What Is a Viatical Settlement and How Does It Work?

A viatical settlement offers individuals facing a terminal or chronic illness a way to access a portion of their life insurance policy’s death benefit while they are still living. This financial arrangement involves selling the policy to a third-party, known as a viatical settlement provider, for a lump sum cash payment. The policyholder, referred to as the viator, relinquishes ownership of the policy and the right to name a beneficiary. In return, the provider assumes responsibility for future premium payments and receives the full death benefit upon the insured’s passing. This option provides financial liquidity, enabling individuals to cover medical expenses, living costs, or enhance their quality of life during a challenging period.

Eligibility for a Viatical Settlement

To qualify for a viatical settlement, a policyholder must meet specific health and policy-related criteria. The primary requirement is a diagnosis of a terminal or chronic illness, defined by a life expectancy of 24 months or less as certified by a physician. For chronically ill individuals, eligibility may involve being unable to perform at least two activities of daily living (ADLs) such as bathing, dressing, or eating.

The type and status of the life insurance policy also play a role in eligibility. While permanent policies like whole life or universal life are preferred due to their cash value accumulation, some term life policies, especially those with conversion options, may qualify. Providers require the policy to have been in force for a minimum period, commonly two years, and may set a minimum death benefit threshold, around $100,000 to $200,000. The policyholder must hold clear ownership of the policy and have the legal right to transfer its benefits. Any outstanding loans or liens against the policy may need to be addressed or will affect the settlement amount.

The Viatical Settlement Transaction

The process of completing a viatical settlement begins with the policyholder initiating an inquiry by contacting a licensed viatical settlement provider or broker. The policyholder provides details about their life insurance policy and authorizes the release of medical records. This allows the provider to conduct a preliminary assessment of eligibility and value.

Following inquiry, the provider conducts a medical underwriting process, reviewing the policyholder’s medical history and obtaining an independent life expectancy assessment. Concurrently, the policy’s value is assessed based on its death benefit, ongoing premium costs, and the insured’s life expectancy. This evaluation informs the provider’s offer.

Once an offer is presented to the policyholder for review and acceptance, the process moves to documentation and closing. This involves preparing legal agreements like the assignment of policy ownership and change of beneficiary forms. Upon completion of all necessary paperwork and confirmation from the insurance company regarding the transfer of ownership, the lump sum payment is released to the policyholder through an escrow agent. The entire process can take between 4 to 10 weeks from initial contact to the transfer of funds.

Financial Considerations

The lump sum payout received by the policyholder in a viatical settlement is influenced by several financial factors. These include the policy’s face value, the insured’s life expectancy, the cost of future premium payments, and current market demand for such policies. The payout is a percentage of the death benefit, ranging from 50% to 85%, and is always greater than the policy’s cash surrender value but less than the full death benefit. A shorter life expectancy leads to a higher percentage payout, as the buyer anticipates fewer premium payments before receiving the death benefit.

Policyholders decide how they use the proceeds, whether for medical expenses, living costs, or other personal needs. The tax treatment of the proceeds is a financial aspect. Under U.S. federal law, proceeds from a viatical settlement are tax-exempt if the policyholder is certified by a physician as terminally ill with a life expectancy of 24 months or less. If chronically ill, proceeds may also be tax-free, but only to the extent used for qualified medical or long-term care expenses not covered by other insurance or government benefits. Individuals should consult with a tax professional to understand the specific implications for their situation, as state tax laws can vary.

Viatical Settlements and Life Settlements

Viatical settlements and life settlements are both financial transactions involving the sale of a life insurance policy to a third party, but they differ based on the health status and life expectancy of the policyholder. A viatical settlement is for individuals who are terminally or chronically ill, with a life expectancy of two years or less. This option provides immediate financial relief to those facing significant health-related expenses.

In contrast, a life settlement involves the sale of a life insurance policy by an individual who is healthy, often over 65 or 70, and who may no longer need or want their policy. The motivation for a life settlement can include estate planning, funding retirement, or no longer affording the premiums, rather than an urgent need due to illness. Payouts for viatical settlements are a higher percentage of the policy’s face value (50% to 85%) compared to life settlements (10% to 25%) due to the shorter life expectancy involved, meaning fewer premiums for the buyer to pay. While viatical settlements are tax-exempt for qualifying individuals, life settlement proceeds may be subject to taxation.