Viatical settlements allow a life insurance policy owner to sell the policy to a third party at a discounted rate from the face value of the policy. The latest Dr Wise investment advice column on the Securities & Futures Commission website suggests that the risks of viatical settlements are very different from investments commonly sold in Hong Kong such as stocks or bonds.

Typically, an insured person will have a shortened life expectancy and is in need of financial resources to offset medical or other expenses. Viatical settlements are arranged by a 'middleman', commonly known as a viatical provider.

The viatical provider purchases the policy ownership and beneficiary rights from the policy owner and sells the investment opportunity in the death benefit to an investor. When the insured dies, the investor gets the death benefit under the policy.

There is not a large market allowing life insurance policy owners to viaticate (or sell) their policies in Hong Kong. However, the commission is becoming increasingly aware of offers of viaticated insurance policies to Hong Kong investors.

Returns depend on life expectancy

The purchase price of viatical settlements and the returns thereon are highly dependent on the accuracy of the estimate of the insured's life expectancy as compared with the actual date they die.

The identity and creditability of the viatical provider is also very important as it plays a key role in locating the insurance policies available for purchase and arranging the transfer of beneficial ownership to investors.

In most cases, the viatical provider or an affiliated company is responsible for continuing to service the insurance policy after the viatical settlement is entered into, such as, paying policy premiums on a timely basis, maintaining contact with the insured and tracking the health status of the insured.

Normally speaking, a viatical provider will make certain disclosures to an investor before entering into a purchase agreement, including for example, information on the net death benefit, rate of return, the identity of the party or parties responsible for making future premiums, the life expectancy of the insured and who determines the life expectancy of the insured, such as in-house staff, independent physicians, and specialty firms.

Since the basis of a viatical settlement is a life insurance product, premiums must continue to be paid until the insured dies and the policy matures. The viatical provider usually factors in future premiums when selling viatical settlements to investors and funds are set aside by the viatical provider and held by an escrow agent in an escrow account for the estimated life expectancy of the insured. The viatical provider or an affiliated company uses these funds to pay future premiums.

However, depending on the purchase agreement, investors may be asked to make further contributions to pay for premiums if the insured outlives his original life expectancy.

Fraud may arise

Although viatical settlements could provide important social benefits, the system is open to potential abuses. One area of exposure is the critical role played by the 'middleman', or the viatical provider, whose job is to match a seller of a policy with one or more investors. The viatical provider has incentives to take advantage of terminally ill patients who are desperate for funding and overcharge investors to pay more than a policy is worth.

There are numerous reports of failures and frauds involving viatical providers in the US. Combined with deceptive sales practices and inflated commissions paid to viatical brokers and financial planners who offer these products as investment alternatives, sellers of policies and investors must be aware of the special risks of these products.

SFC looks into the products

The commission is looking into the offer of these products in Hong Kong and will take appropriate action if there has been a breach of the law.

Under the Securities & Futures Ordinance, it is an offence to offer the public any securities, interests in collective investment schemes or regulated investment agreements unless authorised by the commission or exempt.

To date, no viatical settlement product has been authorised by the commission for public offer in Hong Kong.

Intermediaries licensed or registered with the commission are required to exercise due skill, care and diligence in making investment recommendations to their clients. In particular, investors should expect intermediaries to make full disclosure of the risks involved and ensure the suitability of the investments recommended.