Late in 2007, no less a personage than TV celebrity Larry King made headlines with a financial problem that's becoming increasingly common. In November, King filed suit against an insurance brokerage, claiming that he was tricked into selling two very large life insurance policies on himself to a firm that then resold them. King, liable for heavy taxes on the money he received, and probably now uninsurable due to health problems, realized belatedly that what he'd done was not in his own best interests. He'd let a stranger take charge of his life insurance. And he's not the only one.
STOLI, or stranger-oriented life insurance, has been on the radar screen of both the American Council of Life Insurers (ACLI) and the National Association of Insurance Commissioners (NAIC) for some time. An outgrowth of the viatical industry, in which policies can be sold so that the policyholder can derive immediate benefit when the money is needed for medical or living expenses, it started, according to Jack Dolan at ACLI, roughly five to seven years ago, though no actual date can be traced. Nebraska, Kentucky, and Indiana have already taken the first steps toward stopping the practice, and 25 other states are considering legislation.
In STOLI, as opposed to a standard viatical settlement, the insured--or someone capable of being insured--is approached by another party, whether an advisor, an insurance broker, or an investment company with no "insurable interest" in that person, with an offer to fund insurance premiums for a specified period of time. The individual approached may already have considerable life insurance in place (like King), or may be a senior citizen in relatively good health but without insurance. The insured or potential insured is offered a "life settlement," a lump-sum payment, in exchange for the payer of the life settlement (these days, generally an investor or group of investors) being named as beneficiary on the policy after a specified period of time. This proposed beneficiary also pays the premiums for the policy. There may also be another payment made at the time the beneficiary designation is changed.
If the insured or insurable person agrees to the arrangement, the proposed beneficiary sends the person, if uninsured, off to undergo a physical. Once all requirements have been satisfied, the insured person collects his or her settlement, the investor takes over paying the premiums, and within the contracted period of time--often two years--is named beneficiary of the policy. In the meantime, the insured has gotten not only a considerable lump sum (in King's case it was $1.4 million on policies worth $15 million), but also a substantial life insurance policy for free that, if death occurs before the end of the specified time period, will pay out to family heirs. If the insured dies after the specified time period, the investors collect. The lump sum is nonrefundable (unless the insured decides to back out of the contract, in which case it can be very pricey to pay it back), the premiums are paid, and everybody's happy. Right?
Well, not exactly. While many proponents of STOLI life settlements tout the lapse rate of policies as proof that insureds can get something out of policies that might otherwise no longer serve their needs, the life insurance industry begs to differ. Not only that, but those taking advantage of such arrangements are probably unaware that the money may not be tax free, as is the money from a policy, and that they may also be liable to charges of fraud by the insurance company.
Add to that the fact that if their health changes and they do want to get another policy, they may no longer be eligible--or they may not be eligible because of the amount of the policy involved in the life settlement.
Marlene Y. Satter, a freelance business writer who can be reached at firstname.lastname@example.org.