New AIDS treatments have been hyped to the point where magazines covers shout "Cure!" Contrary to the headlines, there has been almost no reaction from disability insurers; social security guidelines remain unchanged.

However panic has given way to chaos in selling life insurance to what are called viatical settlement companies. Like any financial market, viatical firms and funding sources have reacted wildly to the hype. In a matter of months, bank financing has virtually dried up. In its place, high-risk private investor funding has mushroomed.

Sellers have overreacted as well - unloading policies without concern for poor prices or the fact that settlements closed prior to 1/1/1997 are taxable income under federal law. (They remain tax-free under NY state & city law.)

Federal legislation passed this summer makes viatical settlements tax-free as of January 1997 If two conditions are met the buying firm must be licensed in the state of the seller, and life expectancy must be less than two years.

Non-New Yorkers who live in states that don't yet have licensing must get proof from buyers that the sale meets certain price guidelines established by the NAIC (National Association of Insurance Commissioners).

New York's Unique

For New Yorkers, the shift in funding may create dramatic, unintended price and tax consequences for sellers. Why? Because New York has had the strictest licensing requirements it had attracted mostly mainstream financed firms. Many investor-financed firms in fact pointedly refused to apply for licensing in New York.

The result is that going into January 1997 in New York, an estimated nine out of the thirteen licensed firms in New York are either out of business or out of money. Competitive choice for New Yorkers has narrowed significantly. Most of the firms New Yorkers see advertised are not licensed; most advertisers in fact aren't even firms with their own money.

The situation promises to be doubly frustrating because New York sellers won't be able to legally deal with new "cowboy" investor-financed firms that are not licensed in New York. If they do deal with them the new federal law makes the settlement taxable.

Cowboy offers Most of the rest of the country remains unlicensed. They can deal with these "cowboy" firms but need to watch out for badly written contracts, false assurances, scams, and delays - the things licensing protects consumers from.

Even so "cowboy" offers these days are far higher than those from establishment-financed firms. Why? All that the investor-financed firms care about is their profits which are made through their middle-man fees in putting the deal together. If it takes a high offer to make that happen, so be it. The small investors who are the ones left owning the policies sold won't know if the deal was bad for them until a year or two later. Since small investors are usually "pooled" to buy a policy they have little ability to check out the facts before purchase - unlike the self-funded "establishment" companies.

Because of this the "cowboys" especially want policies held by people whose life expectancy is mid-range - 24-36 months. Why? With life expectancy vague they can claim to investors that life expectancy is really much lower so they can justify higher middleman fees - without any easy way for the investors to verify this.

Because their middleman fees are high, the "cowboys" can't pay much more for policies where the seller has a low life expectancy. Their middleman fees plus the fees they pay to people who find the small investors are so expensive that their highest offers are often only in the low 70% range.

Establishment offers The irony is that establishment-financed firms normally bid high work with much cheaper money and buy the policies for themselves. This enables them to pay up to 80%-90% for a policy from someone with a very low life-expectancy. This also makes them extremely reluctant to bid at all on people with mid-range life expectancies. They want a sure deal.

To give an idea of the differences here's one recent example

• a person with a high 240 t-cell count whose life expectancy on paper is easily 2-4 years received a 63% offer from a cowboy company;
• a person with 10 t-cells, who has had to be taken off the new drugs and whose prognosis is poor indeed received a 64.5% and 65% offer from two establishment companies.

Given this stark contrast, many might be tempted to deal with the "cowboy" firms. If they do they can expect these kinds of FALSE assurances which clients have reported to me

• that all settlements are tax-free in 1997;
• that no 1099 forms will be issued to the IRS;
• that the firm has in fact applied for licensing;
• that all that counts is the buyer's state of residency;
• that all that counts is the broker's state of residency;
• that the buyer simply needs to say they were resident elsewhere.

In fact only settlements that satisfy both conditions are tax-free; 1099 forms will be ready and sent out as of 1/1/97; the seller's state of residency is the only one mentioned at all by the law; and changing residency is a complex act that impacts entitlements and all income tax.

While those with long-life expectancies are currently getting higher than normal offers, the life expectancy put on their 1099 form by the seller may be higher than two years - and that will make the funds received taxable income.

Action

What should a New York seller do?

• hold off viaticating if at all possible until the market settles;
• research any other way to generate funds, such as accelerated benefits;
• if very ill, negotiate carefully since establishment-funded offers in this sector are depressed and investor-funded offers may have a low cap;
• if not very sick, negotiate carefully since establishment-funded firms may not even make an offer and investor-funded offers are limited to only two firms;
• if not very sick, realize that life expectancy may be more than two years which may make the transaction taxable;
• seek professional help if viatication is necessary to negotiate the best price, to protect against consumer abuse, and to make sure the transaction is tax-free.