Is It Life Settlement or STOLI: A Producer’s Guide between a Legitimate Practice and a Possible Felony

October 30, 2008

SOURCE: InsuranceNewsNet, Inc.

Life settlements, an industry that did not exist 10 years ago, has exploded into a booming billion-dollar industry and one of the fastest growing segments of the life insurance industry today.  Experts estimated that the market reached approximately $15 billion in 2006 and predict that there still remains a significant room for long-term growth.

But experts caution producers who want to tap this burgeoning sector against crossing the line between life settlement transactions, which is legal in all 50 states, and stranger-originated life insurance (STOLI) practice.

Unlike life settlements, STOLIs (also known as speculator-initiated life insurance, SPIN-LIFE), are considered by American Council of Life Insurers (ACLI), the Association for Advanced Life Underwriting (AALU) and the National Association of Insurance and Financial Advisors (NAIFA)as arrangements that attempt to circumvent state laws on insurable interest.

In 2007, the National Association of Insurance Commissioners (NAIC) adopted the revised Viatical Settlements Model Act to curb STOLI practices by imposing a five-year ban on STOLI transactions while encouraging legitimate life settlements.

But the line that divides a life settlement and a STOLI is not always clear. Some experts complain that even reputable sources have come out with confusing STOLI definitions.

For instance, one definition implies that a transaction is a STOLI when it involves a complete stranger who takes out a life policy on an unknown individual without his or her knowledge. Yet a transaction involving a consenting insured can still qualify as a STOLI even though the structure of arrangement is very similar to corporate-owned life insurance (COLI).

Their advice to producers is to know your life settlement and STOLI before attempting to go there or consult an expert to guide you away from potential legal problems. Many life settlement companies also provide educational programs about the industry. Various resources about life settlements are available from other trade publications and the Life Insurance Settlement Association (LISA) as well.

LISA is a nonprofit trade association for members of the viatical and life settlement industry and requires its members to fully comply with all applicable laws, including antitrust laws, federal, state, and local laws, and all trade regulations and legal requirements

The following information may help you distinguish between a life settlement and a STOLI.

Definition:
 

• According to NAIC, a life settlement is any transaction that involves the “transfer of life insurance benefits available under a policy.” A STOLI transaction is defined as involving life insurance policies manufactured for the purpose of the secondary market.
• In the initial issue of the newsletter STOLI Alert produced by AALU. ACLI and NAIFA, a STOLI arrangement “is initiated by strangers who attempt to circumvent the purpose of state insurable interest laws for their own investment purposes.”
• The National Conference of Insurance Legislators’ (NCOIL) defines STOLI as 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.”

STOLI Red Flags

• Purchasing of a life insurance policy on an insured typically between 65 and 85 years old in exchange for an immediate lump sum payment.
• Purchasing a life insurance policy on an insured – at no cost to the individual – in exchange for a partial payment of the policy’s face value to the insured’s beneficiaries upon the owner’s death.</div>
• Purchasing a life insurance policy or encouraging another person to purchase a life policy primarily to sell the policy to a third party.
• Offering an elderly person a lump sum in exchange for purchasing a life insurance policy at the expense of the individual who made the offer and naming the individual who made the offer as the beneficiary.
• Requiring an insured purchasing a life insurance policy in his or her own name to also sign an agreement where investors get beneficial ownership of the policy usually after a two-year contestability period has expired.
• Selling policies immediately after they were initially purchased.
• Offering an individual with a life insurance contract for free or at no cost.
• Involving a company that is not a member of LISA.
• Not having a transparent transaction about how many parties received commissions and how much was paid out in undisclosed fees.

According to Adam Flood, author of Stranger-Originated Life Insurance: How the NAIC Tamed an Old Dog with a New Trick, a STOLI transaction may also involve an irrevocable trust or ILIT.

In this set up, a policy on the life of the insured is purchased by the ILIT for the benefit of the insured’s family or favorite charity. A loan is provided to the trust sufficient to cover the premiums for the first two years. After two years and when the loan has matured the trustee may:

• Pay off the loan with any additional fees and any interest and retains possession of the policy.
• Sell the policy to an investor group that pays off the loan and keeps any profit thereafter.
• Walk away from the loan allowing the lender to foreclose on the insurance policy as collateral.

If the trust sells the policy to an investor group it is likely a STOLI arrangement, says Flood.

Where STOLI Transactions are Illegal

About a dozen states have passed laws taking action to stop STOLI abuses according to NAIFA. This year alone several states passed legislations to protect consumers, particularly seniors, against STOLI arrangements. These states include:

• Ohio
• Connecticut
• Oklahoma
• Kansas
• Nebraska
• Indiana
• West Virginia

Florida regulators are currently gathering information about STOLI and could present a recommendation to state lawmakers next year although it has already passed a law designed partially preventing people from taking out insurance policies on strangers.

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