2. Insurance Planning. 10. Viatical Settlements Flashcards
Module Introduction
Bob Winters vividly recollected the day his life had changed. He sat in stunned silence, as his doctor explained that he had been diagnosed with advanced pancreatic cancer. Bob’s only comforting thought was that the oncologist believed that treatments could delay the progression of the cancer and extend his life.
During the next few months, as the initial shock slowly faded, Bob thought of his financial plans. He was glad that he had planned well for the future of his beloved family. The proceeds from his various life insurance policies, along with his other investments and savings would take care of their financial needs after his death.
Now, six months later, he was not so sure. Bob’s team of physicians had informed him that the pancreatic cancer had spread to his liver, abdominal wall, and lungs. The initial advanced cancer diagnosis was now considered terminal (i.e., uncurable and likely to lead to death). His health insurance did not cover newer medicines available through clinical trials and his current course of more traditional treatments were proving too expensive. He had been forced to draw large amounts from his investments.
Bob consulted a financial advisor who explained that options existed for people with terminal illnesses when financial burdens seem insurmountable. Traditionally, life insurance serves the purpose of helping surviving beneficiaries meet expenses after the death of the insured. Now, however, there are options that let the terminally ill tap into their life insurance benefits while they are still living. Bob learned that these options are known as viatical settlements and accelerated death benefits.
The Viatical Settlements module will present you with the purpose of viatical settlements, the legal principles that guide them, and the option of accelerated death benefits.
The online portion of this module takes the average student approximately two hours to complete.
Upon completion of this module you should be able to:
* Identify the provisions that give life insurance its flexibility,
* Explain the function of assignment provision,
* Define the legal nature of property,
* Describe the process of viatical settlements,
* Outline the legal principles of viatical settlements,
* Identify supplemental policy benefits,
* Define accelerated death benefits, and
* List the coverages of living insurance.
Module Overview
An individual may have adequate life insurance, and the life insurance may have cash values. However, the promise to pay the face amount on the insured’s death, may offer little solace at a time when major expenses are being incurred. The cash surrender value could be helpful, as it could serve as collateral for a policy loan. Such a loan will be limited to the policy’s surrender value, which may be minimal in comparison to the face amount if the policy is fairly new.
If the insured is expected to die within a short time period, the actuarial value of the death benefit promise of the policy will be greater than its cash value. This actuarial value will be quite close to the face amount if death is expected within a matter of months.
The assignment provision of the life insurance contract and the legal nature of property, which includes life insurance, allows transfer of ownership through a transaction called a viatical settlement. Viatical settlement firms purchase life insurance from individuals who have terminal or chronic illnesses, thereby providing the individual with needed funds. Viatical settlements are guided by legal principles, pricing guidelines and ethical concepts. Supplemental policy benefits such as accelerated death benefits also provide financial assistance, while the insured is still living. The accelerated death benefits, also called living benefits, provide the option of terminal illness coverage, catastrophic illness coverage or dread disease coverage without the need to sell the policy to a viatical company.
To ensure that you have an understanding of viatical settlements, the following lessons will be covered in this module:
* Provisions Flexibility
* Viatical Settlements
* Supplemental Policy Benefits
Section 1 – Flexibility of Provisions
Policyowners are provided with a greater flexibility through several provisions in life and health insurance policies. The value of the contract is enhanced, as these provisions provide policyowners with a package of options. The assignment provision is especially valuable for individuals who are considering viatical settlement.
To ensure that you have an understanding of the flexibility of provisions in life and health insurance policies, the following topic will be covered in this lesson:
* Assignment Provisions
Upon completion of this lesson, you should be able to:
* Define the assignment provision,
* List the legal classifications of property, and
* Categorize the types of assignments.
Exam Tip with Audio:
Describe Absolute Assignment and Taxation
An absolute assignment is the complete transfer, by the existing policy owner of all of his or her rights in the policy to another person. In other words, it is a change of ownership. In the case of a gift, the assignment is a voluntary property transfer involving no monetary consideration. Gifts of life insurance policies are frequently made among family members, for both personal and tax-related reasons.
Sometimes a life insurance policy is sold for a valuable consideration. This is known as a transfer-for-value. A life insurance policy that is sold or exchanged for valuable consideration may cause the death benefit to be taxed in certain situations. Under the transfer-for-value rule the death benefit amount that exceeds the new policy owner-beneficiary’s adjusted basis is subject to income tax at ordinary income rates when the insured dies. The transfer-for-value rule cannot be avoided by cancelling the transaction at a later time.
There are exceptions to the transfer-for-value rule which will not cause the death benefit to be subject to income taxes at the insured’s death. This occurs when the insurance policy is transferred to the following individuals or entities.
* The insured
* The insured’s business partner in a partnership
* The transferor’s spouse incident to a divorce
* A new owner who takes the transferor’s basis in the contract
* To a partnership in which the insured is a partner
* To a corporation in which the insured is a shareholder or officer
As with a gift, these transactions are accomplished through an absolute assignment of policy rights, typically by using an absolute assignment form furnished by the insurer.
One of the most common circumstances in which absolute assignments are used is with viatical settlements.
An irrevocable beneficiary must consent to an assignment of the policy, as he or she is, in effect, a joint owner. Of course, a revocable beneficiary has no rights respecting the transfer. The question arises, however, whether an absolute assignment, by itself, changes the beneficiary. Many courts have held that they do, whereas other courts have held the opposite. The new owner, of course, can change the beneficiary by following the customary procedures.
Exam Tip: Listen in for need-to-know information on transfer-for-value rules, exceptions, and common testing applications.
Audio:
* Couple of good questions here
* Transfer for value will change the tax treatment of the death benefit to the owner after the transfer for value
* Normally, life insurance proceeds received tax free
* But with transfer for value, excess death benefit over new owner’s basis will be taxable at ordinary income at the death of the insured
Exceptions to transfer for value rule:
* Transfer to insured
* Transfer to insured’s partner in a partnership
* Transfer to an insured spouse in a divorce setting
* Transfer to a new owner who takes the transfer’s basis in the contract (which could happen in a corporate reorganization)
* Transfer to a partnership in which insured is a partner
* Transfer to a corporation to which the insured is a shareholder or office
Not an exception - transfer to a fellow shareholder of a corporation
Exam Tip with Audio:
Describe Collateral Assignment
A collateral assignment is a temporary transfer of only some policy ownership rights to another person. Collateral assignments are ordinarily used in connection with loans from banks or other lending institutions and persons.
They are partial, meaning only some policy rights are transferred, in contrast to absolute assignments where all policy rights are transferred.
They are temporary, in that the transferred partial rights revert to the policyowner upon debt repayment.
The vast majority of life insurance policy collateral assignments in the United States use the insurance company’s specific form or American Bankers Association (ABA) Collateral Assignment Form No. 10. The form attempts to provide adequate protection to the lender and, at the same time, permits the policyowner to retain certain rights under the policy.
Thus, the assignee, for example, the lending institution, obtains the right to:
Collect the proceeds at maturity/death
Surrender the policy pursuant to its terms
* Obtain policy loans
* Receive dividends, and
* Exercise and receive benefits of nonforfeiture rights.
On the other hand, the policyowner retains the right to:
* Collect any disability benefits
* Change the beneficiary, subject to the assignment, and
* Elect optional modes of settlement, subject to the assignment.
Under the form, the assignee agrees:
* To pay to the beneficiary any proceeds in excess of the policyowner’s debt
* Not to surrender or obtain a loan from the insurance company, except for paying premiums, unless there is default on the debt or premium payments, and then not until 20 days after notification to the policyowner, and
* To forward the policy to the insurer for endorsement of any change of beneficiary or election of settlement option.
Note: If Mrs. Dean’s policy had as much cash value as she needed to borrow, she could have taken a policy loan directly from the insurance company, thus avoiding the scrutiny of a traditional bank loan. Such policy loans are faster to process, require no application or approval, and have extremely flexible repayment options.
Exam Tip: Listen in for an insightful discussion on collateral assignment and an overview of key facts to commit to memory.
Audio:
* Absolute assignment - total and complete transfer of ownership of a policy to another party
* Collateral assignment - partial and temporary assignment (not permanent like the absolute assignment; does not change ownership, but it assigns some rights in the policy as collateral.
* Typically to a lender as a collateral for a loan.
* Should the borrower default on the loan, lender could invade the policy, either cash value or received benefit (death benefit to repay the loan)
Section 1 – Flexibility of Provisions Summary
The legal nature of property refers to the ownership rights of the property. These are the basis for the various classifications and sub-classifications of property.
In this lesson we have covered the following:
Property ownership rights including:
* Rights of possession
* Rights of control, and
* Rights of disposition.
- Real property: Refers to land and objects permanently attached to land.
- Personal property: Includes movable property, such as automobiles, furniture, stocks, and insurance policies.
- Assignments involve the transfer of ownership of life insurance policies.
They are of two types:
* Absolute Assignments: The complete transfer of all ownership rights.
* Collateral Assignments: A temporary and partial transfer of ownership rights.
A life insurance policy cannot be treated like other types of property and therefore its ownership rights cannot be transferred.
* False
* True
False
* The assignment provision treats life insurance policies like other types of property and allows ownership rights to be transferred by the current owner to another person.
James owns different types of property. Which of the following would be classified as “personal property?” (Select all that apply)
* Beach-Front Mansion in Florida
* Life Insurance Policy
* A Yacht
Life Insurance Policy
A Yacht
* James’ life insurance policy and his yacht are both classified as “personal property.”
* His beach-front mansion in Florida, however, is classified as “real property.”
What are the features of an absolute assignment? (Select all that apply)
* It is the complete transfer of all ownership rights.
* It is a temporary transfer of ownership rights.
* It is used with viatical settlements.
* It is a partial transfer of ownership rights.
* It requires the consent of an irrevocable beneficiary.
It is the complete transfer of all ownership rights.
It is used with viatical settlements.
It requires the consent of an irrevocable beneficiary.
* Absolute assignment is the complete transfer of all ownership rights and requires the consent of an irrevocable beneficiary. It is commonly used with viatical settlements.
* Collateral assignment is a temporary transfer of only some ownership rights.
Section 2 – Viatical Settlements
Individuals with relatively short life expectancies often face unemployment and large medical and hospice bills. Many have no health insurance. If they are insured by life insurance policies, they may be able to sell their policies via a so-called viatical settlement to a viatical settlement firm.
The term viatical comes from the Latin term viaticum which means “provisions for a long journey,” or “allowance for traveling expenses.” Viatical settlements are cash payments made to individuals who sell their life insurance for a substantial percentage of the death benefit.
Viatical settlements are governed by legal principles that include ethical concepts and pricing guidelines that regulate the settlement offer amount.
To ensure that you have an understanding of viatical settlements, the following topic will be covered in this lesson:
* Viatical Settlement Legal Principles
Upon completion of this lesson, you should be able to:
* Sequence the process of a viatical settlement,
* Define the legal principles that guide viatical settlements,
* Discuss the factors on which the settlement offer amount depends,
* Outline the ethical concepts that influence viatical settlements, and
* Explain viatical settlement pricing guidelines and tax implications.
Practitioner Advice:
Describe a Viatical Settlement Firm
A viatical settlement firm is a specialized company, or group of investors, that purchases life insurance policies from terminally ill individuals for lump sum cash payment. It is a private enterprise and not considered an insurance company.
Individuals, agents and financial planners typically bring potential sellers to the viatical settlement firm. In a viatical settlement transaction, people with chronic or terminal illnesses assign their life insurance policies to viatical settlement companies in exchange for a percentage of the policy’s face value. The viatical settlement firm, in turn, may sell the policy to a third-party investor.
The viatical settlement firm or the investor becomes the beneficiary to the policy. They pay the premiums and collect the face value of the policy after the original policyholder dies.
Practitioner Advice: Many people view viatical companies in a negative light. They are seen as investors looking for a quick profit rather than altruistic companies looking to help the terminally ill. The investors are happiest when the insured dies sooner rather than later, as they collect their profits faster. This view is legitimate based on the nature of how viaticals work. However, recent legislation has reduced the amount of fraud and deception that previously existed. Advisors should help the terminally ill to explore the accelerated death benefit (living benefit) options within their life policies before resorting to viaticals. Such policy options tend to provide a much larger payment (usually 90-95% of the death benefit) than would be received from a viatical company. Viaticals should be viewed as a last resort financial solution.
Yves has been diagnosed with terminal cancer. He is 36 years old and is expected to live for fewer than six months. Yves owns a life insurance policy that would pay $100,000 upon his death. Based on his circumstances, Yves approaches a viatical settlement firm and they offer him $80,000 for the life insurance policy.
Around the same time, Colette, who is also 36, is diagnosed with advanced cancer. Her life expectancy is fewer than two years. Colette owns a life insurance policy with a face amount of $100,000 as well.
Compared to the offer to Yves, the viatical settlement firm will offer Colette __ ____??____ __ for her policy.
* an equal amount
* a greater amount
* a lower amount
* nothing
a lower amount
* The viatical settlement firm will offer Colette a lower amount for her policy than was offered to Yves.
* The reason for the lower amount is that Yves has a far shorter life expectancy.
Jamie has needed substantial supervision to safeguard him from threats to health and safety due to severe cognitive impairment. Under the guidance of his family and financial planner, a decision has been made to enter a viatical settlement to cover the supervision costs and other housing expenses unrelated to his health.
Prior to finalizing the viatical settlement, Jamie’s financial planner noted that only qualified long-term care costs, such as the personal supervision, would be tax-free. Jamie’s unrelated housing expenses would be taxable, if taken from the pool of viatical settlement proceeds.
Based on this situation identify the most likely certified diagnosis for Jamie.
I. Chronically ill
II. Terminally ill
* I only
* II only
* Both I and II
* Neither I nor II
I only
A chronically ill individual is someone who has been certified (at least annually) by a licensed health care practitioner as:
* Being unable to perform, without substantial assistance from another individual, at least two daily living activities (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity; or
* Requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment.
Jamie’s state aligns with the second definition listed above.
Since Jamie is considered chronically ill, the only viatical settlement proceeds that will receive tax-free treatment are those used for qualified long-term care expenses.
Section 2 – Viatical Settlements Summary
A viatical settlement is the sale of a life insurance policy of a terminally or chronically ill person. The viatical settlement company becomes the beneficiary of the policy in exchange for a cash payment to the policyholder. When the policyholder dies, the viatical settlement company collects the death proceeds.
In this lesson we have covered the following:
* Viatical Settlement Legal Principles govern the viatical settlement transaction.
* Viatical Settlement Firm purchases the life insurance policy from a terminally ill person.
* Viator is the policyowner who sells his life insurance policy.
- The Settlement Offer Amount depends largely on the policy face amount and the insured’s life expectancy.
- Ethical Concepts prevent abuse of the viatical settlement transaction. They are outlined in the Viatical Settlement Model Act. Viatical Settlement Model Act defines the following:
- Pricing guidelines are based on the life expectancy of the terminally ill individual.
- Income Tax exemption is applied to proceeds of a viatical settlement if the insured is terminally ill.
- Terminally Ill legally refers to a person whose life expectancy is less than 24 months.
- Chronically Ill individuals are unable to perform 2 of the 6 activities of daily living (ADLs) for 90+ days and/or subject to sever cognitive impairment and in need of substantial assistance.
Arrange the following events in the correct sequence.
* Henry received cash payment from the viatical settlement firm.
* The viatical settlement firm received the death proceeds of Henry’s life insurance policy from the insurance company.
* Submitted answer: The viatical settlement firm received the death proceeds of Henry’s life insurance policy from the insurance company.
* Henry purchased a life insurance policy.
* Henry died.
* Henry approached a viatical settlement firm and sold his life insurance to them.
* Henry was diagnosed with a fatal form of cancer.
* The viatical settlement firm continued paying Henry’s life insurance premiums.
Henry purchased a life insurance policy when he was 25 years old and was diagnosed with a fatal form of cancer when he was 33. He approached a viatical settlement firm and sold his life insurance to them in exchange for cash payment. The firm continued paying his life insurance premiums. A year later, upon Henry’s death, the viatical settlement firm claimed the death proceeds of his life insurance policy from the insurance company.
* Henry purchased a life insurance policy.
* Henry was diagnosed with a fatal form of cancer.
* Henry approached a viatical settlement firm and sold his life insurance to them.
* Henry received cash payment from the viatical settlement firm.
* The viatical settlement firm continued paying Henry’s life insurance premiums.
* Henry died.
* The viatical settlement firm received the death proceeds of Henry’s life insurance policy from the insurance company.
* The viatical settlement firm received the death proceeds of Henry’s life insurance policy from the insurance company.
On which of the following factors does a viatical settlement offer NOT depend?
* Future premium payments
* The insured’s life expectancy
* The policy face amount
* The beneficiary’s relationship to insured
* Outstanding policy loans
The beneficiary’s relationship to insured
* The viatical settlement offer depends on the following factors: the insured’s life expectancy, the policy face amount, future premium payments, outstanding policy loans and prevailing interest rates.
* It does not depend on the beneficiary’s relationship to insured because a viatical settlement is an absolute assignment that requires the prior consent of an irrevocable beneficiary to the policy.
Which legal regulation requires that certain disclosures must be made to the viator by the viatical settlement firm?
* The Viatical Fair Disclosure Act
* The Insurance Disclosure Model Act
* The Viatical Settlement Model Act
* The National Insurance Act
The Viatical Settlement Model Act
* The Viatical Settlement Model Act requires that disclosures regarding government benefits, tax implications, rescission rights and alternatives must be made to the viator.
* The other Acts are non-existent.
