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. §§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 4 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 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 2 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 contract for sale defined in the act as a “viatical settlement contract.” In Florida, all viatical settlements close in escrow pending transfer of title to the life insurance policy to the new owner. Also similar to a real estate transaction, third parties, known as “viatical settlement brokers,” are available to assist the viator in the sale process, for which they earn a commission. Anatomy of a Viatical Settlement Transaction • Basis of the Transaction—the Insurance Contract The basis of a viatical or life settlement transaction begins with the life insurance policy itself. In consideration for the owner’s timely payment of premiums to the insurance carrier, the policy conveys certain rights and benefits, chiefly the right of the beneficiary(ies) of record to collect the benefits of the policy upon the death of the insured. A contract for insurance is an asset which, if validly issued and not contrary to the policy’s terms, can be sold or assigned just like any other piece of property.3 The most important right conveyed by a settlement transaction is the policy owner’s contractual right to change the beneficiary designation. Also, upon completion of the settlement transaction, the new policy owner is responsible for the payment of all future policy premiums.
• The Application Process The settlement process begins when the viator executes a viatical settlement application and provides authorization to the insured’s attending physician and the issuing insurance company to disclose confidential information pertaining to the insured’s health and insurance coverage. This information is necessary for a buyer to evaluate the policy for potential purchase. If the viator is not also the insured, both the viator and the insured typically will be required to review and sign the application. In addition to the viator’s execution of the application documents, he or she is also required to provide some form of photo identification, a copy of the life insurance policy to be sold, and a copy of the application for the policy. As a general rule, viators are not required to submit to a medical examination as part of the application process.
Although anyone with access to the Internet can locate information on companies that provide viatical settlements, a client should have his or her attorney, accountant, financial planner, or a viatical settlement broker assist in the sale of the life insurance policy. The viatical settlement broker, as defined in the act, has a fiduciary obligation to the viator, meaning the viatical settlement broker will use its best efforts to obtain the highest purchase offer possible for the policy. This generally entails sending the insurance policy information and medical information to multiple viatical settlement providers to solicit offers and, subsequently, negotiating the financial terms of a potential sale.
In order to make their medical records available to third parties in the viatical settlement process, insureds must authorize their physicians and other health care givers, in writing, to release their private medical records. In 1996, the U.S. Congress enacted the Health Insurance Portability and Accountability Act of 1996. Pub. L. No. 104-191, 110 Stat. 1936 (“HIPAA”). HIPAA implements sweeping changes to the U.S. health care system which are beyond the scope of this article. Although HIPAA was not intended specifically to impact the viatical settlement industry, it does directly affect the disclosure of protected health information by physicians. Any disclosure of protected health information in furtherance of a viatical settlement transaction may be delayed if not undertaken in compliance with HIPAA. In some instances, the insured’s treating physician may be contacted to provide further information.
• Medical Underwriting The medical release allows the viatical settlement broker to obtain current medical records from the insured’s attending physician, including any radiology, laboratory, or hospital records. At a minimum, two years of records are required. These records are then provided to a review company that specializes in viatical and life settlement mortality profiles for a determination of an estimated life expectancy. Once a medical underwriter has obtained all of the viator’s medical records, it can generate a preliminary estimate of the insured’s life expectancy and thereafter issue a final report. The report is then used by the viatical settlement provider to determine if the offered policy comes within its underwriting guidelines for purchase.
There is a difference in the underwriting of viatical and life settlements. The evaluation of a viatical settlement will focus on detailed analysis of the specific terminal illness with which the insured has been diagnosed. This evaluation can be done by a physician with expertise in treating that specific illness. However, in the case of a life settlement, there is no terminal illness. Additional factors may be examined and medical underwriters may use more traditional insurance industry practices to determine an estimated life expectancy.
• The Viatical Settlement Contract If the life insurance policy satisfies a viatical settlement provider’s underwriting guidelines, it may offer to purchase the policy. Once the parties agree on a price, the viatical settlement provider will issue a viatical settlement contract and other related forms necessary to close the transaction. The viatical settlement contract is the key legal document between the viatical settlement provider and the viator. It contains the price to be paid to the viator for the policy and other important terms and conditions of the sale, including those dealing with mandatory disclosures, the viator’s right to rescind the contract, and post-closing contact with the insured for health status updates. Other related forms typically include an escrow agreement with the entity that will hold the funds payable to the viator, the forms from the issuing insurance company necessary to record the change in the policy ownership and beneficiary(ies), releases for execution by the existing policy beneficiary(ies), a power of attorney and funding instructions.
A viatical settlement contract and the related forms must be approved by the State of Florida Office of Insurance Regulation (the “department”) prior to use.4 By statute, the department must reject any viatical settlement contract or related form that is unreasonable, contrary to the public interest, discriminatory, or misleading or unfair to the viator.5 As part of the form approval process, the department requires that each form have a unique number in the lower left hand corner. This approval requirement provides viators with a measure of protection in that the department has reviewed the provisions of the viatical settlement contract and related forms and has required the removal of any unfair provisions prior to use of the form.
Florida law also requires that, before entering into a viatical settlement contract with a viator, the viatical settlement provider must also first obtain a witnessed document in which the viator:
1) Consents to the viatical settlement contract;
2) Represents that he or she has a full and complete understanding of the viatical settlement contract and the benefits of the life insurance policy;
3) Releases his or her medical records; and
4) Acknowledges that he or she has entered into the viatical settlement contract freely and voluntarily.6
• Closing the Transaction In Florida, all viatical settlement contracts must be closed in escrow.7 The public policy reason for this requirement is the protection of the viator from unscrupulous buyers who could make the necessary changes to acquire the ownership and beneficial rights to a particular policy and then fail to pay the viator. Similar to a real estate closing, the escrow agent’s role in a viatical settlement transaction is to receive and hold the executed viatical settlement contract and related documents, including the insurance company forms executed by the viator to transfer the ownership of the policy, and to receive and hold the funds transferred from the viatical settlement provider in the amount of the agreed-upon purchase price for the policy (hereinafter referred to as the “viatical settlement proceeds”).
This requirement insures that the consideration for the sale of the policy is on deposit with a regulated third party that is independent from the viatical settlement provider. Florida law allows an escrow agent to be an attorney, CPA, financial institution, or other person providing escrow services under the authority of a regulatory body. The escrow agent cannot be affiliated with or under the control of a viatical settlement provider or a viatical settlement broker.8
Once signed by the viator, the viatical settlement contract and the assignment of policy ownership and change of beneficiary forms are forwarded to the escrow agent. Upon receipt of these documents by the escrow agent, the viatical settlement provider must deposit all of the funds for the purchase of the policy as set forth in the viatical settlement contract into an account managed by the escrow agent.9 The account must be with a financial institution licensed under Florida law or a federally chartered financial institution that is a member of the Federal Reserve System.
Once the viatical settlement provider has deposited the viatical settlement proceeds into escrow, the escrow agent may then release to the viatical settlement provider the documents received from the viator. The viatical settlement provider prepares the assignment of ownership and change of beneficiary forms to reflect the new owner and new beneficiaries of the policy. The viatical settlement provider then forwards these documents to the insurance company and requests that the changes be recorded in the company’s books and records. The amount of time it takes to process the changes varies from one insurance company to another.
The escrow agent is not required to transfer the viatical settlement proceeds to the viator until it receives the acknowledgment from the issuing insurance company that the policy changes have in fact been made. The escrow agent then has three business days to transfer the viatical settlement proceeds to the viator.10 Failure to transfer the viatical settlement proceeds in three days renders the transaction voidable. Most viatical settlement providers give the viator the option to receive funds via either wire transfer or cashier’s check. Viatical settlement proceeds must be paid in a lump sum, and not in installments.11 Post-Closing Contact With the Insured After the assignment of the life insurance policy’s ownership and the change of beneficiaries have been acknowledged and the viator has received the viatical settlement proceeds, the transaction is considered closed, subject to the expiration of the viator’s right of rescission (discussed below). However, this is not the end of the relationship between the viatical settlement provider and the viator. The viatical settlement provider needs to stay in contact with the insured in order to monitor his or her health status, maintain current contact information, such as address and telephone number, and ultimately to know when to submit a claim for policy benefits. This is commonly referred to as tracking or monitoring. In Florida, the viatical settlement provider that closed the original settlement transaction is responsible for tracking the insured.12 However, the viatical settlement provider may contract with third parties to perform tracking services, and there are a number of firms in the industry that specialize in this area.
Methods of tracking insureds may vary, but most are intended to be as unintrusive to the insured’s private life as possible. Post-closing contact with an insured can generally be accomplished via periodic telephone calls, exchange of preprinted post cards, and e-mail. Some states restrict the frequency of post-closing contact with insureds for privacy reasons. The frequency of contact is directly related to the insured’s estimated life expectancy. Although the act is silent on this issue, many jurisdictions have provisions in their regulations restricting post-closing contact with insureds. Other states allow contact with insureds for purposes of health inquiries no more than once every 30 days for insureds with a life expectancy of one year or less and no more than once every three months for insureds with life expectancies of more than one year. In addition, most viatical settlement providers give an insured the option to designate any individual over the age of 18 to be the contact person for health status inquiries if the insured does not wish to be contacted. Typically, insureds designate their spouses, other family members, or their attorney, accountant, or physician. Mandatory Disclosures Florida law requires viatical settlement providers or brokers to provide specific information to viators before entering into a viatical settlement contract. Nearly all jurisdictions that regulate viatical settlements require substantially similar disclosures, the purpose of which is to give a person who is contemplating the sale of a life insurance policy basic information that may be material to that decision. Florida requires the following information to be disclosed:
1) That there are possible alternatives to viatical settlement contracts including, but not limited to, accelerated benefits available from the insurer that issued the policy.
2) That proceeds of the viatical settlement could be taxable.
3) That viatical settlement proceeds could be subject to the claims of creditors.
4) That receipt of the viatical settlement proceeds could adversely affect the recipient’s eligibility for Medicaid or other government benefits or entitlements.
5) That all viatical settlement contracts must contain an unconditional rescission provision.
6) The name, business address, and telephone number of the independent third party escrow agent.13 Viator’s Right to Rescind Florida law also requires a viatical settlement contract to include an unconditional rescission provision permitting a viator to rescind the contract within 15 days after receipt of the viatical settlement proceeds.14 A viator may change his or her mind at any time, even after the transaction is funded, as long as it is within the 15-day period, and the viator refunds the entire purchase price. The viatical settlement broker or provider must notify the viator of this rescission right in writing before entering into a contract to purchase the viator’s insurance policy. If the viator rescinds the contract, everyone involved in the transaction must be returned to presale status, which will include the recording by the insurance company of the presale policy owner and beneficiary(ies). Privacy Considerations Privacy considerations arise throughout all stages of a viatical settlement transaction. It begins with the release and transmittal of a prospective viator’s medical records, continues with the maintenance of those records by the viatical settlement provider during the pendency of the transaction and concludes with the viator’s death. The insured’s medical records will also become part of a permanent file that will be stored and maintained by the viatical settlement provider or a third party retained by the provider to perform tracking services after the viatical settlement transaction has closed. Florida law provides that all information relating to transactions of all viatical settlement contracts must be maintained by the licensee for a period of three years after the death of the insured and must be available to the department for its inspection during reasonable business hours.15 Conclusion Estate planning practitioners are well advised to acquaint themselves with viatical and life settlements as a viable alternative to the lapse or surrender of a life insurance policy that may no longer be needed. The continued expansion of the secondary market in life insurance policies provides clients with a valuable source of funding for alternative income-producing investments or long-term health care, and will provide estate planners with a new tool to help their clients achieve their estate planning goals.
1 Conning & Co., Viatical Settlements: The Emerging Secondary Market for Life Insurance Policies, 1999, pp. 39-42. 2 Niel Alexander, New Value in Old Policies, J. Accountancy Online (Oct. 2001). 3 Couch on Insurance 3d, §34:17. 4 Fla. Stat. §626.9921(1). 5 Fla. Stat. §626.9921(2). 6 Fla. Stat. §626.9924(1). 7 Fla. Stat. §626.9924(3). 8 Fla. Stat. §626.9911(1). 9 Fla. Stat. §626.9924(3). 10 Fla. Stat. §626.9924(5). 11 Fla. Stat. §626.9924(3). 12 Fla. Stat. §626.9924(10). 13 Fla. Stat. §626.9923. 14 Fla. Stat. §626.9923(5). 15 Fla. Stat. §626.9922(2).
Stephen L. Ziegler is a partner with Murray Simmons & Ziegler, LLP in Ft. Lauderdale. He received his J.D. from the University of Florida College of Law. Mr. Ziegler’s practice areas include probate, complex business and insurance litigation and life settlement law. This article is submitted on behalf of the Real Property, Probate and Trust Law Section, Laird A. Lyle, chair, and William P. Sklar and Richard R. Gans, editors.
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