Analyzing an Emerging Industry: Viatical Transactions and the Secondary Market for Life Insurance Policies

Traditionally, life insurance has been primarily viewed as a legacy paid to designated beneficiaries after the death of the insured. Increasingly, financial planners, estate planners, and other financial advisors are advising clients to consider their life insurance policies as an underutilized asset that can provide significant financial resources to them while they are still alive (Wolk, 1997; Sutherland FE Drivanos, 1999; Levy, 1999; Chodes, Tow, & Hoopingarner, 1998). Viatical Transactions Definition and Market Origins A viatical settlement is one in which a terminally ill individual sells his or her life insurance policy for a percentage of the total face value. The person selling the policy is referred to as the viator while the process is known as viaticating the policy (Wolk, 1997). The market originated as an outgrowth of the AIDS epidemic as a means of obtaining critical financial resources for the last days of life. Improvements in the treatment of AIDS that have prolonged the life expectancies of the patients have resulted in a broadening of the array of terminal illnesses that are considered as potential sources of viatical transactions. Cancer, cardiovascular disease, Alzheimer's disease, and ALS (Lou Gehrig's disease) are among them. Factors in the Demand for Viatical Settlements The financial need of terminally ill patients to fund final health-- care and living expenses is the major demand factor in the market for viatical settlements. The sale of an insured's life insurance policy is considered an alternative to surrendering the policy for its cash value or obtaining accelerated death benefits from the insurer. Financial hardship is a major consequence of dealing with a life-threatening disease. According to Sutherland and Drivanos (1999), in the largest study of seriously ill and dying patients published in 1994 in the Journal of the American Medical Association, nearly a third of families caring for a seriously ill member lose most or all of their life savings. This fact was found to be true even though 96 percent of these patients had health insurance coverage. Another 29 percent of families lose their major source of income. More-- over, patients whose families experience financial hardship were 30 percent more likely to forego life-sustaining treatment. Other demand factors included the need for funds to pay tax liabilities and efficient wealth transfer to heirs and charities. Favorable tax treatment under the 1996 Health Insurance Portability and Accountability Act (HIPAA) has also helped to drive the market and will also be discussed. Although viatical transactions are most correctly reserved for those cases in which the life expectancy of the insured is two years or less, the term is often loosely used to apply to other segments of the secondary market for life policies. More information about these segments will be discussed later in this paper. The Supply Side of the Market The supply side of the market is comprised of viatical brokers and funding sources, including viatical firms and individual investors. Viatical brokers are those who identify potential victors and help them find funding sources. They are usually paid a fee from the funding source for completed transactions, that is, the purchase of the victor's life insurance policy. The funding sources are firms and individuals that purchase the policies as investments in the hope of making a profit. The source of profit is the policy's death benefit that, theoretically, will yield a return greater than the cost of the policy (what is paid to the victor) and the cost of servicing the policy (premiums and other expenses). The Extension of the Market: Life Settlements Although the secondary market for life insurance policies originated among the terminally ill, it has evolved well beyond that constraint. A second category of viatical transaction involves the transfer of a policy in which the insured's life expectancy, though shorter than normal due to chronic illness, extends longer than two years. …