Selling death short: the regulatory and policy implications of viatical settlements.

• Author: Albert, Miriam R.
• Position: Symposium on Health Care Policy: What Lessons Have We Learned from the AIDS Pandemic?

INTRODUCTION

In recent years, the escalation of AIDS into a national crisis has devastated its victims' health as well as their finances.(1) This crisis has generated the need for innovations both in medical approaches to the treatment of AIDS and HIV, and in financial options available to help patients finance their medical and other living expenses. One response of the financial community has been the creation of vehicles to provide terminally-ill policyholders with early access to the death benefits under their life insurance policies, which would otherwise be unavailable to them during their lives.(2)

As these new financial vehicles became more established, questions about the need for regulation arose. The most popular of these new vehicles is an asset-backed security known as a viatical. settlement.(3) Viatical settlements are a specialized form of receivable financing under which viatical settlement companies buy from the policyholder, at a discounted rate, the right to receive death benefits under life insurance policies.(4) The viatical settlement company may then hold the policy, sell the policy to an individual investor, or pool the policy with others and sell fractions of the pool to investors.(5) The return to investors is the difference between the discounted value paid to the policyholder and the full value paid by the issuing insurance company upon the policyholder's death.(6)

Though the concept of viatication may sound ghoulish, the business of viatical settlements is generally legal and provides a service to terminally-ill patients.(7) The purchase price for the policies enables the policyholders to realize some estimation of the policies' present value, to use for their living and medical expenses.

Viatical settlements raise regulatory concerns under the insurance laws.(8) The initial sale of life insurance policies by terminally ill policyholders, known as viators,(9) to viatical settlement companies is subject to varying amounts of regulation at the state level, typically by a state's insurance department.(10) As a result of the differences in the states' regulations, the sale of otherwise identical policies in different states may lead to different financial outcomes for viators living in different states. While this is not necessarily problematic, these differing results may lead to financial inequities for otherwise similarly-situated viators.

Part I of this Article provides an overview of the creation and growth of the viatical industry as a response to the increasing medical costs and decreasing income streams facing AIDS- and HIV-infected patients.(11) Part II sets out the problem of whether and how to regulate the viatical industry, examining the risks and theoretical justifications for regulating the purchase side of the viatical industry.(12) Part III details the existing regulation of the viatical industry.(13) And Part IV is an evaluation of existing regulations in the viatical industry, in light of the various theoretical rationales for government intervention, concluding that, on balance, some regulation is needed to protect this vulnerable population.(14)

1. OVERVIEW OF THE VIATICAL INDUSTRY

   The first viatical settlement companies emerged in the late 1980s, and primarily acted as brokers, matching up terminally-ill policyholders with investors.(15) The initial growth of the viatical industry was primarily a function of the lack of any significant alternative available from the life insurance industry. Recently, however, more domestic insurance companies have begun offering accelerated benefits to their policyholders, typically in the form of accelerated death benefits provisions in traditional life insurance policies,(16) and, less frequently, in the form of loans on insurance policies(17) and long-term care insurance.(18) The recent increase in the options available under life insurance policies does not mean that the increasing numbers of policyholders seeking early access to their death benefits is a short-term phenomenon. The size of the viatical industry has grown from an estimated five million dollars in 1989 to approximately four hundred million dollars in 1995, with projected volumes for 1996 and beyond estimated in excess of five hundred million dollars.(19)

   There are two basic roles for viatical settlement companies: providers, who buy the policies themselves and hold them as the named beneficiary thereunder, and brokers, who act as intermediaries between viatical settlement providers and viators by performing underwriting functions, and negotiating a fee to be paid by the viatical settlement provider.(20)

   The mechanics of viatical settlements are fairly straightforward. Viatical. settlement companies buy almost any type of life insurance, including term, whole, universal and group life policies, as long as the policy is in good standing, contains no prohibition against assignment for value,(21) and has been in force for at least two years so that the customary two-year period of contestability has expired.(22) In most cases, the insured must produce a medical certificate attesting to the fact that death is certain to occur within some set time period, typically from six months to a year.(23) The viatical settlement company then makes an offer to pay the insured a percentage of the face value of the policy; payment is typically made in a lump sum within a few weeks.(24)

   Although viatical settlements may serve an altruistic purpose, both parties to the transaction make money. The viator receives some estimate of the present value of his policy, and the viatical settlement company takes part of the purchase price the investor pays, and also may take part of the insurance proceeds when paid out.(25)

   The amount paid to the viator for a policy is an estimation of its present value.(26) This present value is calculated in light of factors such as the projected life expectancy of the policyholder, the prevailing economic climate (particularly current interest rates), the face value of the policy, and the cost of at least two years of future premiums, which, under the viatical settlement agreement, become the responsibility of the purchaser, absent a disability waiver of premiums.(27) Additional factors for calculating present value include the financial strength of the issuing life insurance company, the viatical settlement company's cost of funding the policy acquisition, and any miscellaneous expenses.(28)

   The most uncertain of these factors is the projected life expectancy of the policyholder; the timing of and effect on individuals afflicted with AIDS varies greatly.(29) Because AIDS is a relatively new terminal illness, there are as yet no established life expectancy tables for patients afflicted with HIV or AIDS.(30) Accordingly, viatical settlement companies tend to estimate life expectancies of AIDS-afflicted policyholders in a conservative manner.(31) This translates into a lower price paid to insureds.(32)

   While viatical settlements undoubtedly provide a service to the policyholders, the transactions are not without financial, legal, and collateral risks. The primary financial risk for both viators and viatical settlement companies flows out of the uncertainty in estimating life expectancies.(33) Some estimate of life expectancy must be used to calculate the payout.(34) The insured's life expectancy is the most significant factor in ascertaining the present value of a given policy; the shorter the life expectancy of the policyholder, the greater the percentage of the policy value paid to him.(35) Likewise, and this is the troublesome part for the squeamish investor, the shorter the actual life of the policyholder, the greater the return to the investors.(36) If the viator dies earlier than or outlives the projected life expectancy used to calculate the viatical settlement payment, the return to the investor is affected.(37)

   Viatical settlements also pose legal risks to both sides. Viators run the risk of losing other benefits, such as welfare or Medicare, as a result of the sale of their policy; viatical settlement companies risk the possibility of a determination that the viator lacked the necessary mental capacity to enter into the settlement, or that the decision was made under duress.(38) Additional legal risks include the possibility that a court will hold the policy to be non-assignable or cancelable, or that not all the prior beneficiaries have waived their rights, if irrevocable, under the policy.(39) Finally, because of the nature of the viatical settlement transaction, the insurance company that issued the original policy ultimately provides credit for the deal, exposing both the viator and the viatical settlement company to the risk that this insurance company will default on its payment obligations.(40)

   Viatical settlements also pose collateral risks for viators, who run the risk that their private medical history furnished to the viatical settlement company will somehow become more publicly disseminated.(41)

   Because of the underlying emotional issues and risks involved with viatical transactions, the issue of whether to regulate the viatical industry in order to minimize, or at least better manage, some of these risks has been extensively debated by various interested parties almost since the first viatical settlement.(42) Such parties include viatical settlement companies and industry groups, AIDS lobbyists, state insurance departments, and the Securities and Exchange Commission.(43)

2. DESCRIPTION OF THE PROBLEM

   Recognized deviations from the economic model of perfect competition, with its goal of economic efficiency, provide traditional rationales for government intervention.(44) The viatical industry reflects evidence of two such deviations: local monopolies and information asymmetries. This section analyzes each of these market failures as a basis for regulation in the viatical industry.

   1. Local Monopoly Problems

      The existence of...