Informed Investor: Evaluating life insurance coverage and needs, Part IV: Viatical settlements

Life insurance policyholders may realize at some point during the term of their policies that they no longer want to own the policy. Some possible reasons for no longer wanting to own a life insurance policy are premium unaffordability and removing the life insurance policy out of one’s gross estate. With respect to removing the policy out of one’s gross estate, life insurance policyholders should understand that while the life insurance proceeds are not considered taxable income to the beneficiaries, with most policies the insurance proceeds are included in the deceased policyholder’s gross estate and possibly subject to federal and/or state estate taxes.

Fortunately there are alternatives for life insurance policyholders who want to terminate their policies, and who thereby would lose life insurance protection and insurance premiums previously paid. These alternatives are a viatical settlement and an assignment, discussed below.

A viatical settlement allows life insurance policyholders to sell their policies to an investor, resulting in an immediate cash settlement and benefit for the policyholder. In return, the investor/buyer in the viatical settlement becomes the new life insurance policy owner, is responsible for paying the policy premiums, and collects the death benefit when the insured dies.

At one time, most viatical settlements were offered to individuals with a life-threatening illness such as AIDS. Today, individuals who are not facing an immediate health crisis may sell their life insurance policies and receive cash. Some life insurance policyholders, particularly those individuals owning cash value (permanent) life insurance policies, are being contacted by viatical firms to sell their life insurance policies for cash.

The following is some information and guidance for federal employees who are considering selling their life insurance policies through a viatical settlement:

• When the life insurance policy is sold, as previously noted, the investor/buyer in the viatical settlement becomes the new policy owner, pays the future premiums, and collects the death benefit when the insured dies. The original beneficiaries designated by the seller—the original policy owner—will receive nothing at the death of the insured.

• Every state insurance department has a list of viatical settlement providers and brokers licensed to do business in their states. Employees should make sure their provider is on the list.

• Employees should ask their state insurance department for a copy of regulations related to viatical settlements for their financial advisors to review.

• Employees interested in selling their life insurance policies should contact their state insurance department before they sell their policies.

• Employees who are enrolled in the Federal Employees Group Life Insurance (FEGLI) program and who are terminally ill (expected to die within nine months) can assign their FEGLI coverage to a viatical settlement firm in exchange for cash; FEGLI coverage available for a viatical settlement include “Basic” coverage, Option A (Standard) and Option B (Multiple of Salary).

Another method of removing one’s self as a life insurance policy owner but maintaining coverage is through assignment. Assignment means that ownership and control of the policy goes to someone else, the assignee. Ownership and control of the policy includes designating new policy beneficiaries if so desired.

An employee who is enrolled in the FEGLI program may assign the Basic life insurance and optional coverages—Option A (Standard) and Option B (Multiple of Salary). Assignment may be made to an individual, to a corporation, or to an irrevocable trust. Under FEGLI, a decision to assign one’s life insurance coverage is irrevocable. Once done, an assignment cannot be changed.

The following example illustrates an assignment of FEGLI coverage and why the employee wants to perform an assignment.

Tom, a federal employee living in Maryland, currently has $500,000 of FEGLI coverage ($100,000 Basic plus Option B equal to four times his salary). Tom owns a house worth $400,000, a TSP account equal to $300,000, and other investments totaling $200,000. Including the FEGLI coverage, the value of Tom’s gross estate is $1,400,000.

While the value of Tom’s gross estate is below the federal gross estate exemption of $5.25 million in effect during 2013, his gross estate is $400,000 above the State of Maryland gross estate exemption of $1 million. Tom assigns his FEGLI coverage to his brother. His brother keeps the same beneficiaries, Tom’s children. Tom continues to pay the FEGLI premiums and when Tom passes away the FEGLI gross proceeds will not be included in his gross estate.

Any employee or annuitant is allowed to assign their FEGLI policy to a viatical company and receive cash from the viatical company. The Office of FEGLI (OFEGLI) allows an employee or annuitant to request this even if the individual is not terminally or chronically ill.

But in practice no viatical firm in the industry will pay for receiving assignment for an individual’s life insurance policy in which the individual insured is not terminally or chronically ill. It simply makes no sense. The firm would have no expectation of when they would receive the death benefit. In practice, the firm would have to significantly discount the amount paid for the policy in order to take into account the uncertainty, resulting in a settlement amount close to zero.