The Investment

By Elrod, Henry | Journal of the International Academy for Case Studies, November 2011 | Go to article overview

The Investment


Elrod, Henry, Journal of the International Academy for Case Studies


INSTRUCTOR'S NOTES

THE INVESTMENT

The epilogue to the case is that, as happened in many viatical settlement investments, the seller Jacob got the $70,000 he needed, but more important, he got the benefit of great advances in the treatment of HIV/AIDS, and is still living over a decade later. The investors, David and Nita Beth, ultimately lost their investment, as the viatical settlement pool was unable to continue paying the premiums on the policies purchased for the investors, let the policies lapse, and failed.

Students should consider the information following in their analysis of this case. Here are optional discussion questions:

1. Do you think David and Nita Beth should make this investment? Why, or why not?

2. Should Jacob sell his insurance? Who is affected by his decision? What other alternatives should he investigate?

3. Prepare a presentation or report to support your answers to 1 and 2. Consider the investment from the point of view of the seller as well as the buyer, and report on the tax, insurance, investment, and ethical aspects of the transaction, and how these aspects support your recommendation for David and Beth, and for Jacob.

4. David and Beth were introduced to the investment by advisors who were not investment professionals (a life insurance agent and his next door neighbor, a real estate agent. What steps could they have taken to improve their chance of getting sound professional investment advice?

TAX.

Students should discover that the proceeds of the death benefit of a life insurance policy are not taxable income to the beneficiary. They should also discover that there are restrictions on the investments that can be made in an IRA or 401-K that may cause the income from the viatical settlement investment to lose its character and become taxable income. Whether the benefit is taxable to the buyer upon the death of the insured depends on the status of the viatical settlement provider under IRS Reg. [section] 101(g)(2)(B) and the status of the insured under IRS Reg. [section] 101(g)(4)(A) and IRS Reg. [section] 101(g)(4)(B). Revenue Ruling 2002-82 explains the requirements that viatical settlement providers who own the life insurance contracts from which death benefits are paid, and that the insured who sells the contract, must meet to enjoy the exclusion from income of the proceeds of the sale and the proceeds of the policy upon the death of the insured. Generally, under Section 101(a)(1) of the Health Insurance Portability and Accountability Act of 1996, the amounts received under a life insurance contract by reason of the death of the insured are excluded from gross income (IRS, 2002).

Normally, the sales price paid to the insured selling the policy is considered a death benefit under the policy for tax purposes if the seller is certified by a Doctor to have 24 months or less time to live, i.e., the seller must be terminally ill (APLA, 2008). For those only chronically ill, where death might occur in five years or less, for instance, the payment to the seller can be taxable, depending on the type of policy and the relationship of the settlement payment to the cash value and death benefit before and after the transaction. The relationship of the total premiums paid to the cash value and to the death benefit before and after the transaction, will determine whether the income from a life settlement for a chronically ill seller is taxed at capital gains rates or as ordinary income, or both.

The seller should also consider whether the receipt of a lump sum settlement, which will count as income whether taxable or not, might affect their eligibility for SSI and/or Medicaid payments (APLA, 2008).

FINANCIAL AND INVESTMENT.

Once invested in viatical settlements such as the one Nita Beth and David bought, investors cannot easily get their cash investment back. Viatical settlements are not considered liquid investments, as there is no functioning market for these products, and the syndicator or pool manager may be unwilling or unable to buy an interest back. …

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