December 13, 2007
Officials taking action
Originally published Dec. 1, 2007 - re-posted with corrections listed at the bottom of the post.
What is a STOLI (stranger-oriented life insurance) arrangement? It’s a life settlement where an investor, group of investor or even hedge fund offer to purchase a life insurance policy in order to collect the death benefit sometime in the future. The target market for STOLI arrangements are seniors aged 65-85 and in good enough health to qualify for a life insurance policy. Of greater interest are wealthier seniors who can take out multi-million dollar polices.
A typical deal: Let’s say Joe Sample, a healthy 70 year old male, runs accross a flyer at the local senior center offering to make him some money. In exchange for cash, Joe takes out a $250,000 whole-life insurance policy. Joe designates a beneficiary, and a investment company arranges premium financing to pay the premium (and any cash up paid up front) for two years. If Joe dies in the first two years, his beneficiary gets the money and pays back the premium financing (plus fees). If he lives beyond two years he gets the option of paying off the premium financing and keeping the policy or the policy is sold to investors who collect when he dies.
Why two years? This is the contestability period of a typical life insurance policy. After a policy is in force two years, death benefits are usually paid with no questions asked.
Where did this type of deal come from? To answer that, let’s first hop the way-back machine to the early 1990 and the spread of the AIDS epidemic.
With the spread of AIDS came a increase in the number of normally healthy people with in-force life insurance policies who needed money. Investors stepped in and by purchasing the polices, paid the policyholders money while they were alive and collected the death benefit (and a profit) when they died. This came to be know as a viatical settlements, from the Latin word viaticum, or provisions for a journey.
After medical treatments helped AIDS patients live longer, companies in the viaticals business realized they could profitably purchase policies from healthy people, and the life settlement industry took off.
A recent change in accounting rules allows policy owners to count a policy as an asset. This has attracted investors, including investment banks, hedge funds and other institutions.
So if a profitable business model exists and all parties involved make money, what’s the problem with STOLI arrangements? A number of things:
- Companies offering the arrangements are not disclosing tax implications.
- Large fees are being charged leaving less money than anticipated.
- Having a STOLI arrangement can affect someones ability to get more life insurance.
- If more policies are kept in force and life insurers pay more claims, the cost to everyone goes up.
- Congress may step in and make all life insurance benefits taxable, harming legitimate purchasers.
- Finally - it’s downright creepy to have people rooting for your death. With multi-million dollar policies in-force, it’s not hard to imagine criminal conduct.
The Ohio Department of Insurance with the help of Rep. Jay Hottinger (R - Newark) and Rep. Matt H. Barrett (D - Amherst) helped write House Bill 404 to make STOLI arrangements more transparent to the buyers and only allow family members or business partners to benefit from a life policies death benefit. They hope to pass this bill in 2008.
With state legislators, regulatory departments and insurance companies teaming up to eliminate them, it seems the days of the STOLI arrangement may be coming to an end.
Editors update: After a few emails from life producer acquaintances, I’ve made the following corrections:
The original article said that the viatical companies paid the policy premiums during the contestability period; it’s been pointed out to me that typically the investors involved arrange premium financing (a loan) to pay the first two years of premium. If the insured dies within the first two years, their dependents (or estate) inherits the death benefit, but a loan with fees attached is payable to the premium financier. If the insured decides to keep the policy after the contestability period, then the premium finance loan must be satisfied.
While I’ve been referring to these as STOLI arrangements, other sources refer to them as SILI (stranger initiated life insurance) arrangements. I think STOLI sounds better than SILI.
