Chapter 2
Basics of Lifetime Settlements

The important points addressed in this lesson are:

Terms defining participants in the lifetime settlement process
Steps involved in arranging a lifetime settlement
Items a policyholder should consider before selling a life insurance policy
Factors affecting the speed of a settlement
Factors affecting the size of a settlement


Terminology

Not unexpectedly, the emergence of this new market for lifetime settlements has coined several important terms. Before we proceed further in our discussion of life settlements, let’s look at these new terms and their meanings.

An important place to begin in defining of these terms is to offer some explanation of the derivation of the word viatical. It comes from the ancient Roman word viaticum, which referred to the custom of providing money or supplies to an officer embarking on an official mission. Over time, it became the term associated with the supplying of money or supplies for any journey. The journey envisioned in a viatical settlement is the journey to death, and the settlement provides funds for that journey.

Please note: the following discussion addresses commonly-used terms in an “everyday” context.  Some states have enacted laws to regulate these secondary market transactions, and those laws may define the following terms in a more narrow, legal context.  We’ll present more information on state laws later in this course.  We recommend that you become familiar with the state laws that apply to you before engaging in any transactions.


A viatical settlement is the sale of a life insurance policy by an individual who has a life-threatening illness to a third party in return for a percentage of the face amount of the policy. It generally involves individuals suffering from a terminal illness who have a life expectancy of up to 48 or 60 months.

POLICYHOLDER
INVESTOR
seller
buyer

VIATOR
VIATICAL SETTLEMENT PROVIDER
or
PURCHASER



An important party to these viatical settlements is the viator. The viator owns a life insurance policy that insures the life of an individual with a catastrophic, life-threatening or chronic illness or condition and enters into a viatical settlement contract. In many individually owned policies, the viator is also the insured, but it is also common for the viator and the insured to be different -- as in the case of business-owned policies.

The party that enters into a viatical settlement contract and purchases the life insurance policy is known as a viatical settlement provider.  

A viatical settlement contract is a written agreement entered into between a viatical settlement provider and a viator. The agreement establishes the terms under which the viatical settlement provider will pay compensation in return for the viator’s assignment, transfer or sale of the death benefit or ownership of all or a portion of the insurance policy to the viatical settlement provider.

The viatical settlement proceeds result from the viatical settlement contract.  A viaticated policy is a life insurance policy that has been acquired by a viatical settlement provider pursuant to a viatical settlement contract.  The proceeds will be something greater than the policy’s cash value (which is available from the insurer) and less than the policy’s death benefit (the amount the investor will receive when the contract “matures”, i.e.,  the insured passes away.)  This amount is based on several factors: expected life expectancy, anticipated premium payments, quality of the insurer, etc.

As with many market transactions, third parties often assist buyers and sellers in executing a transaction.  In the new secondary market for life insurance, the party that stands between the policy-selling viator and the policy-buying viatical settlement provider is a viatical settlement broker. This party, who acts on behalf of a viator, negotiates viatical settlements between a viator and one or more viatical settlement providers. A viatical settlement broker is deemed to represent only the viator and owes a fiduciary duty to the viator.

Once the policy is purchased by a viatical settlement provider, the provider may in turn sell the policy to another investor or group of investors.  Some viatical settlement providers simply act as clearing houses for viaticated policies on behalf of other investors.   The person who buys a viaticated life insurance policy is called a viatical settlement purchaser, or sometimes called a settlement funding company.

A viatical settlement purchase agreement is a contract or an agreement to purchase a viaticated life insurance policy from a viatical settlement provider.  It differs from the viatical settlement contract that we just defined because the viator is not a party to it, rather the insurance policy purchaser is.

We noted earlier that a viatical settlement broker represents the viator in negotiations with the viatical settlement provider. Similarly, a viatical settlement provider employs viatical settlement investment agents to solicit funding for the purchase of viatical settlements.


VIATOR
<--->
VIATICAL SETTLEMENT
BROKER
<--->
VIATICAL SETTLEMENT PROVIDER
<--->
VIATICAL SETTLEMENT AGENT
<--->
VIATICAL SETTLEMENT PURCHASER


In addition to the various market participants, several other terms have critical meaning to the lifetime settlement process.

The terms “chronically ill” and “terminally ill” have specific usages due to their life-settlement applicability.   A terminally ill individual is defined in the Viatical Settlements Model Act  as having an illness or sickness that can reasonably be expected to result in death in 24 months or less. The Health Insurance Portability and Accountability Act also defines terminal illness in the same 24 month timeframe. When we turn our attention to the taxation of viatical settlements later in this course, we will see that the settlement’s income taxability is substantially affected by a terminally ill versus a chronically ill diagnosis.

Chronically ill means:

being unable to perform at least two activities of daily living; or
requiring substantial supervision to protect himself or herself from threats to health and safety due to severe cognitive impairment.

Activities of daily living  include (in order of increasing severity) mobility, bathing, dressing, toileting, transference, continence and eating.


For life settlement purposes, the terms “life expectancy” and “net death benefit” have also been amended somewhat from their customary definitions.

Life expectancy is the mean of the number of months the individual insured under the life insurance policy to be viaticated can be expected to live as determined by the viatical settlement provider, taking into consideration medical records and appropriate experiential data.

Net death benefit is the amount of the life insurance policy or certificate to be viaticated, less any outstanding debts or liens.

The sale of the insurance policy is not the end of a viatical transaction.  The investors need to maintain some type of contact with the policy’s insured.  The investment will “mature” upon the death of the insured and filing of proper claim forms with the insurer.  For that reason, the information that is likely to disclose who the insured is has also been identified. Patient-identifying information means an insured’s:

address
telephone number
fax number
photograph or other likeness
employer
employment status
social security number; and
any other information that is likely to lead to the identification of the insured.

When we focus on some of the ethical and market conduct issues of life settlements later in this course, we will see that maintaining the insured’s privacy is critical.

Let’s wrap up our discussion of viatical industry terms with two final definitions: “senior settlement” and “nonconforming policy“.

A senior settlement is the transfer of ownership or benefits of an in-force life insurance policy under which a healthy individual, age 65 or older, is insured. Although a viatical settlement and a senior settlement are similar to the extent that they involve the sale of an existing life insurance contract to a third party, they are not the same. A viatical settlement is generally defined as one involving insureds of any age with a life expectancy of 48 months or less. A senior settlement involves older insureds with a life expectancy of more than 48 months.   Please note: even though senior settlements are, in some ways, much different from viatical settlements -- the terminology that applies to viatical settlements has been extended to include senior settlements.   For example, a viator is simply the seller of a life insurance policy, regardless of whether the insured is terminally or not.  Likewise, a viatical settlement provider will purchase life policies through both viatical and senior settlements.  

A nonconforming policy, in the sense in which it is used in the viatical industry, is a life insurance policy that is within the contestable period.    


Mechanics of a Settlement

The process of selling a policy (“viaticating” in the jargon of the viatical industry) is a relatively simple one. In fact, it is similar to the process that the policyowner went through in purchasing the policy initially — but, in a sense, in reverse.

In most cases, the best place for the policyowner to begin the process of selling his or her life insurance policy is with a viatical settlement broker, attorney, life insurance agent or financial planner, who will represent the policyowner and comparison shop for the best offer. When the sale is completed, it is the buyer, not the seller of the policy, who will pay the broker a commission.   In some states, brokers need to be licensed -- so it's important to check with state law -- state regulations are discussed later in this program.

The viatical settlement broker will help the policyowner complete an application, which will provide information about the insured, his or her medical history, and the names and addresses of any attending physicians.

In addition to the application, which is sent to the viatical settlement broker, the policyowner usually must provide a copy of the policy and a policy release, which enables the broker to obtain verification of coverage from the insurance company. The insured must also provide a medical release, authorizing his or her physician to release medical information, and obtain a letter from the physician attesting to the insured’s competency.

The viatical settlement broker will present the information about the policy and medical history of the insured to a range of potential policy-buyers and solicit offers. The offers made for the coverage are then presented to the policyowner for a decision. When the policyowner has chosen the offer he or she is willing to accept, closing documents are signed with the new owner, and a new beneficiary is named. At that time, funds (which may have been placed in escrow) are released to the viator.

For those contemplating the sale of their policies, experts suggest a number of steps that a policyowner should follow in addition to those that have already been discussed:

Discuss life expectancy with a physician.
Obtain multiple bids (three to five) from competing viatical settlement companies.
Seek professional legal and financial advice in evaluating any bids received from viatical settlement companies.
Check with state authorities to see if the settlement companies are properly licensed and/or if any complaints have been filed.
Weigh the immediate need for maintaining a particular standard of living against the future needs of dependents.
Ask the insurance company to split a large policy into several smaller policies so that they may be sold as needed.
Take all guaranteed face amount increases into account when negotiating any offers to sell the policy.
If covered under a group insurance policy and leaving an employer’s service, don’t permit the coverage to expire. It may be convertible to individual coverage within the first month following termination of service.
Determine how and how often the viatical settlement company will contact the insured to track its investment.
Normally, when a life insurance policy is in the process of being purchased under a viatical settlement, the viatical settlement company will deposit the settlement funds with an independent escrow agent. When the closing process is completed, the independent escrow agent releases the funds to the viator.

From the buyer‘s point of view, the viatical settlement company will often deposit into a premium escrow account the amount of funds needed to pay policy premiums through the insured’s life expectancy plus an additional limited period, usually one year. So, if a viator has a life expectancy of one year, it would not be unusual for the viatical settlement company to deposit funds equal to two years of premiums in the premium escrow account.  Such deposits are less likely in the case of senior settlements.  

The timing of the lifetime settlement (specifically, how long it will take to receive the settlement proceeds) is often a concern to a viator. From the time that a company receives a viator’s completed application, it may take from four to ten weeks for funds to be dispersed, depending on the viatical settlement company selected. In addition, the following will affect the length of time before payment is received:

the responsiveness of the viator’s physicians;
the responsiveness of the viator’s insurance company in providing verification of coverage; and
the duration of the review by the viatical settlement company.

In addition, the timing of the settlement will depend on:

the responsiveness of the viator to the receipt of offers;
the number of viatical settlement companies from whom offers are requested; and
the insurance company’s responsiveness in acknowledging the ownership and beneficiary changes.


Unlike security transactions, which settle in a matter of days, the sale of a life insurance policy is not a quick fix to a viator’s financial problems.  In this respect, a lifetime settlement is comparable with a real estate closing.   However, for those with time and patience, viatication can lead to financial independence.

The amount that the viator can expect to receive for his or her policy depends on a number of factors.  In general, however, viators can expect between 60 and 80 percent of a policy’s face amount in a viatical settlement.  The pricing of senior settlements, based on longer life expectancies, is considerably less.   More specifically, the price paid for a life insurance policy is based on:

the insured’s life expectancy—the shorter the expectancy, the higher the payment;
the annual premium amount;
the policy type and insurance company rating;
the market rate available on other similar investments; and
whether the policy is beyond the contestability period.

These pricing factors are discussed in detail later in this program.