Viatical and Life Settlements FAQs

There are questions surrounding viatical and life settlements. Life insurance is a big deal in any household. Without it, you’d have to worry about your loved ones. There are many options to choose from when it comes to buying life insurance. Our experts answer some questions revolving around this topic.

Question – What factors will determine the amount of a viatical or life settlement?

Answer – The following factors will affect the amount of settlement received:

  1. The insured’s life expectancy – The shorter the period until the insured is expected to die, the more the settlement company will pay.
  2. The period in which the company can contest the existence of a valid contract must have passed – The incontestable period, as well as the suicide provision (typically two years), generally must have expired. This period may begin again for policies that have been reinstated after a lapse for nonpayment of premium.
  3. Company’s financial rating – The company that issued the policy must have a high financial rating.
  4. The amount of the premiums – The premium level is important, since the buyer of the policy must continue making the payments for the remainder of the insured’s lifetime.
  5. The size of the policy – Most settlement companies have upper and lower limits. For example, for viatical settlements a top limit of $1,000,000 scaling down to a minimum of $50,000 is typical. For life settlements the death benefit must generally be at least $250,000, and some providers will only consider policies of $1 million or more.
  6. The current prime interest rate ­– The prime rate is important, since the buyer will compare the settlement agreement to other types of investments.
  7. Time of payment – The time between applying for the settlement and having the cash is generally three to eight weeks (but can be as long as six months). However, this will depend on how quickly the medical information, life expectancy reports, beneficiary release forms, etc. are in the hands of the settlement company.

Question – What other considerations are involved in deciding whether or not to enter into a viatical or life settlement?

Answer – Planners and those insureds who are considering viatical and life settlements should also consider the following:

  1. Confidentiality and beneficiaries – Most companies stress the confidential nature of the transaction but they require the named beneficiary to release any possible claim to the proceeds. If the insured does not want the beneficiary to know of the sale, he or she may change beneficiaries just prior to completing the settlement. If the estate is named as beneficiary, the insured (owner) would be the only one who would need to sign the release forms. However, if death occurred after the time the beneficiary was changed, but before the settlement was completed, the insurance proceeds would be paid to the estate and would, therefore, be subject to probate administration.
  2. Group insurance – Group insurance policies may be eligible to be sold in viatical and life settlements, but they generally must be portable. If a group insurance policy is sold this will usually require that one’s employer is notified.
  3. Resale of policies – Confidentiality may be lost if the policy is sold by the settlement company in the secondary market to individual investors, since a new investor would want to know the health status and life expectancy of the insured.
  4. Escrow accounts – An escrow account is generally used to make certain that the payment of the agreed upon amount is made to the insured shortly after the insurance company notifies the escrow company that the ownership of the policy has been transferred.
  5. Shop and negotiate – Several settlement companies should be investigated in order to negotiate the best offer.

Question – What types of life insurance policies are typically sold in the secondary market?

Answer – Single life policies are generally much more attractive to viatical and life settlement providers. A viatical settlement of a survivorship policy is unlikely due to the fact that both insured’s would have to be terminally ill or have very short life expectancies. The life settlement market for survivorship policies isn’t much better, because the settlement companies have to wait until the death of the second insured to collect the death proceeds. Both insureds would need to have life expectancies not exceeding eleven to fifteen years.

As for product types, Universal Life (UL) policies are generally more attractive to settlement companies, especially in the case of life settlements. This is because the settlement companies have flexibility to reduce premiums to just cover the annual cost of insurance charges or pay some other minimum premium amount, flexibility to take cash value out of the policy and invest it in a different manner, and flexibility to reduce the face amount if needed. This includes Variable Universal Life (VUL). However, as discussed below, special rules apply when a VUL policy is settled.

Term insurance and group term insurance can also frequently be settled. However, certain factors make them more attractive to settlement companies; such as conversion features which enable them to be converted to a flexible premium cash value product.

Whole life policies, especially in the case of life settlements, may be less attractive to settlement companies because they tend to be less flexible when it comes to premium flexibility, ability to pull out cash values, and the ability to adjust the death benefit. In addition, since these products are generally designed to endow at maturity (e.g., age 100), they tend to have higher cash values. This makes it less likely that the settlement offer will exceed the surrender value.

Question – What special rules apply when a variable life or variable universal life policy is settled?

Answer – Since a variable life insurance product is treated as a security, the settlement of a variable life insurance policy is subject to Financial Industry Regulatory Authority (FINRA) best practices standards that apply to broker-dealers and registered representatives.9 The five primary areas of concern that FINRA identified for its members engaging in settlements of variable life policies include: (1) suitability; (2) due diligence; (3) best execution; (4) training and supervision; and (5) compensation. As a result of these standards, most broker-dealers have developed suitability and due diligence questionnaires, disclosure forms, and standardized the amount of acceptable compensation for variable life insurance settlements. In addition, a principal of the broker-dealer will generally review each variable life settlement transaction to ensure that it is suitable for the client.

Question – Can a life settlement followed by the purchase of a new policy with the settlement proceeds qualify as a 1035 exchange?

Answer – It has been suggested that if the settlement proceeds are never in the hands of the policy owner and the proceeds are sent by the settlement company (via an escrow agent) directly to a life insurance carrier to be used to purchase a new life insurance policy, then a 1035 exchange treatment applies. It is the authors’ opinion that this would not qualify as a valid 1035 exchange, due to the fact that there is a sale in the middle of the exchange transaction.

Question – Can a viatical settlement be used as a means of getting a life insurance policy out of one’s estate for estate tax purposes?

Answer – For the individual who will not live more than three years, a transfer of an existing policy to an irrevocable trust or a third person will be ineffective to avoid inclusion of the policy in the gross estate at death. For example, an individual who owns a $500,000 life insurance policy on his life and whose estate is in the 60 percent estate tax bracket will only pass on $300,000 to the beneficiaries of the policy (.40 × $500,000 = $200,000; $500,000 − $200,000 = $300,000).

A sale of the policy avoids the three-year rule because the viatication is a sale for fair market value in money or money’s worth. This could provide additional value to the insured’s family and reduce estate taxes because the conversion into cash converts the intangible asset into cash that can be given to family members in the form of tax-free annual exclusion gifts, spent down by the individual, or a combination of the two.

For example, the same individual who owns a $500,000 policy on his life will leave his beneficiaries only $225,000 if he dies owning the policy. Instead, the individual sells the policy and receives $350,000 (70 percent of the face amount). The individual can make annual exclusion gifts of the $350,000 to his four children, their spouses, and ten grandchildren over his remaining assumed life expectancy of two years. Under the viatical settlement, the individual has transferred $350,000 to his family tax-free, providing them an additional $125,000 ($350,000 − $225,000). (In addition, the estate can pass the after-estate tax value of the premiums not spent in maintaining the policy as well as the after-income-and-estate tax on the earnings on the declining balance of the $350,000 viatical proceeds over his remaining life.)

Getting a life insurance policy out of the insured’s estate can sometimes save the estate administration costs of having to file an estate tax return.

Question – Can an owner of a policy who is not the insured enter into a viatical or life settlement?

Answer – Yes. Only the policy owner can viaticate or settle an insurance policy. However, if the policy owner is not the insured, the cooperation of the insured will be required in order to do so.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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