When it comes to life insurance, there are many different options available to those who are either looking to insure themselves or who are already insured. There is also an expansive glossary of terms that policyholders need to understand; for example, a viatical settlement.
A policyholder must understand the definition of a viatical settlement, what are the primary features of a viatical settlement, and how it will affect them in practice.
Firstly, to determine what is a viatical settlement you must first look at the viatical settlement definition, which can be defined as: “a contractual agreement to provide a life insurance policyholder the cash settlement of their policy at a reduced rate while that policyholder is still alive.”
So, What Is the Primary Feature of a Viatical Settlement?
Essentially, it is the prepayment of a death benefit at a reduced rate. However, it is important to note that the cash settlement is provided in exchange for the sale and transfer of the ownership rights of the life insurance policy.
In practice, the settlement company will take over the ownership of the life insurance policy and eventually receive the death benefit.
The funds the policyholder gains access to can be used for anything the insured wishes. However, this transaction means the insured relinquishes all rights to their insurance policy. As such, the insured’s beneficiaries will not receive any financial settlement in the event of the insured’s death.
Why Should You Consider a Viatical Settlement Policy?
A viatical settlement is for terminally or chronically ill policyholders who will benefit from receiving the cash settlement during their lifetime. A policyholder may also decide to opt for a viatical settlement if they think their beneficiaries do not need the death benefit that they would have been entitled to.
How Does a Viatical Settlement Work?
Before addressing a viatical settlement policy, it is important to understand the relevant parties involved. The below FAQs will address the parties involved in the settlement:
- What is the name of the person who enters into a viatical settlement? A Viator owns an individual life insurance policy and seeks to enter a viatical settlement contract. This person may also be referred to as the ‘insured’ as they are the ones for whom the life insurance policy is written.
- Who buys the insurance policy from the Viator, and what is their name? A ‘viatical settlement provider’ or ‘viatical provider’ is usually a company but sometimes an individual who purchases the policy. The provider may then sell the beneficiary and ownership rights to investors.
- Can the Viator have a representative? Yes, a ‘viatical settlement broker’ or ‘viatical broker’ will represent a policyholder and seek to negotiate the settlement between the policyholder and the viatical settlement provider.
- Does anybody oversee the transaction and ensure all obligations are met? Yes, this is the role of an ‘escrow agent.’ An escrow agent will be an independent intermediary who will ensure that the transaction terms and conditions are carried out in full.
A viatical settlement is a big decision for any policyholder and requires a lot of careful consideration. Below is an outline of the procedure that is commonly followed when entering a viatical settlement policy:
- It is often worth discussing this matter with potential beneficiaries. Consider whether the matter should be discussed with relevant family members.
- Consider all of the relevant options and potential alternatives. It may be worth seeking professional financial advice for viable alternatives. These alternatives should be disclosed to policyholders by both viatical brokers and viatical providers.
- Approach brokers or providers to discuss obtaining a price for the life insurance policy. The price is usually represented as a percentage of the policy’s death benefit. When determining how much an insurance policy is worth a provider will typically evaluate the insurance policy, the health records of the insured, and any other relevant information. A shorter life expectancy is likely to receive a higher percentage of the policy as a general rule.
At this stage, it is also worth ensuring that the settlement provider is licensed to act in this capacity, especially in circumstances where a broker does not represent policyholders.
- Once a satisfactory provider has been found, the settlement needs to be applied for and all relevant documents must be provided.
- After the provider has approved the settlement, the policyholder will send signed documents transferring ownership of the policy to the viatical provider.
- The settlement funds are then sent to the escrow agent within three business days of the provider receiving ownership of the insured’s policy.
- Once the policyholder has received the funds and the settlement provider receives ownership and control of the policy, the transaction is complete.
It is important to note that once the policyholder has received funds, they typically have 10 days to change their mind. To cancel the viatical settlement, they must ensure all funds are returned to the viatical provider within these 10 days. If the Viator dies during these 10 days, the settlement contract is rescinded.
Other Important Considerations of Viatical Settlements
Together with determining the primary feature of a viatical settlement, other important considerations dictate whether a viatical settlement is the best course of action for policyholders; these may include:
Life Expectancy
Life expectancy is an educated estimate of how long a policyholder may live. The reality is it is not an accurate forecast. A policyholder could live longer or die sooner regardless of their current health or projected life expectancy. Both policyholders and settlement providers should consider how either of these scenarios could affect their decision to enter a viatical settlement.
Regulation
Most states will regulate viatical settlements, and the rules will vary from state to state. The laws governing viatical settlements will often require providers to disclose important information about the transaction and require providers to be authorized or licensed to act. It should be ensured that all providers have the authority to act and that all policyholders are aware of the state requirements when entering viatical settlements.
A noteworthy regulation is that some states will require that a policy has been held for at least two years before entering a viatical settlement.
Costs
It is uncommon to pay an upfront fee, but fees or commissions will be earned by those involved in the transaction. A viatical settlement is, after all, a business transaction, and a profit is being sought. Additionally, it is always worth exploring the options available and ensuring that all of the associated fees and costs are clear.
Tax
Whether tax will be payable on a viatical settlement will depend on the circumstances. It is always recommended that taxation advice be sought before any settlement.
As a general rule, the tax will not be payable with a life expectancy of two years or less. Tax will also not be payable in certain situations, such as when the funds are used for long-term care expenses. Still, this needs to be clarified by an expert when undertaking the settlement.
Financial Considerations Policyholders
While receiving a lump sum of a life insurance policy can certainly have its benefits, policyholders must make a fully informed decision and be aware of some of the potential drawbacks or financial consequences of viatical settlements; Such as:
- Beneficiaries will not receive a death benefit once the policy has been sold and the settlement has been finalized.
- Creditors can seek to recover their debts against any sums received from a settlement.
- If there are outstanding loans against the policy’s cash value, that loan may need to be repaid before receiving the settlement funds.
- A settlement sum could affect a policyholder’s entitlement to certain benefits.
Alternatives to Viatical Settlements
As discussed, a viatical settlement provider is under the obligation to provide potential Viators with information regarding the alternatives to viatical settlements. It is always advised that potential Viators carry out their due diligence and are aware of the other options that may be available to them.
Accelerated Death Benefit
Accelerated death benefits are a provision within a life insurance policy that allows a policyholder to access the death benefit while still alive. These provisions can be quite common and are often included within policies at no extra cost.
An accelerated death benefit may not be purchased in isolation and will only form part of a life insurance policy. Therefore, it is always recommended that policyholders carefully examine the terms and conditions of their policies to determine whether an accelerated death benefit clause has been included in their policy and whether they will benefit from it.
Additionally, it allows policyholders to potentially achieve some of the same outcomes they might have through a viatical settlement. However, an accelerated death benefit can allow policyholders to receive a lump sum to pay for their daily living and medical expenses and still look after the needs of their beneficiaries once they pass.
This works in practice by the policyholder accessing some death benefit payments before they pass. The amount that can be accessed will depend on the policy’s value and whether or not the insurance provider implements any cap. The remaining share of the death benefit will be left to the beneficiaries in the event of the policyholder’s death.
Another key difference between a viatical settlement and accelerated death benefits is that the policyholder must continue to make the insurance premium payments. This differs from viatical settlements as the viatical provider who purchases the policy will take over the responsibility of the insurance payment premiums with accelerated death benefits.
Similar to viatical settlements, accelerated death benefits are only paid to those with a terminal illness or low life expectancy. Some insurance policy providers will require a life expectancy of six months or less, which is generally lower than those granted viatical settlements.
Some insurance providers will pay an accelerated death benefit where policyholders have certain survivable critical illnesses that result in unmanageable medical bills or a shortened life expectancy. This will be subject to the nuisance of the policyholder’s insurance terms and conditions and is not a guaranteed outcome.
Viatical Settlement vs. Life Settlement
When understanding the primary feature of a viatical settlement, it can be helpful to understand the features of a life settlement to see how they differentiate in practice.
Much like a viatical settlement, a life settlement is a contract to provide a life insurance policyholder with a cash settlement in exchange for ownership and beneficiary rights.
As with viatical settlements, the policyholder will relinquish their rights to the insurance policy in practice, meaning that they will no longer be liable for the monthly premium payments. It is a one-time transaction, and the policyholder is free to use the money as they wish.
However, what differentiates a life settlement from a viatical settlement is that life settlements are designed for healthy seniors. Such as people aged 75 (potentially 65) and over with an average life expectancy and no severe or terminal medical conditions.
It is also worth noting that the payment amount can differ between viatical settlements and life settlements. Generally speaking, the larger the life insurance policy and associated death benefit, the larger the settlement payout, whether undertaking a viatical or life settlement.
However, viatical settlement payouts tend to be higher than life settlements as they are more specialized and are not usually subject to taxation, meaning that a policyholder typically receives 50–70% of their overall insurance policy.
Tax on Life Settlements
This is another key difference between viatical settlements and life settlements. A life insurance policyholder who sells their life insurance through a life settlement will be required to pay taxes on the settlement received, as they are considered a taxable income. Therefore, appropriate advice must be sought on the amount of tax payable as it could significantly impact the sums received.
Regulation
As with viatical settlements, policyholders will want to ensure that any settlement provider is a legitimate entity and has the authority to act on their behalf. Life settlement providers must be licensed to operate, and any provider should be able to supply the appropriate documentation and licenses upon request.
Again, the regulations and requirements of life settlement providers will vary from state to state, and those wishing to enter into a life settlement agreement should be fully apprised of their state’s requirements.
In Conclusion
This article addresses the key question of what is the primary feature of a viatical settlement?
In short, a viatical settlement is a process whereby a terminally or chronically ill life insurance policyholder sells their life insurance to a legitimate third party.
In doing so, they will receive a cash payout representing a percentage of their death benefit and will terminate all rights and affiliations to their insurance policy. As they no longer hold a valid life insurance policy, they will not be liable for the insurance premiums. Consequently, any named beneficiaries within that life insurance policy will no longer receive the benefit upon the death of the former policyholder.
Before undertaking a viatical settlement, a policyholder is always advised to carefully consider all of the implications and what it means for them and their loved ones.
