Life is unpredictable, and a life insurance policy you bought years ago might not make financial sense under new circumstances.
Viatical settlements are one way for people with terminal or chronic illnesses to get the benefits of their life insurance while they’re alive — and experienced investors can sometimes benefit as well.
What is a viatical insurance settlement?
When a life insurance policyholder has a terminal or chronic illness and a short life expectancy, they sometimes sell their policy in an arrangement known as a viatical settlement. These settlements can be made with almost any type of life insurance, including term, permanent, and joint policies.
A buyer, usually a life settlement company, purchases the policy and takes over all future premium payments. The buyer also collects the policy’s death benefit when the seller dies. This means the seller can’t pass the benefit on to any other beneficiaries.
In exchange, the seller or “viator” gets a cash payment within days or weeks — less than the amount of the original death benefit (or the policy’s “face value”), but more than the cash surrender value, or the amount they’d get if they simply canceled the policy.
Viatical settlements became a business in the late 1980s when the AIDS crisis caused an increase in demand; terminally-ill policyholders needed the extra funds for end-of-life care and financial planning.
Who qualifies for a viatical settlement?
People with terminal or chronic illnesses
To sell a policy in a viatical settlement, you’ll need to be diagnosed with a chronic or terminal health condition (the settlement company will ask for medical records).
For their purposes, the National Association of Insurance Commissioners (NAIC) defines a chronic illness as a condition that affects basic daily life activities like eating, bathing, or sleeping. A terminal illness comes with an abbreviated life expectancy.
In general, you need to hold a life insurance policy for two to five years before selling it in a viatical settlement. Individual states regulate the specific waiting periods, but two years is common. This prevents people from buying policies just to sell them after getting a diagnosis.
Policies need a minimum face value, usually at least $200,000.
When does selling make sense?
The main drawback of selling a life insurance policy is that the beneficiaries you originally selected won’t get any money. In some cases, though, the beneficiaries will no longer need the payout (children who achieve financial independence, for example).
If medical bills are a more pressing need, a viatical settlement can get you cash relatively quickly. Some people who sold their policies during the AIDS crisis were able to improve their quality of life substantially in their final days.
A settlement also relieves you of having to pay premiums. If you simply stop paying premiums and let your policy lapse, you may qualify for a cash surrender value, but you won’t get as much as you would in a viatical settlement.
Industry regulation for viatical settlements
Since the law considers life insurance personal property, policies are legal to buy and sell. But the viatical settlement industry is becoming more heavily regulated in order to ensure sellers get fair prices and brokers (and settlement companies) act in the seller’s best interest.
In 43 states, settlement companies and brokers need to be licensed by state insurance departments and follow privacy and anti-fraud laws. They’re required to make certain disclosures to consumers, including information about risks.
Each state has its own insurance department, and yours may have a list of licensed viatical settlement companies and brokers. Start by looking up your state department on the NAIC website. For tax reasons, you’ll want to do business with someone who’s licensed in the state where you live.
It’s also strongly recommended that you meet with a financial advisor first if you can afford the expense, since an unbiased professional can help you determine if you’re really getting a good deal.
Selling a life insurance policy
How the process works
To start the process of selling your life insurance policy, you’ll either go to a settlement company directly or work with a licensed viatical settlement broker (who will approach companies on your behalf). Brokers should have a fiduciary duty to act in your best interest, not just to make the sale. Though a broker takes a lot of work out of the process, they do charge fees of their own (either a flat rate or a percentage of the payout, around 20% to 30% typically).
Settlement company representatives review your medical records and insurance info. Then, you should expect to be asked questions about your health, family history, and daily life.
After going over the details, they’ll provide you with an in-force illustration — an estimate of how much you’ll pay in premiums if you keep your policy “in force” for your estimated life expectancy. They should also give you privacy notices describing who can access your health info; buyers of viatical settlements can check in on the seller’s medical condition.
Then they’ll make you an offer for a cash settlement that’s a percentage of your policy’s face value. Just like when you’re buying life insurance, you should shop around and compare a few different offers to find the best one.
Tips and questions to ask
Checking with the state insurance department is a good first step to make sure you’re dealing with someone licensed in your state and to find out more about local regulations. You want to find out as much as you can during the process, including:
- Whether you can reconsider and return the settlement after receiving the money.
- Whether any creditors can claim your settlement.
- Who the legal owner will be (usually the settlement company or an investor) and whether they can resell the policy themselves.
- How a settlement affects your ability to earn public assistance, like Medicaid or food stamp benefits.
Fees and costs
You’ll probably face some transaction costs—brokers and settlement companies should state their commissions and fees up front, but if they don’t, feel free to ask. Broker commissions can be substantial, so plan on that cost if you’re working with a broker.
How much money will you be offered?
Determining how much to pay out in a viatical settlement is sometimes called “reverse underwriting”—older candidates with shorter life expectancies are more likely to get big payouts since investors don’t get paid themselves until the death of the seller or “viator.”
Life expectancy is the biggest factor, but the type and size of your policy matter, too. Settlement companies consider whether you have a term or permanent policy, how much you’re paying in premiums, whether you have any outstanding policy loans, and how high current interest rates are, among other factors. Permanent policies accrue cash value, so they’re worth more than term policies.
Figures vary widely, but as a general rule, companies pay between 20% to 85% of your policy’s face value. The amount will be lower than the face value or death benefit, but higher than the cash surrender value (what you’d get if you just canceled).
How do you receive funds?
The settlement company will typically deposit the funds in an escrow account for protection during the process. Once you transfer ownership of the policy, the company transfers the funds to you – often within a few business days.
Viatical settlements are often, but not always, tax-free for the seller. If your life expectancy is two years or less, you won’t pay taxes on settlement payouts in most states. If you’re chronically ill, however, you may be required to spend the funds on long-term care expenses if you want to avoid paying taxes on them.
Each state has slightly different regulations on how viatical settlements are taxed; that’s another good reason to engage an independent financial advisor who should know your state’s laws.
Investing in a life insurance policy
How investments work
Settlement companies can sell policies to individual investors. If you invest in a life insurance policy, you become the beneficiary – you pay all remaining premiums and get the death benefit. This can be a lucrative investment with returns as high as 10%, but the catch is that your rate of return depends on how long the seller lives. If they outlive their life expectancy, you’ll get less of a return; if they die sooner, you’ll get more.
Who can invest in viatical settlements?
Since viatical settlements are highly risky investments, they aren’t appropriate for most portfolios. You’re actually required to be an accredited investor — someone who meets the high income and asset requirements — before you invest in a life insurance policy.
Risk of investment
Most investments don’t have guaranteed returns, but viatical settlements are especially uncertain. There’s no way to know exactly how long someone will live, even with advanced medical science. So, you may be paying premiums for a long time without knowing if or when you’ll ever see a profit. You might even start dipping into your principal investment.
Investor due diligence
Before you invest in a viatical settlement, find out:
- How long you’re expected to pay policy premiums.
- The insurance company’s financial health (look for an “A” rating on a common financial index like Standard and Poor’s or Moody’s).
- What control you retain over the investment.
- Whether you can access information about the viator’s health condition.
- If the insurance policy is within the “contestability period” (a period of time after the policy is issued when the insurer can refuse to pay out benefits – the length of time varies by state).
- If the investment is considered a security, which requires anti-fraud provisions.
Advantages of a viatical insurance settlement
Money for medical care
Viatical settlements can go towards a wide range of medical costs, from in-home care to experimental treatments not covered by insurance.
If medical bills are mounting, this might be the smartest way to use the cash.
No responsibility for insurance premiums
Once you sell, you’re done paying premiums — and you’ll get more cash than you would if you let the policy lapse.
Funding other goals
With some exceptions, viators can use the settlement money however they choose, depending on their needs and priorities. The money could secure an estate, for example, or settle outstanding debts.
Higher payout than most settlements
Compared to other ways to make money from a life insurance policy, viatical settlements (if you qualify) typically lead to the largest payouts.
Disadvantages of a viatical insurance settlement
No death benefit for beneficiaries
This is the biggest drawback for many viators, and it’s worth a discussion with your beneficiaries so they know what to expect.
Possible Medicaid disqualification
If you’re receiving need-based medical benefits like Medicare or Medicaid, a sudden influx of cash might make your income too high to qualify.
High risk for investors
On the investing side, viatical settlements are about as risky as investments come, and they’re sometimes sold by salespeople eager for a commission. You should go into the investment knowing there’s a strong chance it won’t be profitable.
Alternatives to viatical settlements
If you’re not terminally or chronically ill, or you’d rather not go through the viatical settlement process, there are other ways to get cash from a life insurance policy while you’re still alive.
Borrowing against your policy’s cash value
Whole, universal, and other permanent life insurance policies have a cash value that grows over time. Borrowing from your policy is a good way to get funds while keeping the coverage in place. This method works best if you have a plan to repay the loan over time.
Life settlements work a lot like viatical settlements (you sell your policy to an investor, usually a company), but there are some crucial differences. You don’t need to be ill or have a short life expectancy for a life settlement.
You can only sell a permanent policy, not a term policy, and the payout is taxable — you’ll pay income and/or capital gains taxes on any money you get, not counting premium payments.
Accelerated death benefits
An accelerated death benefit (ADB) lets you use a portion of your death benefit while leaving the remainder to your beneficiaries and keeping the policy in force. ADBs are usually an option written into an insurance policy from the start or a “rider” option you add for a fee. You deal directly with the insurer; no third-party settlement companies or brokers necessary.
Like viatical settlements, ADBs are reserved for the terminally and chronically ill. Some choose to combine an ADB and a viatical settlement by getting ADB benefits and selling the remainder of the policy.
Whether you’re selling or investing, a viatical settlement is a big decision and one that should be made after a lot of thought and research. Even if you don’t need to sell your life insurance policy now, it’s an option open to you in the future.