How Is a Life Settlement Similar to a Viatical Settlement?

Life insurance policies, traditionally viewed as instruments providing financial protection upon the insured’s passing, also possess inherent financial value that can be accessed during the policyholder’s lifetime. These policies are assets, and like other assets, their ownership can be transferred under specific conditions. Policyholders seeking to unlock this value can explore financial mechanisms that allow them to monetize their policies before the death benefit is paid out. These options provide avenues for individuals to access liquidity from their life insurance coverage when immediate financial needs arise or when the original purpose of the policy no longer aligns with their circumstances.

Understanding Life Settlements

A life settlement involves the sale of an existing life insurance policy to a third-party buyer for a cash sum. This payment exceeds the policy’s cash surrender value but is less than the full death benefit. Policyholders typically consider a life settlement when they no longer need the coverage, find premium payments unaffordable, or require immediate liquidity.

Individuals generally qualifying for a life settlement are often aged 65 or older, or they may have experienced a significant change in health that impacts their life expectancy, even if not terminally ill. The basic mechanics involve the policyholder transferring ownership of their policy to the buyer. In return, the policyholder receives a lump-sum cash payment, relinquishing all future claims to the death benefit. The buyer then assumes responsibility for all subsequent premium payments and becomes the designated beneficiary, receiving the death benefit when the insured dies. The insured’s health status is a factor in determining the policy’s value, as it influences the buyer’s projected return on investment, but a terminal illness is not a prerequisite for this transaction.

Understanding Viatical Settlements

A viatical settlement represents a specific type of transaction involving the sale of a life insurance policy, distinguished by the policyholder’s health status. This arrangement is designed for individuals who are terminally or chronically ill. For tax purposes, a “terminally ill” individual is generally defined as someone certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months.

Alternatively, a “chronically ill” individual is typically someone certified by a licensed health care practitioner as being unable to perform at least two activities of daily living (such as eating, bathing, dressing, toileting, transferring, and continence) for a period of at least 90 days, or requiring substantial supervision due to severe cognitive impairment. A significant distinction is that the cash received from a viatical settlement may be tax-exempt under federal law, provided specific conditions related to the policyholder’s terminal or chronic illness are met, as outlined in the Internal Revenue Code.

Shared Characteristics of Both Transactions

Both life settlements and viatical settlements involve the fundamental process of a policyholder selling an existing life insurance policy to a third party. This initial step allows individuals to convert an illiquid asset into immediate cash, providing a financial alternative to letting a policy lapse or surrendering it for its often lower cash value.

In both types of settlements, the new owner assumes control over the policy, including responsibility for all future premiums. This frees the original policyholder from ongoing financial obligations. The policyholder receives a lump-sum cash payment, providing immediate liquidity. The buyer becomes the designated beneficiary, receiving the death benefit upon the insured’s death. These transactions are typically funded by institutional investors or investor groups, creating a secondary market for life insurance policies.

The price paid for a policy in both life and viatical settlements is determined through a market-driven valuation process. This valuation considers several factors, including the insured’s life expectancy, the amount of the death benefit, and the projected future premium costs, all aimed at providing an attractive return for the investor. Both types of transactions are subject to extensive state-level regulation, which includes requirements for specific disclosures to protect consumers and licensing for the providers facilitating these settlements.

The processes for both life and viatical settlements involve the disclosure of the policyholder’s personal and medical information to potential buyers and third-party administrators. This necessitates adherence to strict privacy protocols to safeguard sensitive data, aligning with general medical privacy expectations.