3.7 Viatical Settlements and Life Settlements
A viatical settlement is a financial transaction in which a life insurance policyowner—known as the viator—sells an existing life insurance policy to a third-party investor or viatical settlement provider. The insured must typically have a life-threatening or terminal illness with a life expectancy of approximately two years or less.
Under the agreement, the provider purchases the policy for a lump sum that is generally between 60% and 80% of the policy's face amount. In exchange, the viator transfers all ownership rights to the purchaser. The buyer becomes the new policyowner and beneficiary, assumes responsibility for future premium payments, and collects the full death benefit upon the insured's death. The viator receives immediate access to the discounted proceeds—often income tax free under qualifying conditions—during the insured's lifetime.
For example, if an insured owns a $100,000 policy and enters into a viatical agreement for $60,000, the purchaser may ultimately receive the $100,000 death benefit upon the insured's death. The potential gross profit would be $40,000, less premiums paid after purchase and any transaction-related expenses.
Purchasers incur significant upfront costs, including medical record review, life expectancy evaluations, underwriting analysis, and legal documentation. The primary financial risk to the buyer is longevity risk—if the insured lives significantly longer than projected, ongoing premium payments and the time value of money may reduce or eliminate the anticipated profit.
The policy must be active and in force at the time the viatical agreement is executed, and ownership transfer occurs upon completion of the transaction.
A life settlement is a transaction in which a policyowner sells an existing life insurance policy to a third party for an amount greater than the policy's cash surrender value but less than the policy's death benefit. Upon sale, ownership and beneficiary rights transfer to the purchaser, who assumes responsibility for future premium payments and receives the full death benefit when the insured dies.
Unlike a viatical settlement, a life settlement does not require the insured to be terminally ill. These transactions are typically entered into for financial planning reasons rather than medical necessity. A policyowner may choose a life settlement if premium payments have become unaffordable, the policy is no longer needed for its original purpose, or the owner wishes to reposition coverage into a different policy or financial strategy.
Note: Any state-specific licensing requirements or solicitation regulations governing viatical settlements or life settlements are discussed in the applicable state law chapter.
Quiz
1. Which condition is generally required for a viatical settlement to occur?
A. The policy must have accumulated substantial cash value
B. The insured must be terminally or chronically ill with a limited life expectancy
C. The insured must be over age 65
D. The policy must be a term policy only
Correct Answer: B
Rationale: A viatical settlement typically requires that the insured be terminally or seriously ill, often with a life expectancy of approximately two years or less. This medical condition distinguishes a viatical settlement from a life settlement, which does not require terminal illness.
2. In a viatical settlement, what happens to ownership of the policy?
A. The insured remains owner but assigns partial benefits
B. Ownership transfers to the insurer
C. Ownership and beneficiary rights transfer to the viatical settlement provider
D. The beneficiary remains unchanged
Correct Answer: C
Rationale: Upon execution of a viatical settlement, the policyowner transfers all ownership rights to the third-party purchaser. The buyer becomes both the new policyowner and beneficiary and is responsible for future premium payments.
3. If a policy with a $100,000 face amount is sold in a viatical settlement for $60,000, what is the purchaser's potential gross profit (before expenses and premiums)?
A. $60,000
B. $40,000
C. $100,000
D. $160,000
Correct Answer: B
Rationale: The purchaser pays $60,000 and later receives $100,000 at the insured's death. The potential gross profit is $40,000, minus any premiums paid after purchase and transaction-related expenses. However, longevity risk may reduce profitability.
4. What is the primary financial risk to the purchaser in a viatical settlement?
A. Market risk
B. Interest rate risk
C. Longevity risk (the insured lives longer than expected)
D. Policy cancellation by the insurer
Correct Answer: C
Rationale: The principal risk to the buyer is that the insured lives longer than anticipated. Extended life expectancy increases premium payments and reduces the time-value return on investment, potentially diminishing or eliminating profit.
5. Which statement correctly distinguishes a life settlement from a viatical settlement?
A. A life settlement requires terminal illness
B. A life settlement pays less than cash surrender value
C. A life settlement does not require the insured to be terminally ill
D. A life settlement cannot transfer ownership
Correct Answer: C
Rationale: Unlike a viatical settlement, a life settlement does not require the insured to be terminally ill. Life settlements are typically entered into for financial planning reasons, such as unaffordable premiums or a change in insurance needs.