Let's get viatical

The word 'viatical' comes from the Latin 'viaticum' which means the Holy Communion taken before death, or provisions for a journey. In a similar way, viatical settlements can provide an immediate allowance for those about to go on their final journey.

Simply, a viatical settlement is the sale of a life assurance policy to a private investment company, which pays an immediate cash payout where the client is diagnosed as terminally ill. This cash payout can then be used for anything ' a family holiday, or fulfilling lifelong dreams, for example.

Viatical settlements were pioneered in 1992 in the US. This was in response to the AIDS epidemics and the large number of young people who became terminally ill. Initially viaticals catered for those with a life expectancy of two years or less, although now those with life expectancy up to six years may be considered.

To qualify, an individual needs to hold a life assurance policy, which has been in force for two years, and must be diagnosed as terminally ill. Each individual application needs to be assessed and evaluated before an offer is made.

The viatical company sends out application forms, in which the applicant authorises the viatical company to request information from the attending physician. This is generally a consultant to whom the GP has referred the applicant and life assurance company.

The consultant has to authenticate whether the individual concerned has a terminal illness. The definition of 'terminal' is generally those with three years or less to live. A panel of physicians then evaluates the consultant's assessment. The offer made will depend on the opinions of life expectancy by this panel, although prognoses are rarely totally accurate.

Once a policy is purchased, the payment of premiums becomes the responsibility of the purchaser. The purchaser is responsible for paying any relevant physicians fees, along with commission for broker consultants ' advisers receive commission of around 2% to 3%. These costs are deducted from the value of the sum assured to produce the offer price.

The offer price given is dependent on the life expectancy of the individual concerned. Therefore, where the individual's life expectancy is two years or less, viatical settlements tend to offer prices in the region of 70% to 75% of the sum assured. For periods up to five years, this can fall to an offer price of 50% of the sum assured.

Depending on the response time from doctors, it should take around two to three weeks from the return of completed forms to offer stage. After this, and depending on confirmation by the life assurance company of the registered change of ownership, it should take two to three weeks from acceptance of the offer to payment.

Not for everyone

Viatical settlements should not be recommended to everyone with a terminal illness. Dependants left behind will not receive as much as they would have if the life policy were maintained and therefore viatical settlements are rarely the optimum long-term financial planning option. They should not be recommended to those with dependants under the age of 18, unless there are other policies of assurance or other provision set aside for them.

Indeed, most viatical companies will not offer a settlement if insufficient provision has been made for dependants, or they may ask the applicant to put some of the proceeds in trust. Equally, viatical companies prefer to receive the agreement of partners. Therefore, viaticals are best suited to older individuals with few financial dependants or commitments.

There are also potential problems surrounding the taxation of viaticals. The funds crystallised from selling a life assurance policy are considered by the Inland Revenue to have paid tax at the basic rate. Therefore higher rate taxpayers may face a liability upon sale and could have an impact on tax planning. Indeed, in certain circumstances, viatical settlements may not be suitable because of the tax liability concerned.

It is also important to take into account any charges on the policy. Where life cover is linked to a mortgage, there may not be a residue from the policy, which means the lender may potentially repossess the house. If there is a benefit remaining, it may be enough to live on but affect other means-tested benefits, such as long term care benefits.

Due to these complications, only 1% of the UK population sells life policies to viatical settlements. Despite being much more popular in the US, viaticals remain relatively unknown in the UK and have not found their way into mainstream financial planning. Cultural differences may drive this lower take-up. Surveys have shown Americans are more likely to have a 'spend now' mentality, whereas British culture has traditionally been steeped in inheritance, primogeniture and homeownership. Indeed, the idea of viaticals sits uncomfortably with the British mindset of passing down wealth.

Another key reason, however, is the lack of companies offering viatical services. There are only two main companies offering them in the UK, Life Benefits Resources and International Viatical Settlements. Life Benefits Resources is a registered charity which channels its profits into organisations that support and care for the terminally ill in the UK and Europe. International Viatical Settlements operates on a commercial basis.

However, there are signs that other US players are moving into the marketplace ' although these tend to be in the secondary market, also known as traded life policies. The Mutual Benefits Corporation (MBC), a US viatical company, has been targeting intermediaries since May last year. MBC operates a secondary market for the sale of these life assurance policies. As an alternative to stock market investment, MBC claims it offers investors six investment programmes, offering fixed returns from 12% for a one-year investment to 72% return for a six-year investment. Equally, Shepherds has launched a traded life policies fund, claiming to offer returns at 9% a year.

Secondary market examined

The secondary market is, however, extremely controversial. In a market worth over US$2bn there have been claims viaticals investors have been misled and insurers defrauded over bogus applications. There have also been severe problems with people living longer than expected. Indeed, a cure for terminal cancer could cripple viatical companies contractually bound to pay life assurance premiums for the rest of the insured life. It is also worth considering the investor will continue to pay premiums until the insured's death ' thereby creating a financial interest in the early death of the insured.

There have been concerns over tasteless selling practices in the US, and selling scams in the secondary markets. There are further worries that if the market grows, viatical companies will not be able to get contingency insurance to cover their liabilities.

Most of the concerns, however, have centred on the quality of the investment. This has led to the viatical secondary market being featured in the North American Securities Administrators Association's annual 'top 10 fraud' lists. The Association says: 'Because of uncertainties in predicting even when a terminally ill person is going to die, these investments must be considered extremely speculative'.

It is important that investors understand the actuarial calculations that underlie traded life policies (TLPs). For example, The Shepherds Group has undertaken research on TLPs and found that terminally ill individuals diagnosed to live for 36 months in reality live for 24 months. This contrasts with those who are diagnosed to live for 24 months, who in reality live for 36 months.

This actuarial anomaly forms the basis of the fund's estimated returns. If individuals die sooner than diagnosis, the TLP investor will get greater returns. They will save money on not paying the premiums on the policy, and will get more favourable rates due to the longer terminal diagnosis.

There are concerns over this. Such research means one of two things ' either doctor diagnoses for terminally ill patients are completely inaccurate, in which case there are serious doubts over the consistency of the returns offered by these policies. Alternatively, the research is not as comprehensive as would be desired. Indeed, Shepherd's research also shows the actual lifespan for someone diagnosed to live for 60 months is three months. By their own admission, there is an insufficiently large sample size for this demographic.

There are further factors that investors should consider. There is a time delay risk inherent in the receipt of claim monies, since these are coming from insurance companies. This can affect performance and has been factored into the Shepherd's model. Shepherds estimates that this is generally three months.

There are also tax implications from TLPs. If the investor is a UK resident they will be liable to tax, as they do not have a life interest. The cost of the life policy and premiums cost is deducted from the payout, but the rest is chargeable to Capital Gains Tax. Equally, the management charges for such products can be quite high.

The secondary market might provide good returns, especially in its embryonic stages. But investors need to be very aware of the inherent risks in these products, and their reliance on inaccurate diagnoses. They also need to be aware that advances in diagnostics and medical treatment could severely impact the secondary market.

Despite issues in the secondary market, and the limitations of usage, it is likely viaticals will become increasingly more popular, as they have in the US. While there must remain severe reservations, they may remain a solution for some, giving access to funds at a critical time. When time is at a premium, viaticals may ensure money is not.

Charles Ansdell is senior technical manager at Inter Alliance