Investing isn’t always pretty. While we tend to think of winning investments in terms of soaring stocks, that’s hardly the only way to get returns.
Short selling, for instance, enables investors to profit from declines in a company’s share price. Commodity speculators can earn terrific returns when oil prices skyrocket.
Neither short sellers nor commodity speculators are particularly well-liked by the public, but yet another group seems to be even more vilified: those investing in so-called viatical settlements. Simply put, a viatical settlement investor buys someone’s life insurance policy and profits in proportion to how quickly they die. (Another commonly-used name for viaticals is “life settlements.”)
Here’s how viatical settlements work. A policy holder (any ordinary American with life insurance) decides to sell his or her policy for an immediate cash payment — while they’re still alive. The payment is less than the death benefit of the policy, but higher than the premiums already paid or its current cash surrender value (which the policyholder would get from the insurer for canceling the policy early).
This transaction is known as a viatical settlement and is common among insured people with shorter-than-average life expectancies (and often without close relatives who would otherwise receive the insurance payout). For them, the potential benefit is a much-needed cash infusion that covers pricey medical bills or, at the very least, allows them to spend whatever remaining time they have in more comfort.
Viatical settlement investors, meanwhile, receive the death benefit of the life insurance policy when the seller passes away. The benefit for them is that the sooner that person dies, the quicker the investor gets paid and the higher his or her return on investment.
(On the other hand, as the SEC explains, the investor will have to continue to pay the seller’s insurance premiums, so the longer the seller lives, the lower the investor’s returns.)
As a result — morbid as it sounds — the investor must literally hope for a speedy death in order to maximize returns.
The Late 1980’s AIDS Epidemic
Viatical settlements became widespread during the AIDS epidemic in the 1980’s. At the time, it was commonly assumed that having HIV was a “rapid death sentence” (a notion since refuted) and that life insurance policies were therefore a drain on victims. Online HIV/ AIDS resource TheBody.com recalls that viatical settlements, a once rare transaction, seemed tailor-made for the creative financing needs of 1980’s HIV/AIDS victims. In only six weeks or so, those recently diagnosed could receive 55%-80% of their policy’s death benefit from an investor or company that specialized in these settlements. The same could be said of individuals suffering any number of other serious illnesses.
But as HIV treatments improved, obtaining a viatical settlement became somewhat more difficult. It became clear that HIV patients did not always die a rapid death, which eliminated any guarantees on quick investment returns: a crucial incentive behind all viatical settlements. A “market correction” ensued in which settlements began taking as long as 8-12 weeks and involving mountains of paperwork. Moreover, a growing number of life insurance policies became unsaleable. As a result, overall investment activity in the viatical settlement market temporarily tapered off.
Frauds & Scams
Regrettably, viatical settlements have been at the core of various scams and fraud over the years. As a result of these damaging scandals, the Federal Trade Commission has issued special brochures to elderly or terminally ill people who are considering a viatical or life settlement. This brochure adivses, among other things, to:
– Ensure the viatical company you are considering is licensed
– Resist high-pressure sales tactics
– Verify that the company has the payout money in its possession (and is not “shopping” the policy to third parties.)
FTC Bureau of Consumer Protection Director Jodie Bernstein reminds consumers that “viatical arrangements are complicated” and therefore “must be approached cautiously and with great care.” One particularly common form of viatical settlement fraud, explained in a 2006 FBI financial crimes report, involves “clean sheeting.”
Clean sheeting is the practice of applying for life insurance without disclosing a terminal illness to the insurance company. Because many insurers rely on an “honor system” when they sell policies below a certain death benefit (rather than paying for costly and invasive medical exams), unscrupulous people can temporarily obtain fraudulent policies. The result is a higher number of viaticated life insurance policies than would exist by truthfully disclosing illnesses. Meanwhile, clean sheeted policies frequently offer as little as 10% of the death benefit (as opposed to the standard 50%-70%) because it is anticipated that the insurer will eventually catch up and cancel.
A number of firms have been charged with viatical settlement fraud along these lines. In January 2010, the South Florida Business Journal revealed that the four founders of Mutual Benefits Corp. were handed a 25-count indictment on conspiracy, mail fraud, wire fraud and money laundering, among other charges. The disgraced company is said to have raised over $1.25 billion from 30,000 investors (including many seniors) who were falsely told that viatical settlements were “safe” investments. All told, roughly $837 million in investor funds were lost after the settlements failed to pan out as expected. The founders, who sold these investments through a vast network of sales agents, reportedly became wealthy enough to afford “million-dollar homes, expensive cars, horse farms and international travel” prior to getting busted.
A Growing Industry
Despite past frauds and controversies, the viatical settlement industry shows no signs of slowing down. While only $80 million worth of insurance policies were viaticated in 1990, that number soared to $1 billion by 1999, and Florida’s Office of Insurance Regulation clocked the total in 2009 at $12 billion. They go on to estimate that industry activity will exceed $160 billion “within a few decades.” This of course, remains to be played out.