What are the risks in purchasing a life insurance policy as part of a viatical settlement or life settlement?
They run from a significant risk that the financial results you project (or someone projected for you) may not appear, to risk of total loss of the “investment” and more.
Let’s take a circumstance in which you are asked to “invest” $50,000 – to $62,500 to buy a $100,000 life insurance policy of someone that you know (or more likely a broker finds for you). Let’s assume everyone believes that person has 10-12 months to live. You may think that is a great deal as within a year you can expect to collect the full $100,000 from the insurance company.
There may be significant expenses, sometimes they may be “bundled” into the price you pay (thus hiding the fees involved from you), while other times the fees may be added on and fully disclosed. Often the broker who set you up to buy that policy takes a finder’s fee or commission, typically 10% of the face amount, in this case $10,000, as her fee. To show she is “looking out for your interests” the broker may recommend that you also confirm that the insured person is seriously ill and really does have a life expectancy of less than a year, so you pay an additional $2,000 to various doctors who check out the medical records and may even examine the insured and report back to you that it looks like 10-12 months. And let’s assume to give you added confidence the broker suggests you pay another $500 to a lawyer to investigate and the lawyer reports the insurance policy is in full force and effect and has not previously been assigned to anyone else. In total the broker, doctor and lawyer costs may amount to $12,500.
You might say, that’s still not a bad deal, as if you pay only $62,500 and the policy owner gets $50,000, the broker $10,000 and the other expenses are $2,500, so while you are only investing $62,500 now, you will get back that plus another $37,500 when the insured dies, likely within the year, which works out to far better than a 50% return.
But what if
- The insured person lives far longer than expected?
o Even though the finest doctors may be reasonably certain that the insured whose policy you are buying has only a short time to live, any one person’s will to live can often defy any projections.
o New medical advances and drugs might extend life, and cure previously untreatable diseases. For example when protease inhibitors were developed for treating AIDS, tens of thousands who were expected to die within a year lived. They even may enjoy the same normal life expectancy as persons without AIDS. The companies that invested in viatical settlements of policies on AIDS patients went bankrupt.
- You have to pay premiums on the policies?
o To maintain the life policy in force, the new policy owner has to continue to pay the life premiums on the underlying policy. Thus instead of collecting the death benefit, the new owner may have to pay out next year’s, and the 30 next years’ premiums.
- The insurance company refuses to pay the policy benefits?
o If the policy is less than 2 years old at the time of death, or if the death has not occurred but the assignment is made within 2 years, the policy is full contestable. When the new owner reports that the policy has been assigned that may trigger a re-examination by the insurance company. It would sue to rescind if there is any material misrepresentation. Thus the payment to the original owner would have been made for nothing, and collecting it back would be highly unlikely.
o If the policy is over 2 years old, depending on the state and circumstances, fraud (such as if an imposter took the exam) may be grounds to deny benefits.
- The insurance company goes insolvent?
Depending on the circumstances, if the insurance company crashes, the new policyholder may be wholly or partially out of luck. Life insurance guarantee funds have limited resources and will pay out only up to a certain amount per insured and/or policy owner. So a person who buys a $5 million policy may find out that all the guarantee fund pays out is $250,000. And very often that may take years.
- The policy expires?
Many policies run out after a certain date, or are renewable only to a certain age, or involve huge “step up” premiums. For example, if the terminally ill person has a 20 year term life policy with 15 years to run, that may look great. But not only would you have to continue to pay premium, but if the person does not die within the next 15 years, depending on the policy, the insurance may simply expire, and can not be renewed, or the premium may be exorbitant.
- You can not locate the insured, or you can not get a death certificate, and thus you can not collect the policy benefits?
The insured may take the money he receives and travel and you’d not know when he dies, much less get a death certificate. Or perhaps she will set sail in that new boat your money bought her, and you’ll never know when, or if, she died?
DEFINITIONS:
Accelerated Benefits Option: An Accelerated Death Benefit option allows the policy owner to receive, in advance of the insured person’s death, a significant portion of the death benefit that otherwise would be paid after death to the beneficiaries.
Life Settlement: A
Viatical: The term viatical comes from the Latin term viaticum which means "provisions for a long journey." If a person is terminally ill, a viatical settlement lets the person sell a life insurance policy you already have to a viatical settlement provider.
Viator. The person selling the life insurance policy is the viator. He or she will get a cash payment from the settlement that is less than the full amount of the death benefit in the life insurance policy.. This person gives up ownership of the policy in return for a cash payment. Typically, the viator has a terminal illness.
A viatical settlement provider is the person or company that buys the life insurance policy. The viatical settlement provider becomes the policy owner, must pay any premiums that are due, and will eventually collect the full amount of the death benefit from the insurance company.
The person or company who represents the seller (viator) and can "comparison shop" for viatical offers is a viatical settlement broker. |
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