Uses and Abuses
Predictably, scam operators have come to view this young industry as a lucrative arena for fraud. Some operators use shady practices to defraud investors who purchase life policies, while others perpetrate fraud against those attempting to sell their policies. Sometimes the scams are complex, other times the abuses are simple cases of misrepresentations and outright embezzlement.
When viatical settlements were first introduced, the contract and settlement process were more flexible than they are currently. In some cases the viator would assign the policy to the purchaser, and the purchaser would fail to pay the proceeds. This type of abuse has been eliminated by the use of an escrow agent. Nowadays, the settlement process is handled by an independent party to assure the purchaser receives a properly assigned policy and the seller receives the proceeds.
From an investor‘s point of view, sometimes viaticated policies lapsed due to non-payment of premiums. Remember that the purchaser is responsible for future premium payments on viaticated policies. If those premiums are not paid, the policy lapses and the investor will not receive the death benefits when the contract “matures”. Often in the case of viatical settlements, the purchaser will place monies on deposit with an escrow agent to cover premium payments for the rest of the insured’s life expectancy. This deposit, as part of the closing process, minimizes the possibility of a lapsed policy due to non-payment of premiums.
Other abuses aimed at investors are fruadulent or false advertising, such as:
making outrageous promises, such as guaranteeing returns of 40 percent;
characterizing the investment in viatical settlements as risk free; and
implying that the viatical settlement is, in some manner, guaranteed by a life insurer or government entity.
Remember that actual return earned on a lifetime settlement is based on whether the insured's projected life expectancy was correct. So using terms such as "guaranteed" in advertising is clearly a misrepresentation. As a result, the North American Securities Administrators Association (NASAA) classified "misrepresented viaticals" among the top 10 investment frauds in the country.
It is not solely in terms of advertising, however, that some of the most egregious violations have occurred -- sometimes the schemes are outright theft..
In the case of SEC v. David W. Laing and PCO, Inc., viatical settlements were advertised to investors as a risk-free way to earn 25 percent per year. In addition to that false advertising, the company accepted $95 million from more than 1,100 investors, but never bought the viaticals, using the funds instead to finance personal airplanes and lavish lifestyles. The owner of the company pled guilty to fraud.
In a somewhat similar case, an indictment was brought against a viatical seller alleging that it invested only $6 million of the $115 million it took from investors. Federal agents raided another viatical settlement company due to an insurance fraud known as clean sheeting.
The fraud and misrepresentation that have plagued the viatical industry have given rise to a new lexicon of terms to describe them. These terms include:
Clean sheeting is the deliberate omission of a material fact or the deliberate inclusion of an untrue statement by an applicant during the insurance application process with the intent to commit fraud. It is a material misrepresentation designed by the applicant to obtain a life insurance policy that otherwise would not be underwritten or to obtain a policy at premiums that are lower-than-appropriate for the proposed insured’s level of risk.
A number of regulators have expressed concern over the increased incidence of clean sheeting in the viatical settlements industry. By means of clean sheeting, a terminally ill applicant might viaticate the life insurance policy for a settlement far in excess of the premiums paid.
Another term that has been popularized by fraudulent viatical practices is known as wet paper. Wet paper is a life insurance policy that is still in its contestable period, that is, the ink is still wet on the policy. Wet paper sometimes refers to the purchase of life insurance coverage from a life insurance company with the specific intent of selling the contract to a third party. The National Association of Insurance Commissions (NAIC) has stated that these wet paper sales have been encouraged by some life insurance agents and viatical company representatives in order to profit from the transaction.
Clean sheeting and wet paper also leads to another fraudulent practice known as warehousing. Warehousing is the deliberate putting-aside by a viatical company of a life insurance policy that is known to have been accquired through clean sheeting until the period of contestability expires. Giving the so-called wet ink an opportunity to dry.
Some of these problems are a result of a new market finding the best way to conduct business. Sometimes the solution is as simple as using an escrow agent to safeguard both buyer and seller. Other times, the industry has developed a degree of self-regulation, and in some cases, state governments have enacted statutes. By far, most of the abuses in this new market are aimed at purchasers of viaticated policies. Unsophisticated investors seem most likely to be taken in by fraudulent sales pitches and other deceptive practices -- and perhaps a little bit of their own greed when tempted with very generous possible returns. As the market has matured, the smaller, individual investors have been replaced with large financial institutions that have the resources to investigate and protect themselves from abusive practices. In addition, these large companies have imposed stricter standards and market discipline on the evolving marketplace.
Life settlements, whether viatical or senior settlements, provide a significant increase in the liquidity of life insurance that may mean the difference between an ailing insured living the remainder of his or her life in dignity and financial independence or in poverty and dependence. Like many emerging industries, however, the new market for lifetime settlements has experienced its share of ethical and market conduct problems. In fact, the North American Securities Administrators Association (NASAA) classified misrepresented viaticals among the top 10 frauds in the country.
Adding to the industry’s market conduct and ethical problems has been the lack of initial regulation. Because a viatical company is not an insurance company (even though it may be a subsidiary of one) it is not subject to the strict regulatory standards governing the insurance industry. Furthermore, because viatical settlements are not investments (in the technical sense of the term), the requirements of the Securities and Exchange Commission (SEC) do not clearly apply.
Industry groups, including the National Association of Insurance Commissioners (NAIC) and the North American Securities Administrators Association (NASAA), are grappling with the implications of viaticals on two fronts: those who want to sell their life insurance policies and those who are approached to invest in them.
For those considering becoming an investor in viaticated policies or for viators wishing to sell their policies, it is important to check license requirements with either your insurance department or securities regulator, depending on how viatical oversight is handled in his or her state. Some states may mandate written disclosure to consumers about the costs and risks associated with viaticals and require viatical companies to furnish their financial statements and/or annual reports, while other states may simply demand approval of all viatical sales material.