Viatical settlements in Florida: new issues for estate planners.

• Author: Ziegler, Stephen L.

A longtime client calls you for an appointment to update his estate plan. He owns several life insurance policies, which were taken out to fund estate tax obligations and to fund a shareholder buyout agreement for a closely held business. After the meeting, you determine that the client's financial situation has changed and the underlying reasons for maintaining the policies are no longer present. The client is considering letting the policies lapse because the premiums are now considerable. The client wants your advice as to whether the policies should be allowed to lapse or, instead, whether he should surrender them for their cash value. If you do not advise your client that there is a third option--to sell the policies through a secondary market transaction known as a "viatical settlement," you may cause that client to suffer a substantial financial loss.

Contrary to the early days when viatical settlements were primarily utilized by the terminally ill, today many affluent seniors may be eligible to sell their life insurance benefits pursuant to what is now known as a senior or a life settlement. The main difference between these two settlements is the health of the insured. In a viatical settlement, the insured has been diagnosed terminally ill, generally with a life expectancy of 24 months or less. Similarly, the IRS uses a 24-month time frame when determining whether the proceeds of a viatical settlement paid to an insured are exempt from taxation. In a life settlement the insured, who is typically over the age of 65, has not been diagnosed with a terminal illness, but may have one or more health impairments generally associated with advanced age.

Currently, a majority of the states regulate viatical settlement transactions, which are simply the sale of all ownership and beneficial rights to a life insurance policy in exchange for an immediate cash payment. A smaller number of states also regulate life settlements, and there are some states that have no regulations at all. Florida, however, is fairly unique in that it regulates both viatical and life settlements pursuant to the Florida Viatical Settlement Act (F.S. [subsection] 626.991--626.99295 (2003), hereinafter referred to as "the act"). The act makes no distinction between viatical and life settlements and refers to all settlements as viatical settlements. First enacted in 1996, the act regulated the purchase of death benefits from a terminally ill insured; it did not regulate purchases from comparatively healthy insureds, and did not regulate the resale of death benefits. Since that time, the act has been amended nearly every year. The act is now among the most comprehensive in the U.S., regulating most purchases of life insurance benefits (other than by the issuing insurer).

The Developing Secondary Market

The size of the secondary market for life insurance policies is staggering. According to a report issued several years ago by Conning & Co., an insurance industry researcher, the potential size of the overall viatical and life settlement market is estimated at $134 billion dollars, the vast majority of which will come from the life settlement sector of the market. (1) JE McGowan Consulting estimates the potential secondary market to be greater than $18 billion dollars annually. (2)

In a recent working paper published by the Wharton Financial Institutions Center entitled "The Benefits of a Secondary Market for Life Insurance Policies," authors Neil A. Doherty and Hal J. Singer analyze the effects of an active secondary market in several financial service industries (home mortgages, for example) and compare them with the developing secondary market in life insurance policies that is provided by viatical and life settlement companies. The authors argue that the secondary market in life insurance policies benefits both existing and future policy owners. Current policy owners are provided with an option to sell their policies for compensation that is more competitive than the cash surrender values established by the life insurance industry at the time a policy is purchased. The paper conservatively estimates that, in 2002, life settlements alone generated approximately $242 million dollars above the cash surrender value available to policy owners.

Parties to the Transaction

A good analogy in attempting to understand the parties to a viatical settlement transaction is a real estate closing. Like a real estate closing, in a viatical settlement transaction property is being sold. A life insurance policy is personal property. The owner of that policy, defined in the act as the "viator," sells the policy to a buyer, defined in the act as a "viatical settlement provider," pursuant to a written...