What the Viatical Investor Should Know

States have been grappling with the implications of viatical contracts for both the seller and the potential investor. Of special concern are shady viatical companies that blatantly mislead investors about returns. They play on the "humanitarian" aspect of improving the quality of life for someone in their last days.

For example, here are some sample sales literature statements: "Savvy investors agree, viaticals make a lot of sense." "Viatical settlements are worry-free." It advises potential investors that "90 percent of life insurance policies lapse" anyway, yet the actual life insurance industry lapse average is around 6 percent. And, "All qualified retirement plans can be rolled into a viatical settlement." Well, they can, but would you really want to risk your retirement nest egg against someone's life-expectancy odds?

According to the U.S. Securities and Exchange Commission (SEC), viatical settlements can be risky investments and the agency advises caution. Since they are not securities, the SEC does not regulate viaticals. The North American Securities Administrators Association says viaticals are "risky and unpredictable investments" that "generally do not provide a guaranteed rate of return."

Some states have open investigations against viatical companies and work with other states to address the problem of viatical investor scams and to find solutions.

More than half of the states require viatical companies to be licensed. Being licensed, however, doesn't necessarily mean the industry is regulated.

Florida enacted legislation that prohibits viatical companies operating in the state from offering guaranteed investment returns; penalizes those who violate viatical settlement provisions; and requires viatical settlement brokers to disclose their compensation for the transaction and to be licensed as life insurance agents.

Cracking down on viaticals

The SEC wants viatical companies to make full disclosure of their products and companies, including financial statements on both the company and its owners and investment risks associated with viaticals. The purpose of registering a security is to make sure information is available to investors so they can make an educated decision when they invest.

There are also reports of healthy people applying for life insurance at the urging of viatical companies. The policies are then immediately sold, the seller gets a lump sum payment, and the new policy is resold to investors immediately - almost before the ink on the contract is dry. This is referred to as a "wet ink" scheme. The American Council of Life Insurers (ACLI) says that the practice undermines the "insurable interest" rule in selling life insurance, which is required under a state's insurable interest statute. It also contends that wet ink policies end up stimulating insurance fraud.

In fact, the ACLI reports that two insurers were forced to pay death benefits to viatical settlement companies "even though there had been blatantly intentional fraudulent acts committed by the insured at the time of application," according to Julie Spiezio, senior counsel for the ACLI.

Another ruse called "clean sheeting" happens when terminally ill people apply for an amount of life insurance just under the limits required for a medical exam. They lie about their medical history and sell the new policy immediately.

Buyer beware

In some states, the securities regulator takes the lead in overseeing viaticals, while in others it's the insurance department. It's this lack of uniform control that makes it easy for viatical companies to slip through jurisdictional cracks.

As an investment, viaticals are generally not a good choice for individuals, since there's no guarantee on returns, no data available on investment performance, and not many regulations in place at this time.