Jeffrey Wade
Stranger-owned life insurance (STOLI) is a policy purchased by an investor on the life of a stranger, with the primary objective of treating it as an investment rather than financial protection for beneficiaries. STOLI policies are generally unethical and illegal in many states and localities due to the absence of insurable interest, which refers to the financial or emotional stake that a person has in the life of the insured. If a life insurance company discovers an illegal contract, they have the authority to void it, and the investor loses the death benefit.
| Characteristics | Values |
|---|---|
| Stranger-owned life insurance (STOLI) | Stranger-owned life insurance (STOLI) is a policy someone (usually an investor) buys on another person with whom they don't have an existing relationship. |
| Legality | Stranger-owned life insurance (STOLI) is generally illegal in many states and localities. |
| Insurable interest | To buy life insurance on someone else legally, you must have insurable interest, which means you would suffer a financial or emotional loss from the other person's death. |
| Marketing | Stranger-owned life insurance (STOLI) is often marketed to seniors as "zero premium life insurance," "estate maximization plans," or "no-cost to the insured plans." |
| Risks | Stranger-owned life insurance (STOLI) can lead to a moral hazard, where the stranger who purchases the policy has no insurable interest in the life of the insured and may be incentivized to take actions that increase the likelihood of the insured's death. |
| Consequences | If a stranger-owned life insurance (STOLI) policy is discovered to be illegal, the insurance company will void it and the investor will lose the death benefit. |
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What You'll Learn
Stranger-owned life insurance (STOLI) is illegal in the US
Stranger-owned life insurance (STOLI) is a policy that someone, usually an investor, buys on another person with whom they don't have an existing relationship. The purchaser buys life insurance as an investment rather than because they would suffer a loss from the other person's death. This uncomfortable arrangement allows the policyholder to benefit from a stranger's death.
STOLI policies are generally illegal in the US. To buy life insurance on someone else legally, you must be someone who would suffer from their death, like a family member. Many states have enacted laws specifically outlawing the practice. For example, in 2011, the former New York State Insurance Department (now the New York State Department of Financial Services), U.S. Postal Inspection Service, and the Internal Revenue Service conducted an investigation that led to the arrest of eight people, most of whom were licensed insurance agents who were recruiting elderly clients in a scam that involved STOLI.
STOLI arrangements try to bypass the insurable-interest requirement of purchasing life insurance. This requirement states that the owner of a policy must have an insurable interest in the life of the insured. In other words, the purchaser must be someone who would suffer a loss from the insured person's death. A common workaround of the insurable-interest requirement is to artificially create it. An investor who wants to take out a life insurance policy on a stranger may manufacture insurable interest by granting that stranger a loan. The stranger’s death would leave the loan unpaid, creating a financial loss and fulfilling the definition of insurable interest.
STOLI schemes are typically marketed by agents who stand to make high commissions for the benefit of investors, who hope to enrich themselves when the insured person dies. Seniors are often promised an upfront cash bonus and are told that the life insurance purchase itself is ""free" or "no-cost". These schemes can be very tempting to seniors who may need the money, but it is important to remember that there are often hidden costs. Seniors must be scrupulously careful that there is a legitimate insurable interest in any life insurance policy that is taken out on their lives. If an insurer finds that the policy sold lacked an insurable interest, the insurer can sue to rescind the policy, and the senior may be sued by investors for damages.
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STOLI policies are speculative investments
Stranger-owned life insurance (STOLI) is a policy purchased by an investor on the life of a stranger. The primary purpose of STOLI is to allow the investor to speculate on the life of the insured person, rather than to provide financial support for the insured's beneficiaries. This is achieved by the investor taking over premium payments and becoming the policy beneficiary. The investment pays off if the death benefit is greater than the price the investor paid for the policy plus their premium outlay.
Furthermore, STOLI policies are considered unethical and are largely illegal due to the absence of an insurable interest between the policy owner and the insured. Insurable interest requires that the policy owner would suffer a loss in the event of the insured's death. In the case of STOLI, the investor has no relationship with the insured and therefore does not meet this requirement. Many states in the US have enacted laws specifically outlawing STOLI practices, and insurance companies are increasingly vigilant in detecting such schemes.
The speculative nature of STOLI policies is also evident in the fact that they are often transferred or sold multiple times before the policy matures. This further distances the policy from its original purpose of providing financial protection for the insured's loved ones. The secondary market for STOLI policies is highly risky, as investors may face challenges to the validity of the policy and lose their premium payments if the policy is deemed void.
Overall, STOLI policies are speculative investments that prioritise the financial gains of investors over the interests of the insured. The unethical and often illegal nature of these policies underscores the need for seniors to exercise caution and seek independent professional advice before entering into any life insurance arrangement.
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Seniors are often targeted by STOLI schemes
Stranger-owned life insurance (STOLI) is a policy someone (usually an investor) buys on another person with whom they don't have an existing relationship. The purchaser is buying life insurance as an investment rather than because they would suffer a loss from the other person's death. Seniors are often targeted by STOLI schemes due to their vulnerability and the perception that they are more likely to die sooner rather than later.
STOLI schemes are often marketed to seniors as "zero premium life insurance," "estate maximization plans," or "no-cost to the insured plans." The sales pitches usually occur in pleasant settings, such as nice restaurants or even on yachts, and are characterised as "free," "risk-free," or "no-cost." Seniors are often promised an upfront cash bonus, which can be very tempting, especially if they are facing financial difficulties.
In a typical STOLI scheme, an investor or broker approaches a senior citizen and offers them a loan to purchase life insurance on themselves. The senior applies for a policy, pays the initial premium, and begins coverage. After a specified period, the policy is transferred to the investor or broker, who may pay an additional lump sum. The investor then takes over the premium payments and becomes the policy beneficiary. The investor can then sell the policy to another investor or hold it until the insured person passes away.
Seniors must be cautious of these schemes because they often come with hidden costs and adverse tax consequences. If a STOLI scheme is discovered, the policy may be voided, and the senior could face legal and financial repercussions. It's important for seniors to understand that the purpose of life insurance is to protect their interests and those of their dependents, not to enrich investors. Before making any decisions about life insurance, seniors should seek independent advice from trusted professionals, such as lawyers or financial advisors.
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STOLI investors may sue the insured for damages
Stranger-owned life insurance (STOLI) is a policy purchased by an investor on the life of a stranger. The investor becomes the policy beneficiary and takes over the payment of premiums to the insurer. The investment pays off if the death benefit is greater than the price the investor paid for the policy plus the investor’s premium outlay. This practice is generally illegal because it allows the policyholder to benefit from a stranger's death.
STOLI schemes are often marketed to seniors as "no-cost" life insurance, and they are promised an upfront cash bonus. Seniors must be careful to ensure there is a legitimate insurable interest in any life insurance policy taken out on their lives. If an insurer finds that the policy sold lacked an insurable interest, the insurer can sue to rescind the policy. In such a scenario, investors would likely sue the senior or their estate for damages because the life insurance policy they were holding to secure the death benefit (their "investment") would be declared void.
In the latter half of 2022, the Seventh Circuit Court of Appeals and the Delaware Supreme Court issued decisions making it difficult for investors to recover their premium payments on life insurance policies deemed void ab initio. These decisions set a precedent for other courts to follow, making it challenging for investors to get their premiums back on void policies.
If you are a senior considering a STOLI scheme, it is essential to seek independent advice from a trusted professional, such as a lawyer or financial advisor, to understand the personal, legal, and financial consequences of purchasing life insurance.
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STOLI policies can lead to a moral hazard
Stranger-owned life insurance (STOLI) is a type of policy where a stranger, who has no insurable interest in the life of the insured, purchases a life insurance policy on someone else's life. The purchaser is buying life insurance as an investment rather than because they would suffer a loss from the other person's death. This practice is generally illegal, as it allows the policyholder to benefit from a stranger's death.
The presence of STOLI policies can also lead to adverse selection, where those who are more likely to need insurance are the ones who purchase it. In the context of STOLI, this means that the insured may be individuals with a higher risk of death, such as the elderly or those in poor health. This is advantageous to investors, as they can receive the death benefit sooner rather than later.
Furthermore, STOLI policies can create a situation of asymmetric information, where the insurance company assumes the insured party will act in good faith to protect their life, while the insured may not have the same incentive. For example, the insured may engage in risky behaviour or neglect their health, knowing that the financial consequences will be covered by the insurance policy.
To address the moral hazard presented by STOLI policies, it is essential to ensure that the insured party has provided informed consent and fully understands the risks and consequences of the policy. Additionally, regular monitoring of the policy and the insured's health status can help identify potential issues and ensure that the insured's best interests are being considered.
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Frequently asked questions
Stranger-Owned Life Insurance is a policy someone (usually an investor) buys on another person with whom they don't have an existing relationship. The purchaser is buying life insurance as an investment rather than because they would suffer from the other person's death.
STOLI policies are controversial because they are often initiated without the knowledge or consent of the insured. They are deemed unethical and, in some cases, illegal. One of the main issues with STOLI policies is that they can lead to a moral hazard, where the stranger who purchases the policy has no insurable interest in the life of the insured and may be incentivized to take actions that increase the likelihood of the insured's death so that they can collect the death benefit.
STOLI policies are illegal in many states and localities. If you are caught participating in a STOLI scheme, you may face serious consequences. Insurance companies may also refuse to insure you in the future as you may be considered a moral hazard.
If you are approached about a STOLI policy, it is important to understand the risks and consult with a trusted professional such as a lawyer or financial advisor to seek independent advice on the personal, legal, and financial consequences of the purchase of life insurance.
