The new AIDS drugs are having a dramatic financial impact on those with HIV who want to sell their life insurance.

Sellers face a chaotic viatical market in 1997. The number of buyers has fallen - and buying patterns have changed radically. Offers have fallen for those in poor health while offers have rapidly risen with better health. Payments are now reported to the IRS. Tax-free settlements are possible but only if complex residency, licensing, and life-expectancy requirements are met.

-A News-sensitive Market

A child of the 90s, viatication is the sale of ownership in a life insurance policy giving the new owner the rights to name beneficiaries and reassign ownership - all in exchange for an immediate payment of a percentage of the policy's face amount.

Like any Wall Street market, these buyers react wildly to news - whether it's bad or good. And AIDS news often gets magnified and distorted by researchers wanting to get funds by making a public splash, by the focus of international conferences - and by journalists desperate for dramatic news.

• In Berlin the news was bad; as a result viatical firms got easy access to cheap bank and insurance company funds and made high offers mostly to very sick people - up to 90% of a policy's face value.
  
• In Vancouver the news was good; as a result "conservative" money - bank, insurer, and corporate funds - dried up. But "maverick" money - private investor funds - rushed in to fill the vacuum.

Worse Health? Worse Offers!

Because conservative firms had cheap money they were able to advertise and make 80-85% offers in the past; likewise they often wouldn't even bid below 60%. In NY & CA over 3/4 of these firms are no longer in business. The remaining firms are making low offers when there is any ambiguity about health. However I still see offers in the low 80% range where people are clearly in bad health; people in such circumstances should seek out conservative firms.

Better Health? Better Offers!

Maverick companies are willing to trade high-risk in search of high-returns, filling the void left by departing conservative firms. They act as middlemen who don't get paid unless they make the deal. That why they tend to make extraordinarily high offers - sometimes 15-25% more than industry norms - especially for policies held by people in better health. How can this be? When life expectancy of sellers is ambiguous these mavericks can claim to their investors that life expectancy of these mid-range cases is really much lower. This in turn can justify the higher price used to lure in the policy and pay the broker fees.

A Cap on High Offers

Because mavericks pay at least three commissions - to find the buyer, find the seller, and make the deal - they often can't pay much more than 70-75% for policies - even when the seller truly has a very low life expectancy.

This means that a person in current poor health is severely penalized in the maverick market - while the person who may be selling policies speculatively is making a killing.

The bottom line is that the market has moved from one of 60-85% offers to one of 30-75% offers - a truly ironic financial development spawned by the new drugs.

More Wild Card Offers

Viatication is speculation on life expectancy. Buyers make offers based on their own theories about why some people die and why some live. Conservative firms hire several specialized MDs to evaluate cases. Mavericks are run by entrepreneurs who often don't. Maverick offers in fact are sometimes driven as much by funds availability as by life expectancy. If the maverick has just received an influx of funds, offers will be abnormally high; if not, they may not even be interested in bidding.

Mavericks are motivated by market competition as well. If they don't get the policy, they don't get their dealer fees. And they don't hold the risk.

Growing Contradictions

Here's two cases that illustrate the sharply contrasting differences these current conditions have produced:

• a person with a high 240 t-cell count - whose life expectancy on paper was 2-4 years - received a 63% offer from a maverick company;
  
• a person with 10 t-cells, who had to be taken off the new drugs, received only a 64.5% and 65% offer from two conservative companies.

Tax Complications

The greatest danger to sellers is that sales from 1/1/1977 onwards are declared to the IRS. They are only tax-free if two life expectancy and residency conditions are met.

Life Expectancy Ambiguities

For a settlement to be taxfree for the seller a physician must estimate life expectancy to be less than two years (after an examination). Because most of the current speculative buying and selling is taking place in cases where life expectancy may be more than two years, getting a MD statement that life expectancy may less than two years may be difficult.

Residency limitations

The second requirement depends on whether the seller's state of residence licenses viatical firms or not.

• If the seller's state licenses firms, the actual buyer must be licensed in that state for the sale to be tax-free.
  
• If the seller's state doesn't license firms, the seller must get a written statement that the buyer respects the price minimums recommended by the National Association of Insurance Commissioners - the NAIC.

Hidden Tax Dangers

The problem is that most maverick dealers are not licensed in the key states where many people with HIV live: NY, FL, TX, CA, and IL. These states require licensing. If their residents deal with non-licensed firms, the money is taxable.

Since the amounts are large, these buyers may find themselves at tax time the following year catapulted into a much higher tax-bracket. These are very real, formidable federal tax obligations.

Deceptive Practices

The IRS is now designing the 1099 forms by which this income will be declared in January of each year. There is no procedure yet for the buyers; nor is the information buyers will put on the forms yet identified. This lack of definition sets the stage for misinterpretation, information getting lost, and exploitation by the unscrupulous.

In their eagerness to seal a deal, some brokers and dealers using this delay to either downplay or deny the taxability of these sales or these requirements. Yet Federal law is absolutely clear on these two requirements.

Many brokers falsely claim that if they are licensed in the state of the seller, all's well. This is patently untrue.

Residency Games

Some buyers change residency to states that don't license viatical firms. IRS residency requirements are very strict - and not easily changed; consult an attorney. Moreover, sellers may be inadvertently giving up entitlements they may need in the future - and create liabilities for estate taxes. (Eighteen states levy higher estate taxes for unmarrieds than for people with families.)

Tax Fallout: Fewer Buyers

Sellers in states which require licensing have far fewer buyers to choose from. Many conservative firms have ceased operations; most maverick firms are not licensed.

In New York, for example, there are only several conservative and maverick firms left. In California a similar dramatic fall has taken place. Illinois had only five licensed firms for a year after it started licensing; now it has seven.

This restricts competitive bidding - and bars people in states that license firms from getting tax-free settlements from the maverick firms currently making extraordinary midrange offers.

Pre-1977 Tax Liabilities

Another catch-22 awaits those who sold their life insurance and didn't pay the taxes prior to 1/1/1997. This was in fact income on which tax was due even though 1099 forms didn't state it.

If there is an audit serious enough for bank records to be requested, the payment will be glaringly obvious. This happened in one case - and the taxpayer paid the tax - but the IRS did not impose penalties (nearly 20 types of penalties are possible).

In another case involving accelerated benefits the IRS backed off - presumably to avoid establishing precedent. It is possible that the IRS is not seeking to drag terminally ill people into tax court. However if the payment stares them in the face by law they must act. Caution is the best counsel.

Executors of estates who were aware of the receipt of a settlement by the deceased and who didn't declare it are personally responsible for the tax if the liability surfaces.

Fewer Safeguards

Conservative firms sought state licensing as a way to standardize industry practice and give sellers credibility and confidence in the buyer. Maverick firms often don't qualify by state licensing standards - or don't want strict overview of their operations. This produces some dangers for sellers:

• Unlicensed firms do not pay money into a genuine escrow account held by a truly independent attorney; without this safe neutral ground for the money and the signed papers to change hands, the seller is signing over the policy on faith alone.
  
• Breaches of confidentiality by dealers to investors occur.
  
• Commissions, bonuses, and secret side agreements with brokers are almost never disclosed.
  
• Contracts are not subject to the review of any regulatory agency.
  
• Some contracts are not truly purchase agreements but only "hunting licenses" - promises to pay if money is found.
  
• Contracts may be aborted if the funding suddenly dries up - which can tie up a policy for months, making it unsaleable elsewhere.
  
• The contract page dealing with price can be changed unless buyers initial each page.
  
• Without strong contractual safeguards, buyers will always respect their interests first, then brokers and investors in a conflict, error, or change in the market - not those of the seller.

More Broker Abuse

With the shift from conservative firms to maverick dealers, there has been a massive increase in brokering. A broker is an individual or a company which is paid by buyers to find sellers.

With more brokers fighting to find fewer sellers there has been more abuse. Brokers often don't identify themselves as brokers. An increasing number claim they have their own funds. Most brokers still promote the illusion that their services are free.

Wolves in Sheep's Clothing

Maverick dealers increasingly have their own captive brokers. A captive broker appears to offer brokering to many buyers but in fact funnels sellers to only one company. One conservative firm uses insurance agents to funnel clients in a similar way.

Higher Brokering Costs

Because the market is increasingly unregulated and policies are scarce, mavericks are paying higher, more varying commissions - plus bonuses for certain types of buyers or policies. Many brokers now charge the buyer 7% of the face value of the policy. Some brokers charge 1-2% extra to keep track of when sellers die. These commissions are well above those in real estate and the stock market - for basically introducing the seller to the buyer.

Because these commissions come off the top and are calculated on the face value of the policy this can cost the seller dearly. For example, on a $100,000 policy the 7% commission amounts to is $7000. If the buyer receives 50% or $50,000, this $7000 commission really amounts to 14% of the amount received.

More Broker Steering

Because commissions vary widely and because bonuses are frequently offered, brokers have a clear financial incentive to steer business to the company that pays the broker the highest commission - not to the company that pays the seller the highest offer.

The broker's loyalty is to the buyer - not the seller. The broker doesn't want to endanger future commissions. Brokers have an incentive to close out cases quickly to the satisfaction of the buyer - not the seller - and to not use competitive bidding. Using brokers is faster - because the policy is often being given away on terms advantageous to the buyer, not the seller.

Broker Safeguards

Sellers should question seriously what benefit the broker actually brings - in light of these practices and these costs. If the seller does use a broker, take these countermeasures:

• Commissions should be based on the amount received by the seller - not the face value of the policy.
  
• Commissions should be negotiated down before proceeding; 1-2% is adequate.
  
• The broker commission for each firm contacted should be stated in writing, up front, and in the contract.
  
• The buyer should declare in the contract that there are no side agreements or bonuses paid.

Offer Patterns

Strikingly, maverick companies are far more naive in medical analysis than conservative firms: they're using "other people's money" - and their offers are more market-driven or funds-driven rather than based on strict technical analysis.

Most mavericks still talk in terms of t-cell counts; few seem to rely on viral load measures. An analysis of offers this year shows no correlation with viral load and amount received.

Statistical analysis of one group of 1977 offers shows that t-cell count still is a good rough indicator of likely offer range:

• Where t-counts were less than 50 offers were all in the mid-70% range.
  
• Where t-counts were 100-150 offers were in the 60% range. However, great variation begins to be seen. Here are four offers in the 100-125 t-count range: 55%, 60%, 69%, and 70%! Here are three offers where the t-count was 150: 57%, 60%, and 66%.
  
• Where t-counts were 200+ offers fall to the 50% range - but there was an offer for 59% where the t-count was 250.
  
• Where t-counts were 300 offers fall to the 40% range - but in the statistics ranged from 37-50%.
  
• Some 30%+ offers have occurred in the low 400 t-count range.

Shop!

The point to be drawn from these statistics is that offers have a pattern - but can vary widely. This means that there is a significant benefit to be obtained from competitive bidding through direct dealings with buyers.

Further statistics show that opening bids can be 10-20% less than closing bids - but only when competitive bidding occurred.

Do Competitive Bidding

Because offers vary widely - from company to company and from opening to closing - sellers are wise to use competitive bidding.

A list of firms can be obtained from the VAA [Viatical Association of America] 800/842-9811 and the NVA [National Viatical Association] 800/741-9465. Simply tell the viatical firms you contact that you are not looking for a broker.

For details on how to do competitive bidding see my previous article on viatication, "Was that buy low, sell high, or...?", published in Positively Aware, July/August 1995 - and look for a TPA website on viatication soon. It will include a recent how-to article, "Viaticating Life Benefits," published in Case Review, Summer 1996.

The buyers will want a copy of the insurance immediately. It helps greatly if the physician's office cooperates in two ways: to release to buyers records of the last two years to the firms - and answer calls from their MDs.

When you get offers in, simply let firms know what the highest offer is (but not who made it) - and give all bidders one single chance to make a high bid. Then stay with that high bid. Do not go back and forth - it's likely you'll lose bidders.

Consider Help

This sale is probably the biggest financial transaction most sellers have made in their lives - often bigger and more complex than selling a house.

Review overall finances and estimate how much is needed over time. A partial viatication is possible. Explore other options such as seeing if selling the policy directly to the insurer if life expectancy is less than 6-12 months is possible. Always explore tax and entitlements implications.

The best way to do all this may be to hire a negotiator - just as is being done in the real estate market. This can be a financial or legal expert experienced in the current market - paid by you, not the buyer.

The cost should be based on the actual time incurred or the actual price obtained - usually between 0.5% and 1.5% of the policy. Either way, this will cost 80-90% less than a broker. The bonus in using an expert is getting overall financial or legal advice.

There are now only a handful of experienced negotiators in the US. But if competitive bidding becomes the norm - whether by the seller, a friend, an attorney, or a financial advisor - sellers will save thousands of dollars in useless broker fees and get a price that is 10-20% more than the opening bid.

Short-term Uncertainties

If the media launch more "end of AIDS" articles, conservative firm offers will be even lower - and perhaps even fewer in number.

If the scandal articles get written about small investors being taken for a ride offers may fall. As more investors find they own policies on some very healthy people, some mavericks may go out of business.

Class action suits against some mavericks are being readied. Hard research reveals that the volume of the largest maverick firm has fallen by over 85%. As this firm's funds got scarce, their offers went down.

Watch out if the stock market falls and investors become cautious. If the market implodes because of these factors, is this the end of viatication? Not likely: this innovation is here to stay - although dramatic changes will continue. Like it or not, viatication has been a lifesaver for many when the chips were down.

Long-term Optimism

America seems to invest in anything in the current market. Since small investor funds are usually "pooled" to buy a policy these investors have little ability to check out or monitor the facts. Small investors left owning shares in the policies sold may not know the deal was bad until 2-4 years later. Moreover, it's easy to recruit funds and set up as a maverick again.

In the longer run as it becomes easier for conservative companies to predict how people may react to the new drugs, a new viatical market will emerge - one based again more on technical analysis than on market or financial factors. Mid-range speculative offers may fall but offers for those in poor health may rise.

Expect more states to require licensing - which at first will restrict the number of bidders for a tax-free settlement. But states with strict licensing like New York are rewriting their statutes (as of 1/1/1978) to accommodate - and regulate - the mavericks. As this happens this market will stabilize.