Stranger-Originated Life Insurance (STOLI)

Stranger-originated life insurance, generally written STOLI, is an arrangement under which a life insurance policy is brought into existence for the benefit of an investor who has no insurable interest in the person insured. California's Insurance Code defines it as "an act, practice, or arrangement to initiate the issuance of a life insurance policy in this state for the benefit of a third-party investor who, at the time of policy origination, has no insurable interest, under the laws of this state, in the life of the insured." That state's code is used here as a clear worked example, since these are state laws and they differ.

The word doing the work is "initiate". Life insurance law requires the buyer to have an insurable interest when the policy is taken out, and the doctrine and its timing are set out on the insurable interest page. A STOLI arrangement does not fail that requirement openly. It manufactures the appearance of compliance at issue, so that a policy which was always intended for an investor is written as though it were intended for the insured or their family.

The statute names the devices, which is more useful than a general prohibition. California's definition continues: "STOLI practices include, but are not limited to, cases in which life insurance is purchased with resources or guarantees from or through a person or entity, that, at the time of policy inception, could not lawfully initiate the policy himself, herself, or itself, and where, at the time of inception, there is an arrangement or agreement, to directly or indirectly transfer the ownership of the policy or the policy benefits to a third party." Two elements are described there and both have to be present in the described case: the money came from someone who could not have bought the policy directly, and there was an arrangement at inception to move the policy or its proceeds to a third party. That is a description of a financing structure rather than of a bad intention, which is what makes it something a regulator can act on.

Trusts get named separately, because the trust is the usual mechanism. The same subdivision provides that "[t]rusts that are created to give the appearance of insurable interest and that are used to initiate policies for investors violate insurable interest laws and the prohibition against wagering on life." The structure it describes is familiar: an irrevocable trust is created, nominally for the insured's benefit, the trust applies for and owns the policy, and the insured or a family member is named as beneficiary at issue. On paper the applicant has an insurable interest. In substance the trust exists to hold the policy until it can be transferred, and the statute treats the paper as what it is.

It is classified as fraud, and that is the practical difference from an ordinary void contract. California's definition of a "fraudulent life settlement act" reaches acts committed "for the purpose of depriving another of property or for pecuniary gain", and the list of acts it then gives includes "[e]ntering into stranger-originated life insurance (STOLI)". So the designation carries a purpose element rather than attaching to the label alone, though the purpose is what the structure is built for. A contract void for want of insurable interest simply fails: the insurer refuses the claim and the premiums are usually returned. A statutory fraud designation reaches people rather than paper, and it attaches to the arrangement itself rather than to any later dispute about a claim. That is why the topic lives inside the life settlement statutes rather than in the general law of insurance contracts, and why the people exposed are the promoters, financiers and licensees who assembled the transaction as well as anyone who signed at the kitchen table.

The boundary with the lawful market is drawn in the same sentence, and it must not be lost. The definition closes: "STOLI arrangements do not include lawful life settlement contracts as permitted by the act that added this section or those practices set forth in paragraph (2) of subdivision (k), provided that they are not for the purpose of evading regulation under this act." Selling an existing policy is a recognized, regulated transaction with its own licensing and disclosure regime, and the sale of a policy that was honestly bought years ago is not made suspect by the existence of STOLI. The line is when the investor's interest arose, not whether an investor is involved at the end.

What the arrangement costs the insured is not obvious from the pitch. The offer usually presents as free or nearly free insurance for a period, with a choice at the end between keeping the policy by repaying the financed premiums with interest and handing it over for a payment. Both branches are priced by the promoter in advance, using a measured life expectancy, and the branch the insured is expected to take is the one that transfers the policy. Beyond the economics, the insured has signed an application, answered financial underwriting questions about the purpose of the coverage, and become a party to an arrangement a state may define as fraud. The clearest warning sign is the one the statute itself describes: someone else is paying, and the paperwork contemplates the policy ending up somewhere other than with the insured or their family.

A promoter identifies an insured, usually older, whose life expectancy can be measured and who does not otherwise need or want a large policy. A trust or similar entity is created and applies for the coverage, with the insured or a family member named as beneficiary so that the application shows an insurable interest. Premiums during the policy's early years are funded by a lender introduced by the promoter and secured against the policy. At the end of that period the insured is offered a choice between repaying the financed premiums with interest and surrendering the policy for a payment. The policy then reaches the investor, who holds it to maturity and collects the death benefit.

A hypothetical, to show where the value goes. An 80-year-old is approached with an offer described as free insurance. A trust applies for a $2,000,000 policy on their life. Premiums of about $90,000 a year for two years, $180,000 in total, are funded by a lender the promoter introduces, secured on the policy. At the end of the two years the insured is offered $50,000 to hand the policy over rather than repay the loan. The promoter's side of the arithmetic was set at the outset: a $2,000,000 death benefit acquired for $180,000 of premium plus a $50,000 payment, which is $230,000 of outlay, against a life expectancy their own underwriter measured. The insured's $50,000 is the whole of their share of a contract written on their own life. The figures are invented for the arithmetic; the structure is the one the statute describes.

The follow-through, for anyone shown a proposal like this, is to answer three questions in writing before signing anything. Who is paying the premiums, and what security are they taking? Who owns the policy at issue, and who is contemplated to own it in two years? And is anyone in the transaction licensed in the state, since life settlement providers and brokers are licensed and the licensing is checkable with the state insurance regulator.

Pros

• None accrue to the insured. The arrangement exists to move a death benefit to an investor, and the payment offered to the insured is a fraction of the contract's value.
• The one legitimate transaction in the neighborhood is the sale of a policy that was honestly bought and is no longer wanted, which is a regulated market with its own licensing and disclosure rules and is expressly outside this definition.

Cons

• Where a state defines it, entering into the arrangement can itself be a statutory fraudulent act, so the exposure is not limited to losing a claim.
• A policy taken out without an insurable interest is void, which means the death benefit the family may be counting on is not payable.
• The insured signs financial underwriting answers about the purpose of the coverage, and answers given to fit a promoter's structure are answers on the record.
• The payment offered to the insured is set by the promoter's own life expectancy estimate, and the insured has no independent way to price what they are giving up.
• Coverage issued in the arrangement occupies the insured's capacity to be insured, since insurers underwrite the total amount in force on a life.
• The paperwork is designed to look ordinary, so the tell is the financing and the contemplated transfer rather than anything on the face of the policy.