Stranger-Originated Life Insurance (STOLI) is controversial in the life insurance industry. It involves third-party investors purchasing life insurance policies on the lives of individuals they don’t have a direct relationship with, aiming to benefit from the eventual death benefits.
While STOLI arrangements can offer immediate financial gains for the insured, they also come with a host of ethical and legal concerns. This guide delves into the intricacies of STOLI, its implications, and its position in the broader insurance landscape.
What is a Stranger-Owned Life Insurance (STOLI)?
Stranger-Originated Life Insurance, or STOLI, is a life insurance arrangement where investors, with no insurable interest or direct relationship with the insured, initiate and finance a life insurance policy to benefit from its eventual death payout.
How STOLI Works
- Initiation: Investors or brokers approach seniors or individuals with a limited life expectancy, offering them an upfront payment or other financial incentives in exchange for participating in a STOLI arrangement.
- Policy Purchase: The investor or broker then purchases a life insurance policy on the individual’s life, paying the premiums.
- Policy Transfer: After a certain period, often the expiration of the policy’s contestability period, the policy is transferred to the investor or sold in the secondary market for life insurance.
- Death Benefit: The investor collects the death benefit upon the insured’s death.
Controversies And Concerns
- Ethical Implications: STOLI arrangements can be seen as wagering on human life, which raises significant ethical concerns.
- Legal Issues: Many states in the U.S. have regulations requiring an insurable interest at the inception of a policy. STOLI practices can sometimes skirt or violate these rules.
- Potential Fraud: There’s a risk of misrepresentation during the application process, where the insured might be encouraged to provide inaccurate information to secure the policy.
What is The Difference Between a STOLI And a Life Settlement?
Stranger-Originated Life Insurance (STOLI) and Life Settlements are both practices that involve third parties in life insurance policies, but they differ significantly in their origin and intent. Third-party investors initiate an STOLI without a relationship with the insured. Their primary intent is to profit from the death benefit. Investors or brokers approach potential insured individuals, often seniors, offering financial incentives to participate in a STOLI arrangement. The policy is held until the contestability period expires, after which it might be sold or held until the death benefit is paid out. At the inception of a STOLI policy, there’s no insurable interest between the investor and the insured, leading to ethical and legal concerns.
On the other hand, a life settlement occurs when an existing policyholder, typically a senior, decides to sell their life insurance policy to a third party for a lump sum. The original policyholder might choose to do this because they no longer need the policy, can’t afford the premiums, or want to access a cash value. The third party then takes over the premium payments and becomes the beneficiary, receiving the death benefit upon the insured’s passing. When the policy was originally purchased, there was an insurable interest, as the insured wanted to provide for beneficiaries. The sale to a third party in a life settlement transaction doesn’t require the same insurable interest since the policy is already in force.
While STOLI practices are viewed skeptically and are limited or prohibited in many states due to potential fraud concerns, life settlements are legal in most states. However, regulations for life settlements can vary, with transactions typically overseen to ensure fairness and transparency for the original policyholder. In essence, the key difference between STOLI and life settlements lies in the origin and intent of the policy. STOLI is initiated with the intent to profit, while life settlements involve the sale of an existing policy that was originally purchased for genuine insurance purposes.
Benefits And Drawbacks of Stranger-Owned Life Insurance
- Benefits: STOLI offers immediate financial gains for the insured, often through a lump sum payment or financed premiums.
- Drawbacks: STOLI can lead to potential tax implications for the insured. Additionally, it might limit the individual’s future insurability.
Due to the ethical and legal concerns surrounding STOLI, many states in the U.S. have enacted legislation to curb or regulate these practices. It’s essential for individuals approached for STOLI arrangements to be aware of their state’s stance on the issue and consult with legal professionals.
FAQs on Stranger-Originated Life Insurance (STOLI)
Can a stranger take out a life insurance policy on you?
No, a legitimate life insurance policy requires an insurable interest, meaning the policyholder must have a direct relationship or interest in the continued life of the insured. STOLI practices, however, involve third-party investors initiating policies without a direct relationship, which raises ethical and legal concerns.
Is investor-originated life insurance legal?
The legality of investor-originated life insurance, often called STOLI, varies by state. Many states have regulations or laws that prohibit or limit STOLI practices due to ethical and potential fraud concerns.
What is the purpose of a stranger-originated life insurance?
The primary purpose of STOLI is for third-party investors to profit from the insured’s death benefit. Investors or brokers approach potential insured individuals, often seniors, offering financial incentives in exchange for participating in a STOLI arrangement.
What is it called when you buy someone else’s life insurance policy?
Buying someone else’s life insurance policy is referred to as a “life settlement.” This is a legal transaction where a policyholder sells their life insurance policy to a third party for a lump sum.
Why do most states ban STOLI transactions?
Most states ban or regulate STOLI transactions due to ethical concerns of wagering on human life, potential for fraud, and violating the insurable interest principle, foundational to legitimate life insurance contracts.
Who benefits from investor-originated life insurance when the insured dies?
In an investor-originated life insurance arrangement, the third-party investor or the entity holding the policy at the time of the insured’s death receives the death benefit.