accordance with a secret, preexisting agreement.
To some insurers, SOLI presents a problem of principle by ignoring the insured�s true need for life insurance and by turning a product designed for risk management into a clear investment vehicle. Many settlement companies share this distaste for SOLI and sometimes worry that companies that promote it will give the federal government a good reason to eliminate the positive tax treatment of some viatical and life settlements.
SOLI was a major issue for members of the NAIC when they gathered to create updated versions of the viatical settlement model laws and regulations in 2006 and 2007. While insurers wanted to institute a waiting period between the time a policy is issued and the time a policy can be sold to a life settlement company, the secondary market cautioned that a rigidly enforced waiting period would penalize people who experience a major life change soon after acquiring their coverage.
In 2007, the NAIC�s Life Insurance and Annuities Committee endorsed a five-year waiting period that would be waived if the insured person gets divorced, is widowed, becomes terminally or chronically ill, retires or becomes disabled to the point of being unemployed. NAIC documents also suggest that individuals and settlement companies not be allowed to enter into a settlement agreement before a policy has been issued by an insurance company.
All the public disharmony between insurers and their rivals in the secondary market tends to overshadow the fact that there is a considerable degree of peaceful and even mutually beneficial overlap within the two industries. Life insurance entities such as CNA Financial Group and BMI Financial Group have scooped up viatical and life settlement companies for themselves or have developed their own settlement businesses from scratch. After years of mystery, it was revealed that the insurance giant American International Group was the main financial force behind life settlement leader Coventry. In a clear and public sign that insurance professionals and viatical veterans can coexist in business, former Illinois Director of Insurance Nat Shapo became Coventry�s chief compliance officer in 2005.
Competition from the early viatical companies helped push the insurance industry into offering �accelerated death benefits.� These benefits entitle insureds to a portion of a policy�s face value if they come down with a particular disease, are deemed terminally ill or require long-term care.
Accelerated death benefits work like a combination of traditional life insurance benefits and viatical settlements. When a person is diagnosed with a chronic illness that requires assistance with multiple activities of daily living or has less than a year to live, a policy with accelerated death benefits typically nets the individual up to 50 percent of the policy�s face value. These benefits are treated like viatical settlements in the tax code, meaning that people with less than two years to live receive them tax-free and that people who are chronically ill do not need to count the benefits as income when the money is used to pay for qualified long-term care services.
The portion of the policy�s face value that is not doled out to the client in the form of accelerated death benefits is earmarked for the policyholder�s beneficiaries. Unlike a transaction in the secondary market, accelerated benefits have no effect on policy ownership or beneficiary status. The policyholder remains responsible for paying premiums in full and on time.
The cost of accelerated death benefits and the manner in which an insurer charges for them vary among companies. A few companies charge the policyholder for these benefits for as long as the policy is in force. Others include these benefits in policies from the very beginning but only start charging for them when the insured becomes ill or needs care. These days, a consumer might even be able to secure a policy that includes these benefits at no additional cost.
There has been much debate regarding which financial option�a settlement in the secondary market or an accelerated death benefit from an insurer�is more valuable to unhealthy consumers. Where people stand on this issue will depend on what they want most out of their life insurance policy when they become seriously ill.
In most cases, ill policyholders receive a larger percentage of their policy�s death benefit when they opt for viatical settlements over accelerated death benefits. Whereas an insurer�s accelerated benefits might offer a client no more than 50 percent of a policy�s death benefit for personal use, a viatical settlement company might be willing to buy the same policy for 80 percent of the death benefit or more.
Still, if we compare the amount of death benefits that ultimately go to policyholders and beneficiaries against the amount of money that goes to third parties in these two setups, accelerated death benefits might be deemed the better deal. When a viator sells a policy for 80 percent of its face value, the remaining 20 percent of the policy�s value becomes the property of a settlement company and its investors. But when a policyholder utilizes a 50 percent accelerated death benefit provision, almost all of the policy�s remaining half will eventually belong to the person�s chosen heirs.
In many states, a viatical or life settlement company cannot purchase an unwanted life insurance policy unless the viator understands that accelerated death benefits may be available through the person�s insurance company.
This course material will end following a few more sentences, but the fascinated reader will be interested to know that the story of viatical and life settlement companies is probably far from over. At the time this material was being written, the settlement industry was still influencing the way some insurance companies conducted business, and entrepreneurs were still experimenting with ways to make life settlements increasingly attractive to insureds and investors.
Whether we love, hate or have complicated feelings about viatical and life settlements, it is difficult to deny that the secondary market forces us to think seriously about what a life insurance policy ought to provide for its owner.