Use your life insurance for cash now?

The costs of caregiving bear out the fact that growing old can carry real financial burdens. Recent innovations in the financial services industry underline concerns about paying these costs. Critical illness insurance and long-term care insurance as well as a more recent innovation, the so-called “nursing care” annuity, are touted as ways to lessen the financial stress of aging.

But these products aren’t available to everyone. “What happens to people who are going to a nursing home today? It’s not going to help them to buy a long-term care policy. Somebody who’s got cancer or needs a bypass – they can’t buy a critical illness policy,” says Daniel Kahan, an actuary in Toronto and a staunch supporter of viatical settlements.

Accessing life insurance equity
Viatical arrangements represent an income alternative that’s rooted in insurance but dramatically different from our traditional perception of life insurance. In a viatical settlement (the term viatical is rooted in the Latin viaticum, referring to supplies or money for a journey), the policyholder sells the death benefits of the fe insurance policy at less than face value to a third party; the buyer-investor keeps up premium payments and is entitled to the full death benefit when the policyholder dies. The policyholder gets cash upfront, and the investor’s return is based on the amount paid for the policy and the time that passes before collecting the death benefit.

“Somebody who is 80 years old and has been paying their premiums for 20 years needs to go into a nursing home. Eventually, when they die, their estate gets the money, but they need the money now.” says Kahan. “Why not allow a mechanism where they can convert that equity into cash with an income stream?”

Kahan had hoped changes to the Ontario Insurance Act in December 2000 as part of that province’s Red Tape Reduction Act would allow viatical business. But nervous politicians nixed the new rules at the last minute, saying that viaticals wouldn’t be allowed until proper regulations were in place. In July 2001, the Financial Services Commission of Ontario (FSCO) issued draft regulations, asking for comments.

Opponents of viatical settlements cite widespread fraud in the United States, where viatical settlements are a booming business, as a reason for caution – or not at all (see “Fraud Cuts Both Ways,” page XX). Proponents of viaticals, however, say fears are unfounded and that it’s unfair to refuse policyholders, some needy, the right to sell their policies.
Currently, third-party trade in insurance policies continues to be prohibited in all provinces and territories except Nova Scotia, New Brunswick, Saskatchewan and Quebec. In the provinces where they are legal, lack of regulation means a lack of protection.

The key issue in the draft regulations is how to control the abuses that have characterized the U.S. viatical industry to date. Among the key questions are: who should be allowed to conduct business in viatical settlements; should viatical settlements be limited to only the terminally ill; how long a life expectancy should be stipulated as a condition of viaticating a policy (draft rules call for a two-year limit); and, not least, just who will regulate the industry.
Interested parties are watching Ontario these days. The bulk of life insurance policies in Canada reside in this province, and regulations governing viaticals are on the drawing board.

Seniors a prime market
Where viatical settlement business is legal, seniors are a growth area. The so-called “senior settlements” business, which has little to do with being terminally ill but everything to do with being old, has sprung up as a niche within the viatical industry. It’s a sound business concept, according to Victor Lansdown, who operates Life Source and Associates Inc., a Montreal company that buys life insurance policies. “It [the insurance policy] is a time-valued instrument. The healthy seniors, all they have against them is their age.” In other words, the older you are, the shorter your life expectancy, and the more you can expect to get when you sell your policy. “Seldom are we able to assist a person with a life expectancy of 12 years, for example. The majority would be 10 years [or less].”

Next page: Why the Canadian insurance industry is wary

For its part, the Canadian insurance industry largely opposes viatical settlements, claiming that living benefits, otherwise known as accelerated benefits, in which policyholders with life expectancy of less than two years may obtain an advance of death benefits, already fill the need. Living benefits originated as a compassionate response to the AIDS epidemic of the early ’80s, which saw many terminally ill patients facing staggering drug costs with no way to pay.
There are potential problems with this, however. Although living benefits are offered by most insurers, they are essentially a voluntary guideline, rather than part of any insurance contract. Also, living benefits are usually limited to 12 to 24 months prior to expected death.

“We’re not so much opposed to consumers getting their money. We had major concerns with the fraud associated with the viatical product,” says Andrew Casey, vice-president, legislative, of the Canadian Life and Health Insurance Association (CLHIA). “It was an industry that was rife with fraud and deception.”
Indeed, viatical transactions recently ranked sixth in BusinessWeek’s list of the most prevalent investment frauds in the U.S. Meanwhile, the Canadian Securities Administrators describes viatical settlements as “very risky investments and often fraudulent.” Casey also insists our superior health-care system means a weaker case for viatical settlements in Canada than in the U.S.

Tax implications
There are other technical issues. Casey notes concerns about the tax implications of viaticating a policy. “If your policy is paid out by the company, there’s a tax-free aspect. But once you viaticate it, you’ve sold that policy and that’s taxable.” This income could also affect pension benefits (for example, boosting a pensioner’s income past the threshold for clawback of Old Age Security).

One solution put forward by CAIFA, the Canadian Association of Insurance and Financial Advisors, in its response to FSCO’s consultation draft for viatical settlements in Ontario, is to set up the viatical settlement as a loan. “Among [the benefits to the viator, or person selling the policy] is the ability to avoid tax liability and to pay to a beneficiary any part of the death benefit that remains after repayment of the loan and interest.”

Kahan’s vision goes further – to a not-for-profit organization run by the provincial government to facilitate viatical settlements for the needy. A settlement would take the form of loans made against the security of collateral assignment of the policy. He points out the Ontario Ministry of Health has examined and pretty well established the feasibility of establishing a non-profit viatical organization in Ontario.

Unfortunately, this study seems to have been largely ignored in the current discussions. Says Kahan, “If the government were really interested, they could do it themselves.”

Fraud cuts both ways
The U.S. experience with viatical settlements shows regulators grappling with fraud; not only are insurance applicants participating in the crooked schemes, they’re being helped or encouraged by insurance agents and brokers eager for more policies to be available to investors, according to The website, which serves as a fraud watchdog of sorts for consumers, lists two of the more common viatical investment schemes as:

• Clean-sheeting, in which a life insurance applicant fails to disclose a pre-existing medical condition in response to a question on a life insurance application. Because medical exams can be forgone, this ensures the policy will be issued and can then be sold.
• Wet-ink policies, in which the insured sells their policy or multiple policies from different insurance companies, sometimes within weeks, while there’s little chance of finding out they’re terminally ill.