What is a viatical settlement?

Simply put, a viatical settlement is an agreement for selling a life insurance policy. Why would someone do this? Should you? While life insurance can be seen as an investment for your loved ones after you pass, it may be possible for you to access some of the cash value before you die. 

A viatical settlement allows a policyholder to sell their life insurance for a percentage of the net benefit. It is not legal in most Canadian provinces (but in Ontario, for example, the rules may soon change, specifically around prohibiting the sale of a policy for charitable donations.)

“Viatical settlement” isn’t a term you commonly hear in discussions about life insurance. It’s usually defined as the sale of a life insurance policy by the owner to a third party because the owner is in financial distress. The third party buys the policy at a discounted price, but at a rate higher than the premiums paid or the current cash surrender value. 

The idea behind a viatical settlement is that the policyholder gets an immediate cash settlement that can be used however it’s needed. The new policyholder takes on the payment of the premiums and gets the benefit or payout when the insured person dies. These settlements became a popular option during the early days of the AIDS epidemic in the 1980s, when those afflicted with the disease needed money for their healthcare. 

Viatical vs. life settlement: What’s the difference?

In Canada, according to information provided by the Canadian Life and Health Insurance Association (CLHIA), the terms “viatical settlement” and “life settlement” are used interchangeably. The only difference is that with life settlements, the person selling their insurance policy is still in good health or is just starting to decline. 

So, what is a viatical settlement?

It’s important to know that viatical settlements originated in the United States and are not very common in Canada. 

Most provinces have banned viatical settlements and some insurance companies, such as Sun Life Financial, do not allow their advisors to transact in these settlements. Quebec allows life settlements. Nova Scotia previously allowed them but banned the trading of policies in 2020. Saskatchewan, as well, amended its Life Insurance Act to no longer allow them. 

Some insurance companies, including Perisen and Canadian Life Settlements, will manage the sale of your life insurance. These companies determine the payout based on: 

• The life expectancy of the insured
• The amount of remaining life insurance policy payments
• The net death benefit of the insurance policy
• The type of policy and specific life insurance company. Perisen states that its criteria is insured lives over age 70, whole universal or term-to-100 [years] policies, in force for greater than two years, and a death benefit between $250,000 and $3 million. While there is no guarantee of the percentage payout, it could range from 10% to 70%. 

One reason why viatical statements aren’t popular among insurance companies is they pay more than a cash surrender or a policy lapse, which is a source of profit for the companies. 

In places where these settlements are allowed, companies or licensed brokers will purchase life insurance policies from what’s known as the “viator”—that is, the individual who owns the policy. They will negotiate with the settlement providers on the contracts for the viator. Alternatively, a viator can skip working with a broker and deal directly with the settlement providers.

When a life insurance policyholder works with a viatical settlement broker, the broker shops around the policy and negotiates on their behalf. In the U.S., the provider is licensed by government agencies and has a fiduciary duty to act in their client’s best interest. They get paid either a flat rate or a percentage of the settlement. 

So, why would someone invest in another person’s life insurance policy? Advocates say it provides immediate monetary assistance to policyholders who need it. It also pays out more compared to a cash surrender, and it’s better than letting the policy lapse because the holder can no longer afford to pay the premiums. Detractors say it sets up too much potential for elder financial abuse (the CLHIA views viatical or life settlements as financial exploitation). These are often marketed to vulnerable seniors, who may not have the expertise to know if they’re getting a fair deal.

What are the risks of viatical settlements?

These investments are considered risky because they depend on the life expectancy of the viator. If the viator dies before the estimated life expectancy, the buyer gets a higher return. If they live longer, the return decreases. There is a risk of losing the principal investment (the money the seller paid out) if the person lives past their estimated life expectancy. That’s because the seller will have to pay out additional premiums to maintain the policy. 

How the contracts work

A viatical settlement contract is a written document that outlines the purchase of a life insurance policy from the holder—known as the viator—to the third party or viatical settlement provider. As this is a legal contract, the document must contain the following: 

• The terms of how compensation will be paid
• The viator’s transfer, sale or bequest of the death benefit or ownership of the insurance policy
• An unconditional rescission provision, so the viator can rescind the contract within 15 days after they receive the settlement proceeds. They will have to return the money 

Depending on where you live, the viator may need to release their medical records. As with all contracts, they will also have to confirm they have a full and complete understanding of the contract and the benefits of their life insurance policy, and that they entered into the agreement voluntarily. 

Financial and tax compensation

As mentioned before, a viatical settlement offers a larger sum of money than a cash surrender or a lapse in insurance. When it comes to taxes, it depends where you’re located. In the U.S., viatical settlements are free from federal taxes but may be subject to state taxes.  

In Canada, the money you receive from selling a life insurance policy is taxable. (Find out what is and isn’t taxable for life insurance in Canada.) Also, it’s always a good idea to speak to a lawyer and a tax expert before you sign any contracts. 

Viatical and life settlements are complicated things in insurance. As mentioned before, many provinces and insurance companies do not allow for these settlements. If this is something you want to pursue for financial reasons, there are other alternatives, such as policy transfers, that are legally recognized and allowed in provinces where viatical settlements are prohibited. Make sure you do your research before proceeding.