How Florida regulates viatical settlement contracts.

• Author: Cavendish, Michael

About 10 years ago, a new cottage industry sprang from the ranks of America's venture capitalists. Some enterprising person noticed that certain well-to-do, terminal AIDS patients required medical treatment and living expenses after losing their jobs and employer-provided health insurance. Among these were people who were temporarily destitute but with current life insurance policies. Their dilemma was that the policy benefit was needed immediately for medical treatment, experimental cure drugs, or funds to provide a dignified existence, but the benefit funds would not be available until death--when they were no longer needed.

Into this difficult situation strode the venture capitalists, offering the sick insured a viatical settlement, an immediate lump sum cash payment in return for an assignment of the insured's death benefit. The insured, or viator, was free to spend the cash as desired, and the investor assumed the responsibility of keeping the policy and the premiums current. The transaction seemed simple. The viator received cash when unemployable and uninsurable, and, upon the viator's death, the investor collected the death benefit and, after subtracting the settlement amount, premiums, and administrative expenses, an attractive return. As the venture capitalists grew in sophistication and medical knowledge, they began to consider other types of terminal disease patients and elderly insureds as potential viators as well.

The viatical trade was unregulated, however, and even unknown in some areas of the country. Bad feelings arose over the industry's perceived role as investors in the imminent demise of unfortunate, terminally ill, diseased persons. Allegations of insurance fraud arose in some quarters,(1) and privacy concerns exploded as some firms began to take a comprehensive medical and mathematical interest in the gritty details of the health of aviator. Regulation continued to develop even when most people outside of the AIDS community and the fringe of venture capitalism had not heard of the practice of viatical settlements.

Florida, a demographic leader in AIDS patients and a state with a significant elder population, has taken significant steps to investigate and regulate the viatical trade. Florida's Viatical Settlement Act, revised in 1999 by H.B. 2235, was drafted to regulate the brokers, financiers, and sales agents of the viatical business, and to protect both the viator and the nonprofessional investor from misrepresentations and nondisclosure of the risks of this still-evolving industry. This article examines Florida's regulation of the young viatical industry and offers suggestions for promoting fair, protective viatical settlement regulations for Florida residents.

Background

Viatical settlements are a 10-year-old investment industry built upon the mature life insurance policies of the old and terminally ill. Viatical investment firms buy life insurance policies at a discount, typically between 20 and 40 percent less than face value. The buyer takes over the payment of premiums from the insured and collects the insured's death benefit upon the insured's demise.(2)

The viatical industry reputedly began when opportunistic venture capitalists began purchasing the life policies of endstage AIDS patients at a discount.(3) The industry grew rapidly, brokering $90 million worth of life insurance benefits after its first year of existence.(4) The growth has been geometric. One observer forecasted the viatical settlement market to reach $4 billion per year by this year.(5)

The name viatical derives from the Latin viaticum--roughly translated meaning "provisions for a long journey." Industry pundits claim that the viaticum was a package of money or food given to Roman soldiers before embarking on a perilous campaign.(6)

How Viaticals Work

In the typical viatical settlement transaction, the insured (viator) agrees to sell and assign his or her life insurance policy through a broker to an investment firm. The investment firm may then bundle a number of policies together and resell them in fractions to dozens of individual investors, much like a REIT or a mortgage-backed security. The investment firm may also sell an individual policy or a fraction of an individual policy to a single investor, tying that investor's return directly to the life expectancy of a single viator.(7)

* Benefits to the Viator

Viatical settlements are slowly gaining recognition as an often helpful money management alternative for the very sick and very old, partly because of the favorable tax treatment for viatical settlements laid out in the Health Insurance Portability and Accountability Act of 1996.(8) Viatical settlements are expressly excluded from the terminally ill viator's gross income for tax purposes because they are technically considered payments rendered by reason of death.(9)

By avoiding the payment of taxes, viators can finance additional medical care and meet living expenses for a longer period. The generous tax treatment, allowing viators to retain 100 percent of their settlement, is predicted to lead to increased life insurance sales, as more healthy individuals learn that they can viaticate their policies in the event of a terminal illness.(10) This tax treatment may change in the future, however, as viatical settlements become more commonplace and greater volumes of money move through them.

* Benefits to the Investor

Investing in viaticals is increasingly commonplace in the United States. An active secondary market for viatical settlements has developed, and most anyone can now invest in viaticals through a network of independent financial planners and life insurance agents. Viaticals have not been labeled as more lucrative, safer, or riskier than traditional debt, equity, and real estate investments, but they are undoubtedly based upon an entirely different calculus than those traditional investments. Viaticals, for instance, are immune to interest rate concerns and economic growth or stagnation. For this reason, some investors may prefer viaticals to traditional modes of investment.

* Expansion of the Market

Viatical investment firms are now branching out beyond AIDS patients and those with terminal diseases. Firms are considering persons with maladies such as cancer and heart disease as a larger potential market.(11) Viatical calculations are based on mortality rates and patient-specific medical diagnoses, so, theoretically, an investment firm could offer a viatical settlement to anyone with an assignable life insurance policy, so long as the firm can reasonably predict the viator's life expectancy.

Business "key man" policies may become a popular target for viatical investors.(12) Key man policies are sold widely to small and medium-sized businesses which depend upon the knowledge or contacts of an executive or owner to continue to flourish. Sometimes the key man becomes less critical to the business in a financial sense because the aptitudes of other executives or employees have improved or because the key man wishes to retire. Instead of allowing the policy to lapse or converting to an expensive life policy, some businesses may view a lump sum viatical settlement as an effective way to recapture amounts spent on premiums over the years. Again, the prospects of receiving an offer from a viatical investment firm depend largely on the health and age of the insured.

The recent upswing in sales of term life...