Viatical Settlement
A viatical settlement is a transaction in which a person with a terminal or life-limiting illness sells their life insurance policy to a third-party buyer for a lump sum that is less than the face value but greater than the cash surrender value, providing immediate liquidity to the policyholder.
Viatical settlements emerged in the 1980s during the AIDS crisis as a mechanism for terminally ill policyholders to access the value of their life insurance while still alive. Patients with limited life expectancies needed cash to pay medical bills, living expenses, and end-of-life costs, but their life insurance policies would not pay until death. The viatical settlement created a secondary market for that future benefit.
In a viatical settlement, the terminally ill policyholder sells their policy to a viatical settlement provider — a licensed buyer — for a negotiated lump sum. The settlement amount is a discount to the face value that reflects the buyer's anticipated holding period, cost of maintaining the policy, and required return. The buyer becomes the new policy owner and beneficiary, continues paying premiums if any are due, and collects the full death benefit when the insured dies.
Settlement amounts vary based on the insured's life expectancy: the shorter the anticipated survival period, the closer the settlement amount is to the face value, because the buyer expects to receive the death benefit sooner. An insured with a six-month prognosis might receive 80 percent of face value, while someone with a two-year prognosis might receive 50 to 60 percent.
Viatical settlements are regulated at the state level. Most states require viatical settlement providers and brokers to be licensed. The IRS generally treats proceeds received by terminally ill policyholders — those with a life expectancy of 24 months or less — as income-tax-free under the same rules that apply to accelerated death benefits.
Life settlements are the closely related concept applied to policyholders who are not terminally ill but are elderly and may no longer need or be able to afford the policy. The mechanics are similar, but the discount is typically larger due to the longer expected holding period.