Stranger-Owned Life Insurance (STOLI)

What Is Stranger-Owned Life Insurance?

Stranger-owned life insurance (STOLI) is an arrangement in which an investor holds a life insurance policy without insurable interest on the insured. Without insurable interest, the investor would ordinarily be prohibited from purchasing the original policy. Because of this, STOLI policies are generally illegal and difficult to obtain.

Key Takeaways

  • Stranger-Owned Life Insurance (STOLI) policies are owed by third-parties, usually investors, with no insurable interest.
  • SOLI policies are often offered in exchange for loans that the insured can use during their lifetime.
  • It could also be used to speculate financially on the lives of others.
  • To obtain insurance on somebody else, you must have insurable interest in that person.
  • SOLI is illegal as it gives the policyholder, who has no insurable interest or relationship with the insured, an advantage in the insured's death.
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How Much Life Insurance Do You Need?

Understanding Stranger-Owned Life Insurance (STOLI)

Life insurance is a financial product that pays out a lump-sum death benefit when the insured passes away. In order to buy insurance on somebody else, you need to prove that there is insurable interest on this person. In other words, the insured and the owner can be different people, but only if the death of the insured will cause a financial loss or other hardship to the owner.

Some definitions of insurable interest require that the purchaser and the insured have a loving relationship, such as one that exists between spouses or parents and children.

Stranger-owned life insurance (STOLI), also known as investor-owned life insurance (IOLI) or stranger-originated life insurance, is a way to try and bypass the insurable-interest requirement of purchasing life insurance. Put differently, to buy insurance on somebody whose death would not constitute a valid loss under insurable interest.

STOLI arrangements are broadly illegal, and many schemes include fraudulent financial reporting. For example, a senior citizen uses falsely exaggerated financial numbers to purchase an inordinately large life insurance policy. In exchange, a third party agrees to finance the premiums.

Eventually, the original purchaser puts the policy into a trust before selling it to the third-party lender for a cash payment. The insured gets “free” money. The third-party lender gets a large life insurance policy that pays a tax-free benefit when the insured dies.

STOLI policies also are considered unethical in that they essentially would allow one to gamble on the lives of others.

What Constitutes a Stranger Originated Life Insurance Arrangement?

The primary feature of a STOLI arrangement is that the insurance policy is purchased entirely as an investment or speculative instrument by one or more strangers, and not to provide financial support for the insured's beneficiaries or loved ones.

STOLI arrangements are illegal today, with many states enacting laws specifically outlawing the practice. Previously, however, they were sometimes marketed to older individuals under the guise of "zero premium life insurance," "estate maximization plans," or "no cost to the insured plans,"

Viaticals

Note that STOLIs differ from life settlements (viaticals). Under a viatical, a person who is both the owner and the insured of a life insurance policy agrees to sell their policy to a third-party, often a group of investors. The investors in a viatical settlement pay all future premiums left on the life insurance policy and become the sole beneficiary of the policy when the insured dies. These arrangements are legal in most U.S. states (but are illegal in Canada) and are often marketed to policy owners without any beneficiaries or who have a terminal illness and could use the immediate cash.

Criticism of Stranger-Owned Life Insurance

The lack of insurable interest makes STOLI highly unethical. If the policyholder has insurable interest, it is reasonable to assume that they hope for a long life for the insured rather than an accelerated death just to collect the death benefit. Without the insurable interest, the policyholder has more interest in the insured's death, an event that completes the agreement and benefits the third-party.

Having insurable interest keeps corporate-owned life insurance (COLI) legal and, to some, ethical. While a COLI policy collects premiums from the employer\beneficiary, the financial value of the employee\insured to the company gives the employer interest in the insured’s continued health and well-being.

Even a company-owned policy, broadly legal and widely used, may give employees uneasy feelings. H. H. Holmes, a nineteenth-century businessman and the first noted US serial killer, famously purchased life insurance policies on his employees before murdering them. That’s why the issuance of life insurance is subject to several requirements, including the consent of the insured.

Stranger Originated Life Insurance Arrangement Regulation

STOLI arrangements are not legal. The National Association of Insurance Commissioners (NAIC) proposed sample legislation in 2007 for states to consider adopting (since insurance is regulated state-by-state in the U.S.). To date, most states have adopted STOLI-related laws—with most states adopting wording that closely tracks the NAIC recommendations.

Several states also have provisions that can retroactively invalidate existing life insurance policies if they are revealed to be STOLIs after the fact due to a lack of insurable interest.

Special Considerations

A common workaround of the insurable-interest requirement is to manufacture it, as in the hypothetical situation above. An investor seeking to take out a life insurance policy on a stranger may manufacture insurable interest instantly by granting that stranger a loan. The stranger’s death would leave the loan unrepaid, fulfilling the most skeletal definition of insurable interest.

Despite the Internal Revenue Service and state governments having a distaste for STOLI, as well as insurance companies’ increasing vigilance, the practice persists.

Is Stranger Originated Life Insurance Legal?

No, STOLI arrangements are largely illegal since they do not feature insurable interest between the policy's owner(s) and the insured.

Can Someone Buy a Life Insurance Policy on You Without Your Knowledge?

Sometimes, but only if there is insurable interest. Often, the insured will need to sign the policy application and submit to a medical examination and records request authorization. However, if a parent buys life insurance on behalf of a minor child, the child need not know about the policy, even after they turn 18.

For What Reasons Will Life Insurance Not Pay Out?

If an insurance policy is found to be fraudulent or the application was completed with purposeful errors or omissions, an insurer may refuse to pay out the claim.

For instance, if you withhold information that the insured has a terminal illness, that may be grounds to not pay out the claim upon their death. A claim may also be invalidated if it turns out there is not an insurable interest between the insured and the owner of the policy.

Finally, an insurer may investigate whether the insured has actually died if there is not enough valid proof such as an official death certificate provided.

The Bottom Line

It is only legal and ethical to take out a life insurance policy on somebody with valid insurable interest. STOLI policies are illegal because they do not have insurable interest and are essentially taking a bet on someone elses' lives.

Article Sources
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  1. Munich Re. "STOLI - What You Don't Know May Cost You."

  2. JD Supra. "Betting On Strangers’ Lives: A Brief Look at How Different States Are Scoring the Insurable Interest vs. Incontestability Provision Debate."