Elrod, Henry, Journal of the International Academy for Case Studies
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?
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?
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. § 101(g)(2)(B) and the status of the insured under IRS Reg. § 101(g)(4)(A) and IRS Reg. § 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. …