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Your Money Weekend : YOUR MONEY | PERSONAL FINANCE

Law Aims to Protect 'Death Futures' Buyers

October 27, 2000|Kathy M. Kristof

A new state law should help protect California's most vulnerable investors from losing everything to ill-advised investments in viatical settlements--often dubbed "death futures" because they're an investment that pays off when somebody dies. But experts warn that the law won't completely prevent viatical fraud.

Earlier this month, Gov. Gray Davis signed Senate Bill 1837, which adds viatical settlements and so-called senior settlements to the definition of "securities" in California corporate law. The change, which goes into effect in January, will require viatical companies to register these securities with the state Department of Corporations before they can sell them to small investors.

The only exception to that is when sophisticated investors--those with either high annual incomes or at least $250,000 in net assets--want to include viaticals as a relatively small portion of their portfolio. Even then, the law will require significant disclosure before the sale goes through.

Regulators believe this will benefit senior citizens who are being sold viatical investments with misleading promises of high profits and humanitarian benefits.

Nonetheless, investors still need to be on their guard. Even in the best of cases, regulators act only after consumers have complained. It is unlikely that this, or any law, will be able to prevent all investors from getting taken, particularly by companies that choose to operate outside the rules.

"Companies that want to operate here illegally will continue to do so," says Gloria Grening Wolk, author of two books on viatical settlements. "This is a reactive measure. [State officials] can't do anything until they have complaints."

In reality, what the law should do is halt the legal sale of viaticals to small investors who may be unsuitable for such a risky investment, says William McDonald, head of enforcement for the California Department of Corporations. That's mainly because these investments would have to be registered and approved by the state before they could legally be sold to anyone other than well-heeled investors and pension fund managers. Given what McDonald has seen so far, he doesn't plan to approve any viatical contracts for sale to individuals.

"This is one of the biggest scams in the United States and has been for several years," McDonald says. "Despite the fact that I can't imagine why anyone would want to buy one of these investments--they are dependent entirely on predicting the time of death [of the policyholder], which is impossible to do--they are a very hot investment that is being marketed heavily, particularly to seniors.

Viatical settlements are hybrid investments that sprang up in the late 1980s at the height of the AIDS crisis. A large group of young, single men found themselves losing their jobs and running through their savings while they battled the life-threatening illness. For many, their last remaining asset was a life insurance policy, which wouldn't pay off until they died. It was a cruel irony considering that they desperately needed the money to live and finance their medical care, and many didn't have dependents who relied on them for financial support--the traditional purpose of life insurance.

Someone came up with the idea to sell these life insurance policies. Here's how it would work: The investor agrees to buy the policy for a percentage of the death benefit. The policyholder, in turn, would change the beneficiary on the policy to the investor. So an investor might pay, say, $70,000 for a policy that promised a $100,000 death benefit on a policyholder who was diagnosed with less than two years to live. If the policyholder died on schedule or before, the investor got a double-digit return. But the average annual return diminished each year that the policyholder lived.

As the viatical industry grew and matured, two problems arose. First, when policyholders didn't die as quickly as diagnosed, they were getting harassed by investors inquiring about their health. Secondly, few investors had enough cash to buy a policy outright.

Brokers entered the fray to provide a buffer between policyholders and investors, and policies began to be sold simply with descriptions of the policyholder, rather than with names, addresses or other specifics. Meanwhile, these policies also were sliced into pieces, so that smaller investors could buy just a fraction of a policy.

A host of abuses followed, including outright fraud. And regulators have been hindered by court rulings that placed viatical settlements beyond the purview of securities regulators. State regulators believe the new law will remedy that.

The law puts the onus on the selling company, forcing them to prove that they are either registered with the state to sell viatical investments, or able to qualify for the exemption to the law.

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