Recently, much information has begun circulating about the practice of stranger-oriented life insurance (STOLI) in the life settlement industry. Some of this information is, however, misleading or just plain wrong. For one, the process of a STOLI transaction is not as simple as a complete stranger choosing an unknown consumer out of a crowd and purchasing a life policy on them without their knowledge, as some reports tend to imply.
But what exactly is STOLI, and how does it relate to both the primary and secondary markets for life insurance?
According to the National Conference of Insurance Legislators' (NCOIL) definition of STOLI, it is "a practice or plan to initiate a life insurance policy for the benefit of a third-party investor who, at the time of policy origination, has no insurable interest in the insured."
Among other things, this definition emphasizes that a STOLI occurs at the beginning of a life insurance purchase transaction during the primary policy sale to the purchasing policy owner and with the insured -- in other words, between parties who consent, including a consenting insured.
If you're thinking, "Yes, but doesn't such a definition bring us awfully close to traditional and even common life insurance sales scenarios such as corporate or bank-owned life insurance?", you're right.
You need to ask questions; you cannot remain ignorant of the STOLI issue because you can easily stumble into unknown territory and, in doing so, could lose both your livelihood and your freedom -- especially if the new provisions in the NAIC and NCOIL Model were to become law in your state. Why? Because each model makes it a felony to violate their provisions.
Likewise, if you're not quite up to snuff on STOLI, a potential life settlement transaction is involved, and you're not well-experienced with settlements, it can be easy to misconstrue a STOLI arrangement as a non-STOLI arrangement, and vice versa.
Identifying STOLIs
Examples of STOLI scenarios, derived from the Ohio Department of Insurance Guidelines, include:
- Someone purchases a life policy on an insured -- often someone between the age of 65 and 85 -- in exchange for an immediate lump sum payment.
- Someone offers a contract to a potential insured for "free" or "no-cost" life insurance.
- Someone purchases a life policy on an insured (at no cost to that individual) in exchange for a partial payment of the policy's face value to the insured's beneficiaries upon the owner's death.
- Someone purchases a life policy or encourages another person to purchase a life policy for the sole purpose of eventually selling the policy to a third party.
Also worth noting is what the Ohio Department of Insurance describes as "materially participating in transactions leading up to the purchase of a life policy" within life insurance purchase scenarios such as those described above. Again, it is crucial that you stay informed about stranger-originated life insurance (which is also sometimes referred to as investor-originated life insurance).
It's not easy to stay on top of all things happening with STOLI, given that there are so many confusing STOLI definitions bandied about by seemingly reputable sources. Of course, some biased sources actually can have an interest in confusing the situation.
That's why you should look to sources such as NCOIL and your state's department of insurance. In particular, it is important to note that NCOIL's STOLI definition is included within that organization's revised Model Settlement Act. The model law is a targeted attempt to prohibit STOLI transactions while encouraging legitimate life settlements.
According to NCOIL Life Insurance & Financial Planning Committee Chair Representative Michael Ripley, "The end product of our work represents a thoroughly vetted proposal that takes aim only at what's wrong with the life insurance market -- STOLI."
Even the National Association of Insurance Commissioners (NAIC) did not appropriately address STOLI in its revised Model (Settlement) Act, issued last year. In fact, NAIC leaves the issue open and, therefore, open to abuse.
The good news is that, ultimately, as states appropriately amend their laws to define and stop STOLI from occurring in the first place, such transactions will disappear.
What is STOLI not?
In the meantime, to help you differentiate what is and what is not STOLI, here are three examples of non-STOLI transactions that you may encounter:
- A policy held by a family trust, such as an irrevocable life insurance trust (ILIT), that was originally legitimately purchased for estate protection and is later determined to not be needed and is sold as a life settlement.
- A policy held by a company on a key executive who leaves employment, leaving the company in a position to sell the policy after four years of owning it themselves and paying premiums on the product.
- A policy held by a child on their parent and on which the child borrows the premium in a premium finance loan where, from the outset, there was absolutely no intent to buy the coverage and subsequently sell it.
The bottom line is that, if you are faced with a potential STOLI scenario as it relates to a life settlement transaction and you are not comfortable with your technical grasp of the purchase structure of the policy in question, consult a fellow agent who is adept at such. Ultimately, you, your advisor partner, or your licensed settlement industry provider partner will likely consult a well-informed estate planning attorney for a "reading" of the situation, and it is well worth doing so until the 39 states that regulate viatical and life settlements adopt solid measures that stop STOLI where it starts -- at the initial purchase of the life insurance policy.
M. Bryan Freeman is the founder and president of the life settlement provider Habersham Funding LLC. He can be reached at 888-874-2402 or bfreeman@habershamfunding.com.
