What is Stranger-Owned Life Insurance?

Stranger-owned life insurance (STOLI) is life insurance a person purchases to sell to a third party with no insurable interest, who would therefore be unable to legally purchase the original policy.

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Understanding Stranger-Owned Life Insurance (STOLI)

Stranger-owned life insurance, or stranger-originated life insurance, is a way to bypass the insurable-interest requirement in purchasing a life insurance policy. To legally purchase life insurance on someone else, the purchaser must have an insurable interest in that person’s life. That means the person’s death would adversely affect the purchaser’s finances. Some definitions require that the purchaser and the insured have a loving relationship.

STOLI arrangements are broadly illegal, and many schemes include fraudulent financial reporting. A typical arrangement would have a senior citizen use falsely exaggerated financial numbers to purchase an inordinately large life insurance policy. A third party might agree to finance the premiums. Eventually, the original purchaser would put 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 will pay a tax-free benefit when the insured dies.

Why Stranger-Owned Life Insurance Is Unethical

The lack of insurable interest makes STOLI outrageous from an ethics standpoint as well. If the policyholder has an insurable interest, one can assume that person would rather see the insured go on living than collect the death benefit. Without the insurable interest, the policyholder is hoping for the insured’s death.

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

Even a company-owned policy, broadly legal and in wide use, can give employees an uneasy feeling. H. H. Holmes, a nineteenth-century businessman and serial killer, famously purchased life-insurance policies on his employees before murdering them. That’s why it’s subject to several requirements, including the consent of the insured.

How Investors Manufacture Insurable Interest

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’s and state governments’ distaste for STOLI, as well as insurance companies’ increasing vigilance, the practice persists.