The Wall Street Journal - August 15, 1996
Lynn Asinof, Staff Reporter of The Wall Street Journal

By eliminating income tax on certain advance life-insurance payments, the new law will make it easier for people to use this money to finance their care in the case of a terminal or chronic illness.

The tax exemption will apply both to the acceleration of insurance death benefits and to money received from the sale of those benefits to third parties through something known as a viatical settlement. To qualify, the person receiving the payments must have a chronic illness or less than two years to live. Amounts paid after Dec. 31 will be eligible for the exemption.

Up to now, people with AIDS have been the principal users of viatical settlements. But with the new law making viatical settlements and accelerated death benefits a "much, much better deal," such transactions may become a lot more common for people with a broader range of diseases, says Patricia C. Drivanos, a New York financial planner.

Here's why. Someone with two years to live and a $100,000 life-insurance policy might be able to sell the policy for 75% of its face value -- or $75,000. Under current law, Uncle Sam would probably take 31% or more of that $75,000, leaving the person selling the policy with about half of the policy's face value.

Compare that with the full $100,000 death benefit that the person's heirs would receive free of income tax if the policy weren't sold.

But some people can't wait. Ill and unable to work, saddled with hospital bills, mortgages and other living expenses, they may be forced to tap assets now that otherwise would support their families in the future.

Some people have been getting around the income-tax problem by simply never reporting viatical settlements to the Internal Revenue Service. They do this knowing that companies that buy life-insurance death benefits typically don't send 1099 forms to the recipients and the IRS.

But this has created a moral dilemma for many people, says Karyl Thorn, an independent case manager in Los Angeles. Indeed, Ms. Thorn says passage of the legislation prompted a jubilant phone call from one of her patients, who told her, "Now I don't have to lie to my kids."

Elimination of the income-tax barrier also is expected to help viatical settlements gain acceptance among people with diseases other than AIDS, says John Banks, chief executive officer of Viaticus Inc., a viatical company owned by CNA Financial Corp.

"This really validates the concept as a sort of mainstream financial service," he says. "In my view, this will be a commonplace transaction by the end of the decade," he adds.

The market potential is significant. Even though AIDS accounts for only about 2% of individual insurance death-benefit payouts, AIDS patients dominate the viatical business. But with cancer and heart disease responsible for more than half of all deaths in the country, it's clear that real industry growth must come from these areas. Even Alzheimer's patients may be able to viaticate their policies if doctors are able to reasonably determine life expectancy.

The ability to use life-insurance money tax-free to fund care for the seriously ill may even create a broader market for life insurance, says Jill Peetluk Feinstein, a Great Neck, N.Y., financial planner.

Older people with grown children, for example, typically drop their life-insurance policies or significantly reduce their coverage. "Now, instead of letting them lapse, they may hold on to them, thinking they can access them if they get a disease," she says.

Likewise, singles who don't typically buy life insurance may find that nontaxable viatical settlements or accelerated benefits can be used as an alternative to some kinds of long-term-care insurance.

These transactions, however, aren't a substitute for health insurance or long-term-care insurance. For one thing, viatical companies aren't interested in buying your policy unless there's some way of quantifying life expectancy. Just getting old isn't sufficient.

"This is a time-value use-of-money transaction," explains Ken Klein, president of Living Benefits Inc. and American Life Resources Corp., two viatical companies in New York. "We have to be able to forecast."

Moreover, to meet the criteria as terminally ill for tax purposes, you must have proper physician's certification that you have less than two years to live. People deemed chronically ill must be certified as being unable to perform certain life functions, such as bathing and dressing. In the case of the chronically ill, there's also a cap of about $65,000 a year on the amount that will be considered tax-free.

Nor are viatical settlements or advance benefits the right answer for everyone, particularly people with young families. People need to look at all their assets when making this decision. "You are taking a deep discount on those death benefits," says Ms. Feinstein. "People need to keep in mind why they bought insurance in the first place."

The viatical settlement industry got started only in the late 1980s, but it is maturing rapidly. States are moving to regulate these companies, and more institutional money is coming into the market.

But while the industry is developing more consumer protection, it still pays to shop carefully. The amount of money you get for your policy may vary. "By applying to more than one viatical settlement company, it is possible you will get better offers," says Mr. Klein. "The estimating of life expectancy is not a science."

Remember to check with your insurance company to find out if, and under what conditions, you can accelerate your death benefits. Some may be willing to do this even if it wasn't part of your original policy. Often acceleration is the only option available to the chronically ill, since viatical companies rarely buy policies from these people.

Acceleration also may be a better deal, with some companies offering advance payments as high as 96% for someone with a six-month life expectancy.

Price isn't the only consideration when doing comparison shopping. In states with regulations, dealing with a licensed company guarantees certain minimum standards of operation. Also, make sure there is a solid escrow mechanism to handle the transfer, just as you would if you were selling your house.

Understand how the viatical company will be monitoring your health. You don't want people calling you up every month to find out if you're still alive. A better approach might be to authorize contact with your physician. Finally, make sure you understand who will have access to your health records as part of the sale, particularly if your policy is to be resold.

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