The primary subject matter of this case concerns viatical settlements. This case may be used as a student assignment in a variety of college classes: (a) individual income tax, (b) tax research, (c) financial principles, (d) investments, (e) insurance, (f) fraud examination, or (g) an ethics class. Its primary use is intended to be in a graduate or senior capstone in which the students would be expected to examine the case from all perspectives: tax, investment, fraud, and ethics. The case should take the best students two or three hours of analysis and two hours of writing and editing to prepare if the response is a graded paper, but it could be discussed in a class cold--without any prior preparation by the students other than reading through the case-- as it deals with relatively simple investment, tax, and ethical ideas with which most students have some basic familiarity. For each possible use, the case offers many teaching points that an instructor may use to lead the discussion. Difficulty level is rated four to five.
Nita Beth and her husband David are middle-America, middle class college graduates with some sophistication in investing. They are confronted by the need to invest for the future, and the opportunity to make an investment with high potential returns. Jacob is dying, and needs cash for his medical expenses. He has life insurance, but how can he get the cash he needs now? A viatical settlement transaction may be the answer for these people. Or, is it?
Nita Beth's real name is Anita Elizabeth Wilson Salazar. She is a college professor in a small town in southwest Oklahoma. Having graduated from Southern Illinois about 15 years ago with a master's in accounting, Nita Beth worked briefly in Houston, while she studied for the CPA exam. About the time she finally passed the exam, she met David.
David Salazar had been a police officer in Houston until he was wounded during a routine arrest. He searched the prisoner but somehow missed the knife, and the prisoner managed to stab David while being put in the car. It was just a fluke, really, but the knife had damaged the sciatic nerves down David's left leg, and it left him in almost constant pain and with a slight limp.
After they met in Houston, and subsequently married, Nita Beth took the job teaching school. It offered a steady income, and good working conditions in terms of hours, dress codes, nice people to work with, etc. The pay would probably never be very high, but it was more than competitive with the pay in the beginning and mid level public accounting jobs in Houston. David had rolled over his 403-B plan from HPD when he retired, and he had his disability pension. This too was money never destined to be much higher than it was today, with only COLA raises to look forward to, but it was 80% of his pay as a Sergeant on the police force. Both Nita Beth and David were glad that their income was as good as it was, but they both could see that their expenses were going to keep rising over the years, while their total income probably would not change much. That is why they decided to invest the $85,000 of life insurance proceeds that Nita Beth had received when her dad passed away.
When they talked to the life insurance agent who had brought them the check from the life insurance policy, they asked for his advice on investing. He recommended his friend Tom, who was a part-time real estate broker and part-time investment advisor who rented the office next door. Tom's idea of investment advice was to analyze Nita Beth and David's assets, liabilities and income with a computer program given to him by a life insurance underwriter, and then to recommend products like insurance annuities, life insurance, and conservative mutual funds from companies he represented. For his wealthier clients he had some raw land deals that he had syndicated. Since the Salazars wanted a big percentage return but were too small for the risky real estate deals, and had too little tolerance for stock funds given the bubbles and serious market reverses of the last few years, Tom recommended they invest in a privately syndicated pool of life insurance policies in a transaction called a viatical settlement. Nita Beth and David looked it over, and thought it was a good deal--the best-case scenario showed a 40% return over fewer than five years.
Jacob LeBlanc did not know who transmitted the HIV infection to him, or even it if he got it from a person. Jacob did not do drugs--at least not the kind that one injected--and even if he did not always practice "safe sex" he did know who his partners were. At 31, he was still young looking, and always considered himself healthy. Eight years ago, when he had been in a motorcycle accident, he had received a couple of units of blood in a transfusion during surgery. Jacob recovered from the accident, but a few years later learned that he had contracted the HIV virus--maybe from that blood transfusion. He discovered it after it turned to AIDS, when he had a cold and cough that he could not seem to shake. That and some weight loss took him to the Doctor, and a screening test told the diagnostic tale. It was devastating news: the treatment was expensive and did not work particularly well. When he had used all of his vacation and sick time, and the word got out as to why, the company had let him go. He had the COBRA insurance, but it was ridiculously expensive, and his savings were about gone. The prognosis was not good.
Jacob learned from his insurance agent that the group life policy in his COBRA plan could be converted to an ordinary life insurance policy, and the policy could be sold so that Jacob could have a big part of the death benefit up front. He did it, received $70,000 in cash, paid off his car note, got current with his Doctor bills, and still had plenty of cash for the medicine. He was resigned to his fate, and thought he had made a good deal, considering everything.
Viatical settlements allow insured policy owners to sell their insurance death benefits to investors. The investors then become the owners and beneficiaries of the policies, make premium payments until the insureds die, and collect the death benefits. Investment vehicles for viatical settlement syndication consist of pooling a series of high-premium term and/or ordinary life policies issued on the lives of persons who have been diagnosed with HIV/AIDS or other life threatening illnesses. The price the insureds receive is the present value of the death benefit, discounted at a rate, and over a time, calculated to allow the pool to pay a return on investment, and have enough cash flow to pay its expenses, including the premiums on the policies it buys. This was a win-win-win deal. The insured patients got much needed cash up front, to help pay for treatment, living expenses and so on. The insurance company sold the policies, which were actuarially underwritten so that the insurance underwriter would make money and pay commissions to the sales people. The investment advisor/syndicator collected commissions from the insurance companies for selling the policies, and collected an annual fee for managing the pool, and the investors were to get nearly spectacular returns.
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Henry Elrod, University of the Incarnate Word