Viatical Settlements Explained
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What is a Viatical Settlement?
A viatical settlement is when someone who is terminally or chronically ill sells their life insurance policy to a third party. The policy seller receives a lump sum cash payout that is more than the cash surrender value, but less than the death benefit. The buyer receives the policy’s death benefit when the seller passes.
Anyone with a severe medical condition knows that health insurance doesn’t cover everything. Fortunately, life insurance policyholders have a few options that can help solve financial problems. A viatical settlement is one of them.
The most significant advantage of a viatical settlement (compared to some of the alternatives) is that the seller receives more money than the policy’s cash surrender value. This means more money to cover medical expenses, or even to be more comfortable towards the end of life.
The downside is that potential beneficiaries will not receive the benefit after the seller passes away.
In this guide, we will walk through everything you need to know about viatical settlements, from what they are and how they work to taxation and regulation.
First, it’s essential to provide a viatical settlement definition and define some key terms and discuss the two types of viatical settlements.
Terms To Know
- Viatical settlement – The transfer of ownership of a permanent life insurance policy by someone who is terminally or chronically ill to a third party.
- Cash surrender value – The amount of money you can withdraw if you surrender your policy to your insurance company and allow it to lapse.
- Face value – The amount of the death benefit that your beneficiaries would receive upon your death if you continued the policy through your life.
Types of Viatical Settlements
There are essentially two types of viatical settlements: one for the terminally ill and one for the chronically ill.
Terminally ill is defined as having a life expectancy of fewer than 24 months.
Chronically ill refers to someone who can no longer perform two or more activities of daily living (ADL). ADLs include eating, using the toilet, bathing oneself, or dressing oneself.
Chronically ill also describes someone who requires substantial supervision to protect him/herself from threats to health and safety.
How Viatical Settlements Work
In a viatical settlement, a policyholder connects with a settlement company or broker who provides a cash payment (more than the cash surrender value of a policy and less than the benefit). After the settlement, the purchaser continues to make premium payments and receives the death benefit upon the seller’s passing.
In a viatical settlement transaction, the life insurance policyholder transfers ownership to the buyer. That means the seller is no longer responsible for the policy premiums. The third party, known as a viatical provider, assumes responsibility for all expenses related to the policy.
Viatical Settlement vs. Life Settlement
Viatical settlements and life settlements are similar, but there are some key differences:
- Viatical settlements are designed for the terminally or chronically ill. You do not need to be sick to qualify for a life settlement.
- Viatical settlements often pay significantly more than traditional life settlements.
- A life settlement requires a permanent policy, such as whole life insurance policy, variable life insurance or universal life insurance (or a convertible term policy). A viatical settlement does not have this requirement.
- Viatical settlements and life settlements are taxed differently. A viatical settlement is not subject to federal income tax. Portions of a life settlement are taxed. What you paid in premiums is not counted, but the rest is subject to income and capital gains taxes.
Am I Eligible for a Viatical Settlement?
To be eligible for a viatical settlement, a seller must meet these requirements:
- The policyholder must be terminally ill or chronically ill. Generally, this means a person with a short life expectancy. Sellers must have medical records to prove they meet these specifications.
- The life insurance policies must be at least two years old.
- The policy must have a face value of at least $200,000.
Reasons to Pursue a Viatical Settlement
People opt for a viatical settlement for many reasons. Most often it is because they need money to cover medical or end-of-life expenses.
It should not be a hasty decision, consider your options carefully.
The following situations are the most common motivators for seeking a viatical settlement:
1. You Can No Longer Afford Your Insurance Premiums
Exorbitant medical bills can make other financial commitments almost impossible to maintain. But, letting your insurance policy lapse due to non-payment can lead to little or no payout, depending on the policy type.
If you opt for a viatical settlement, you not only get an immediate cash payment, you will also no longer be responsible for monthly premiums.
2. Your Beneficiaries Don’t Need the Death Benefit
Many people buy life insurance so they have something to leave behind for their beneficiaries.
If your beneficiaries are financially independent, they may not want or need the death benefit. Your current need to lower your financial burdens may be a more prudent concern.
3. Your Term Policy Is Expiring
Term policies typically expire with no cash value and expensive replacement costs. Instead of letting your policy expire worthless, consider converting the policy to a permanent plan and selling it in a life settlement or viatical settlement.
4. You Need To Improve Your Quality Of Life
A viatical settlement allows you to supplement your income so that you can live in financial comfort. If you’re struggling to make ends meet, a cash payment from a life insurance settlement might be exactly what you need to get back above water.
Pros and Cons of Viatical Settlements
Pursuing a viatical is a serious financial decision, before you move forward, it is important to weigh the pros and cons of viatical settlements.
|You get an immediate lump sum payment that is larger than the surrender value of your policy.|
|You no longer have to make premium payments.|
|You can use the payout to cover medical and long-term care costs.|
|You will have more money to enjoy your retirement.|
|Your beneficiaries will not receive anything upon your death.|
|You may become ineligible for Medicaid.|
|Other options, like an accelerated death benefit, might be a better alternative for your unique situation.|
|An accelerated death benefit might make more sense.|
Risks of a Viatical Settlement
A viatical settlement can be a godsend to terminally or chronically ill people who struggle to make ends meet, but it pays to be aware of the risks before moving forward.
In some cases, older whole life or universal life policies have a hidden cash value that is more than what they could be sold for. If this is the case, a viatical settlement does not make financial sense.
Chronically ill patients might find that other alternatives will provide a better return over time.
The IRS doesn’t usually tax viatical settlements, but every situation is unique.
Your state might have different rules concerning viatical settlements. Check with a professional to find out how your settlement might be affected.
Be aware of transaction costs before you proceed with a settlement. Depending on the arrangement agreements, you could pay commissions to multiple parties. There may even be undisclosed fees – double check before you close.
Many states require upfront disclosure of all commissions and fees.
It is possible that creditors could claim some or all of the proceeds of your settlement. If you have outstanding debts, consult with your financial institution to understand if your payout is at risk.
How is a Viatical Settlement Payout Determined?
To determine how much a viatical settlement will pay out, consider the following factors:
- The life expectancy of the insured.
- The expected premium costs (known as the in-force illustration).
- The type and size of the life insurance policy.
To determine life expectancy, settlement providers collect HIPPA release forms and obtain your medical records to predict the policyholder’s life expectancy.
The settlement provider reviews a policy’s in-force illustration to understand what it will cost to keep the policy active until the death of the policyholder.
An in-force illustration is a mathematical model that shows what the remaining premiums will be if the policyholder reaches their life expectancy. It also accounts for interest rates and other factors.
Type and Size of Insurance Policy
Obviously, the larger the policy, the more it’s worth. Besides the policy value, companies also consider the type of life insurance. Permanent policies are generally worth more than term policies.
Once the provider has an estimate of what it will cost to keep the policy active while the insured remains alive, they can compare that cost with the policy’s benefit.
Providers use these estimates and models to understand the amount they can pay the policyholder today to achieve a sufficient return from purchasing the policy.
Viatical Settlement Alternatives
If you do not qualify, or if you are not sure if a viatical settlement is the right financial decision, there are alternatives that allow you to get money via your life insurance policy.
Borrowing against your policy’s cash value is possible. As with all loans, there are interest fees. But unlike most loans, the application can be very quick and there is no need for underwriting.
If the amount is not paid back before the policyholder’s passing, the amount is subtracted from the death benefit.
If a standard policy loan isn’t right for you, some policies allow you to use your policy’s cash value as collateral for secured loans.
Accelerated Death Benefit
An accelerated death benefit is a rider added to an insurance policy. When a policyholder accesses their accelerated death benefit, the insurance company gives out a portion of the death benefit while the policyholder is still living.
Unlike a policy loan, policy owners do not have to repay the amount – it is subtracted from the death benefit.
Policyholders can access the cash surrender value of their life insurance by merely canceling the policy. There are fees associated with surrendering a plan, so policy owners do not receive the full cash value.
This is probably the easiest way to get money from your policy, but it is not as lucrative as a viatical or life settlement.
If you aren’t eligible for a viatical because you have a life expectancy of more than two years, you may still qualify for a life settlement.
Your insurance policy was a significant investment. Explore your options before making any permanent decisions regarding your policy’s future. Be sure to ask yourself, “What is the cash value of my life insurance policy?” And do thorough research before choosing this option.
Viatical Settlements vs. Accelerated Death Benefits
As we covered above, there are numerous ways to relieve the financial burdens of terminal or chronic illness.
Some borrow from friends or family, others take on debt, lower their standards of living, or even sell valuable assets.
You may decide that using your life insurance policy for financial assistance is your best course of action.
Viatical settlements and accelerated death benefits are two of the most interesting options.
What is an Accelerated Death Benefit?
An accelerated death benefit, or ADB, is an optional rider that you purchase at the start of your policy. Some insurance companies still allow for an accelerated death benefit without the rider.
An ADB allows the insured to receive a certain percentage of the policy’s death benefit while they are still living.
The percentage is determined by the insurance contract and life expectancy, but is usually 25-95% of the policy’s face value. The remaining portion is kept in the policy as the death benefit.
To qualify for an ADB, the policyholder must have a terminal or chronic illness and a life expectancy of fewer than two years.
Two important things to consider about an accelerated death benefit:
- The amount of money you get in hand in an accelerated death benefit transaction is usually less than what is subtracted from your death benefit.
- The amount subtracted from your death benefit changes the face value of your policy and usually lowers your monthly premium payments.
How an ADB Works (Example)
Let’s what through an example to get a better understanding of how an accelerated death benefit works.
Say your policy is worth $500,000. You file a claim with your insurance company to accelerate half of your death benefit ($250,000).
The face value of your policy will now be $250,000 because it is cut in half. Your premium payments will likely be lowered (since premiums on a $500,000 policy are more expensive than premiums on a $250,000 policy).
The insurance company has to make up for some of that loss, so they’ll take out some fees. So instead of $250,000, your check is for 70% ADB amount, leaving you with $175,000.
In this scenario, you are left with $175,000 in cash plus a life insurance policy with a $250,000 death benefit. The insurance company walks away with $75,000 in fees.
Since you are still the owner of the policy, you can still pursue a viatical settlement with your new (smaller) policy.
How An ADB Compares With A Viatical Settlement
With an ADB, you get cash up front, and your beneficiaries still receive a death benefit. The ADB payout amount is generally more than the lump sum of a viatical settlement, but you still continue to pay premiums.
A viatical settlement ends your involvement with your policy and your commitment to paying premiums. Your payout is based on mathematical models that estimate your life expectancy and how much it will cost the settlement provider to take over your premiums.
If you no longer need your insurance policy and don’t want to pay your premiums, a viatical settlement makes a lot of sense.
If you still need your policy and are comfortable making future premium payments, accessing your ADB might be a better choice.
We suggest you consult with a professional before making any decisions.
Combining an ADB And A Viatical Settlement
An underutilized option combines both an accelerated death benefit and a viatical settlement.
After a policyholder has completed the ADB process, they still control the portion of the policy that remained after the payout. They can sell that remaining part of the policy to a viatical settlement provider.
In some cases, this combination allows the policyholder to receive the most money for their policy during their lifetime. But, as with any viatical settlement, the beneficiaries will not collect a death benefit.
Accelerated Death Benefit
Can pay anywhere from 25-90% of the policy’s face value.
You will still pay premiums on the life insurance policy.
Generally tax exempt.
The discount factor can be up to 50% of your payout.
You still retain control of the policy.
Can pay up to 80% of the policy’s face value.
There are no future premium payments.
Generally tax exempt.
Broker’s fees and commissions can be up to 30% of your payout.
You relinquish control of the policy.
How to Get the Best Deal
To get the best deal on your viatical settlement, it is essential to be prepared and informed. That starts with knowing your options, limitations, and risks.
Just like with all large financial transactions, take your time and shop around with different providers. Ask about their commissions and fees, and always check if they are licensed in your state.
When talking with a provider or broker, ask about:
- Regulations specific to your state.
- State income tax laws pertaining to viatical settlements.
- Whether or not you are at risk of creditors claiming your proceeds.
- If you are at risk of losing any public assistance such as food stamps or Medicaid.
- What rights you have in canceling the settlement, returning the money, and reinstating your policy.
- If it is in your best interest to use your insurance agent, a life settlement broker, or deal directly with a life settlement provider.
If you’re working with a broker, be sure that whoever is representing you provides quotes from several companies to make sure that you have a competitive offer.
Viatical Settlement Taxation
The proceeds of a viatical settlement are not subject to federal income tax in most cases. However, there are a few caveats and stipulations, and state laws vary.
In general, viatical proceeds are tax-free if they meet these requirements:
- The policyholder must be terminally ill with a life expectancy less than two years or diagnosed with a chronic condition (meaning they are unable to perform 2 activities of daily living).
- The policy must be sold to a state-licensed life settlement provider.
- The provider must abide by requirements agreed to in the Viatical Settlements Model Act.
For an in-depth look at viatical settlement tax implications, read this guide to viatical settlement taxation.
How Are Viatical Settlements Regulated?
Each state regulates viatical settlements through their respective departments of insurance. State regulations protect more than 90% of insured Americans pursuing viatical settlements. Comprehensive viatical settlement laws and regulations exist in 45 states plus Puerto Rico.
It is worth noting that both Michigan and New Mexico regulate viatical settlements but not standard life settlements.
Life and viatical settlement regulations in most states follow these guidelines and models:
- National Conference of Insurance Legislators (NCOIL) Life Settlement Model
- National Association of Insurance Commissioners (NAIC) Viatical Settlement Model
Some states combine guidelines from each of these models.
One of the key elements of viatical settlement regulation is how long you have to own your policy before you can sell it. In most states, the waiting period is two years (see the specifics for your state in the map below).
Although regulations vary from state to state, here are some of the most common rules to be aware of, all of which are designed to protect the policy seller:
- Settlement providers must provide substantial disclosure, including the disclosure of compensation paid to brokers.
- Settlement providers must provide information regarding alternatives to viatical settlements.
- Settlement providers must disclose risks regarding taxation and government assistance programs.
- Viatical settlement agents, brokers, and providers must be licensed.
- The NAIC Viatical Settlement Model suggests minimum payouts depending on the life expectancy of the policyholder.
- Some states include provisions that allow people to sell their policy before the end of the waiting period in the case of terminal illness.
The History Of Viatical Settlements
The word “viatical” comes from the Latin word “viaticum,” which refers to provisions or money for a journey.
The precedent for viatical settlements stems from the 1911 Supreme Court ruling in the case Grigsby v. Russell, which established the legal basis for selling life insurance in a secondary market.
The case revolves around a man named John C. Burchard who was in dire need of a surgical procedure but didn’t have the money. Burchard paid for the surgery by selling his life insurance policy to his physician, Dr. Grigsby, for $100.
When Burchard died, Grigsby tried to claim the death benefit, but the executor of Burchard’s estate challenged his claim.
Oliver Wendell Holmes delivered the Supreme Court ruling:
“So far as reasonable safety permits, it is desirable to give the life policies the ordinary characteristics of property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”
The Court’s ruling established a legal precedent for the life settlement industry that exists today. This precedent has been reinforced over the years, most recently with the Health Insurance Portability and Accountability Act (HIPAA) in 1996.
More than 70 years after the ruling, the modern life settlement industry began to take form. The establishment of the first viatical settlement company became necessary with the emergence of the AIDS epidemic.
Many AIDS victims found that they needed cash to pay for medical treatments more than they needed a death benefit to provide for their beneficiaries. It was under these circumstances that the first “viatical” settlements were created.
Medical advancements made viatical settlements for AIDS patients far less common over time. But these settlements gave way to the highly regulated and mature life and viatical settlement industry that exists today.
Myths and Misconceptions
There is a lot of false information out there when it comes to viatical settlements and life settlements. The most common myths we hear are that viatical settlements are a scam and that viatical settlements are completely unregulated.
Both of these assumptions are categorically false.
Viatical settlements are not scams. They are a completely viable way to access the value of your life insurance policy to get money when you need it most. That said, viatical settlements are not for everyone, and you should understand your alternatives before making any financial decision.
The second myth, that the viatical industry is completely unregulated, is easy to disprove. In the United States, regulations protect more than 90% of Americans, and there are comprehensive viatical settlement laws and regulations in place in 45 states.
For a look at more viatical settlement myths and misconceptions, read our guide on viatical taxation.
If you’re ready to move forward with a viatical settlement, the first step is to contact a certified life settlement company that can purchase your life insurance policy or connect with a broker.
Viatical Settlement Brokers
Brokers are licensed by the state the policyholder lives in. They have a fiduciary responsibility to represent the policyholder’s best interests. The broker negotiates on the insured’s behalf. They take a commission for representing you in a transaction with a life settlement provider. A typical commission is usually at least 10% of the payout.
Viatical Settlement Providers
Life settlement providers are state licensed companies that can purchase life insurance policies on the secondary market. Life settlement and viatical settlement providers purchase policies for their own accounts or on behalf of institutional investors.
Life settlement providers do not have a fiduciary responsibility to act in the best interests of policyholders.
It is important to note that your insurance company plays a vital role in a viatical settlement. Some insurance company agents or representatives can work with or in conjunction with a life settlement broker.
In addition to working with the purchaser, your insurance representative has a fiduciary responsibility to act in your best interest. So even though settlement providers don’t have that responsibility, your insurance company does.