The life settlement industry started in the 1980s during the AIDS epidemic and gave patients that were diagnosed an opportunity to sell their life insurance to help them afford their living expenses and medical bills for their limited time left. The term viatical was commonly used for this type of transaction, and many states’ Departments of Insurance still use the term viatical settlement today.
At the basic level, a viatical settlement and a life settlement are the same thing. The process for applying, case review, and closing process are all the same with the exception to the life expectancy of the insured. Because the industry started with people that had very short life expectancies, viatical is the traditional term, and is still often used for people who have been diagnosed with a terminal illness.
The two main categories of insurance policy sales are life settlements and viatical settlements. A life settlement differs from a viatical settlement because the insured in a life settlement is usually healthy, while a viatical settlement pertains to a sale by an insured with a terminal illness.
Treatments for people with HIV have dramatically improved since the 1980s, so the industry evolved to include seniors and not just terminal illness clients. With seniors, underwriters could still provide somewhat of a predictable life expectancy, even if it was more like 10 or 15 years rather than just 2 or 3 years, and thus the term senior settlement was born. As the industry evolved, the term life settlement simply became an all encompassing term.
At the end of the day if you’re looking to get offers for your life insurance policy it’s not a choice between life settlement or viatical settlement, you simply apply for a settlement and see what kind of offers come back.
What’s different about a viatical is it generally refers to someone with 2 years or less to live. In these cases the IRS considers life settlement proceeds to be non-taxable, and this needs to be supported with a letter from their doctor stating that they have 2 years or less to live. And the purchaser will also issue a 1099-LTC upon request to help signal that you should not owe taxes on this money. If you don’t have a doctor’s note to support 2 years or less, then your settlement is considered a standard life settlement and you will receive a standard 1099.
When a life settlement is paid, the purchaser will issue a 1099 for the money they paid to you to take over the policy. When it comes to owing any taxes, I’m not a legal tax advisor, but the IRS mainly looks at how much money you spent on the policy premiums and compares it with how much you received in a settlement. If you received more than you put into the policy, then that profitable amount is considered taxable as long term capital gains.
Most of the time life settlement amounts are less than what someone has paid into the policy. This is because life insurance is in-fact insurance and not designed to be a highly profitable investment unless you pass early. So the majority of people who take a settlement are probably not going to owe any taxes.
And for the people who get significantly more than what they paid into their policy, there’s a good chance their case will be considered a viatical and will receive a 1099-LTC instead meaning it’s non-taxable.
Those looking to sell term life insurance policy for cash should take a closer look at their policy contract. If you have a terminal diagnosis we can sell a term policy as-is, but for someone of average health or manageable ailments, you’ll need to check if your policy is still convertible.
A conversion means the insurance company will replace your term policy with a permanent universal life policy. The permanent policy allows the investor the ability to keep coverage going for as long as you live. Of course the premiums will be much higher than your term policy, but this is because most term policies don’t end up paying out a death benefit.
You can find your conversion deadline by reviewing your original contract, or you can call your insurance carrier and simply ask - is my policy still convertible?
If it is then we’ll want to order a conversion illustration. Oftentimes people will tell me their term premiums, but they really don’t matter. The conversion will have much higher premiums because it’s a permanent policy. Someone who’s 71 with a $500k conversion will likely have $25k annual premiums, but they may have paid only $2k a year for their term policy. The reason being is that term policies rarely pay out the death benefit. When you applied for the policy, the underwriter reviewed your health and determined that there was a very high probability that the insured would outlive the policy.
Term coverage is a great way to protect your family or business because it’s the cheapest way to get the most coverage, and the loss of a parent or business partner can be economically catastrophic. With that said, people shouldn’t buy a term policy expecting it to pay out. Especially if you’re paying $40k in premiums over the life of the term for a $500k or $1MM death benefit.
So when you have these term policies that are still convertible, and the insured is in average health, oftentimes we get around $10k - $15k for these types of cases. At first, people can be shocked to hear their $500k policy is only worth $10k and impulsively think - wow, someone is going to make $490k off me, but that would only work out if the insured passed away a month after selling the policy, and this is extremely unlikely. Instead, you’re most likely to continue living for another 15 years, and over that time the owner of the policy will have paid $375k in premiums, plus your settlement and closing costs. Really they end up profiting $100k after investing $400k during a 15 year period, which is not exactly highway robbery.
Instead you should consider that selling my life insurance policy for cash and getting $10k is really a gift to help cover some of the cost you paid into the policy, because otherwise your policy was worthless and you would eventually just let it lapse anyway.
FAQ
What is the difference between a life settlement and a viatical settlement?
A viatical settlement is generally reserved for someone with a terminal illness, and a life settlement is an all-encompassing term that includes people in good health.
Who is eligible for a viatical settlement?
Someone who’s been diagnosed with a terminal illness can receive a non-taxable settlement.
How can I determine which type of settlement is the best option for my situation?
The application process is the same and is determined by underwriting and your doctor providing a letter stating you have 2 years or less to live.
References:
(1) https://portal.ct.gov/CID/Fraud/Fraud/Selling-Your-Life-Insurance-Policy-What-you-should-know-about-Life-and-Viatical Settlements#:~:text=The%20two%20main%20categories%20of,insured%20with%20a%20terminal%20illness.
4 years in life settlements
About the author:
I'm a life settlement advocate who became passionate about the industry when I helped my grandfather secure over 60% of his death benefit. Recently, I assisted an 81-year-old woman with $140k annual premiums by finding an investor to buy out her policy while still receiving most of her investment back.
I've also helped clients with expiring term policies receive payouts of $10k - $15k by converting to a new universal life policy. I enjoy educating both agents and clients on the potential benefits of life settlements and am always happy to provide feedback on potential cases.
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