A bit of a morose title I suppose, especially with it being Valentine’s Day… Nonetheless, a viatical settlement is the transaction that takes place when the owner (and the life-insured) of a life insurance policy sells the insurance policy (and beneficiary designation) to an investor for a set amount when the life-insured is diagnosed terminally ill (within two years of dying).
Let me explain with an example. Let’s suppose John is diagnosed with a terminal illness and is expected to die in two years time. He owns a $500,000 life insurance policy. Therefore his beneficiary will get $500,000 when John passes. But John is in need of money now so that he can pay for a full time nurse in a full time nursing home (for potentially two years). There are some clauses within insurance contracts that allow for a certain percentage of the death benefit to be paid to you before you die if you are in such a situation – let’s say the amount that can be paid is 10% – so in this case John *might* be able to get $50,000 from his insurance company to help him in his last days.
If John has no beneficiaries anymore (perhaps they have pre-deceased him), he might instead make a viatical settlement. In this case he would sell his life insurance policy to an investor who might pay him $250,000 for the rights to his insurance policy. In this case, John gets five times as much money as he would otherwise get before his death, and the investors can potentially double his money in two years. This is the viatical settlement in a nutshell.
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Wouldn’t you be able to get a loan for this amount? I guess bank loan officers aren’t in the business of death, but if you knew you were going to die in at most X years, couldn’t you get an interest only term loan for X years and have your estate repay the balance?
Very interesting
Jordan: a good point. Certainly a private lender would be more apt to financing such a transaction since they are more able to handle "special" situations. With the very basic loan screening procedures, I’ll assume that someone who is terminally ill won’t show an income (or much of one) and that alone will raise some flags. Again, bankers can be quite resourceful and someone higher up may make an executive decision to indeed do as you propose.
One wrinkle is that not everyone who is diagnosed as terminally ill will die when they are "supposed" to – some may recover. If the amount borrowed can’t be paid back, and the "payoff" from the policy is in fact 10 years down the road, then the loan provider may end up underwater.
I’ll pen a follow up post, because there is an extension of viaticals: life settlements and an exploding secondary market for life insurance policies (hint: for those with policies who aren’t terminally ill).