What is a Viatical Settlement?

Instructor: Danielle Haak

Danielle has a PhD in Natural Resource Sciences and a MSc in Biological Sciences

A viatical settlement occurs when a life insurance policy owner sells their policy to a third party for a fraction of the payout amount. In this lesson, we'll learn the ins and outs of qualifying for and considering a viatical settlement.

Life Insurance 101

Before we jump into the meat of this lesson, let's take just a moment to review some key life insurance terms. First of all, what is life insurance? Well, Brian can buy a life insurance policy from an insurance company so that when he dies, his wife Sarah receives an insurance payout. In this scenario, Sarah is the beneficiary of the policy because she receives the benefits upon Brian's death.

Most life insurance policies require the buyer to pay monthly or yearly payments, or premiums, but the general idea is that the final insurance payout to the beneficiary will be a higher amount than the buyer pays into it. Because the buyer is making payments, each policy is sometimes worth a cash buy-out value. In this situation, if Brian decided he no longer wanted his life insurance policy, he could sell it back to the insurance company and receive a portion of this money back.

Viatical Settlements

Now that we're up-to-date on the basics of life insurance, there's an additional twist to the story. In the 1980s, a new concept called viatical settlements emerged in response to a growing number of AIDS patients who had life insurance policies, limited life expectancy, and high medical costs.

This new option allowed terminally ill patients to sell their life insurance policy to a third party. The third party paid the ill policy owner more money than the cash buy-out option but less money than the after-death benefits. This option meant that the person selling their policy got a lump sum of money, and after their death, the third party buyer became the beneficiary and could claim the policy's full payout, meaning they made their original money back plus the additional money covered in the policy. With AIDS life expectancy being so short, this became a lucrative investment opportunity for people who could afford to purchase policies for a fraction of what they were worth.

As you have probably figured out, this is a pretty risky investment opportunity. Even if a terminally ill patient has an approximate life expectancy, there is no guarantee they won't live longer than this estimate. If they outlive their expectancy, the third party buyer has to wait longer to claim any benefits. This means there is no guaranteed rate of return with viatical settlements.

Generally speaking, if the seller has a long life expectancy, the policy is sold for less money. If the seller has a short life expectancy, the policy is sold for more money, because the buyer anticipates being able to claim the full amount quickly.

Though viatical settlements were originally intended for terminally ill patients (with a life expectancy of less than 24 months), the concept spread, and more groups quickly became interested in this type of investment.

In response to viatical settlements, some life insurance companies began adding accelerated death benefits to policies. These allow a person to receive a percentage of their policy payout amount once their life expectancy drops below 24 months. Upon death, their beneficiary receives the remainder of the policy amount, minus the amount paid as an accelerated death benefit.

Seller and Investor Considerations

When a policy owner is thinking about selling their life insurance policy to a third party, there are a few things they should consider first. For example, they should make sure this third party is paying a higher amount than the potential cash buy-out option should they return their policy to the insurance company. They should also look into any potential accelerated death benefits (though not all policies include this option). Additionally, even if the policy has been sold to a new person, it still applies to the original policy holder, so it may be difficult or impossible for the original holder to purchase another policy if they decide they want life insurance again.

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