The acquisition of an insurance policy by an insured for the purpose of selling that policy to a third party has bloomed into a new and very controversial cottage industry, according to J. Alan Jensen, J.D. and Stephan Leimberg, CLU.
This is stranger-owned life insurance, and the experts covered the pros and cons during a breakout session at the Million Dollar Round Table annual in Indianapolis this summer.
Jensen, an attorney with Holland & Knight LLP, Portland, Ore., argued in favor of STOLI, while Leimberg, chief executive of both Leimberg Information Services Inc. and Leimberg Associates, both of Bryn Mawr, Pa., spoke in opposition. The two presented their points and counterpoints and also engaged in lively rebuttal.
STOLI “conjures up an unsettling, if not un-American, image of profiteers bilking unwitting elderly insurance prospects,” allowed Jensen.
He said he prefers the term “disposable policies,” because it is “more apt and devoid of some of the negative connotation in STOLI.” The term reflects that this is an “anticipated sale (hence disposable) of the policy after the 2-year contestability period has lapsed,” he said.
Disposable policies are part of the life settlement market, Jensen maintained.
The sale of an insurance policy by an owner to a third party buyer is not illegal, Jensen continued. But he said such sales are subject to some significant qualifications.
When the market exploded and the inventory of qualifying policies could not keep pace with demand, Jensen recalled, some “resourceful agents” started marketing disposable policies to elderly insureds who had no particular need or desire for additional insurance. The elders were told that the transaction “would net them a considerable amount of cash with no out-of-pocket expense required.”
That incurred the wrath of the insurance industry, he said.
Jensen reviewed how disposable policy transactions work, and then presented his take on why the transactions raised a fuss. “The preservation of the insurer’s profit margins seems to be the core of the controversy,” he said.
“Had the insurers profited in typical fashion from the sale of billions of dollars of new coverage, we would not be discussing the issue.”
As for why insurers are fighting sales of the disposable policies, he suggested reason is that the disposable policy probably will not lapse. “This basic fact distinguishes them from other types of whole life insurance policies,” Jensen said.
Since insurers have priced policies on the assumption that a large percentage will not be retained until the insured dies, he explained, this has “raised havoc” concerning policy pricing and profitability.
He argued that “the creation of the secondary market, which allows the sale of the disposable policy, should be regarded as a favorable economic development for the consumer.” Insureds who now find a policy they purchased to meet a need in the past is now unneeded or cannot be afforded “should be allowed to sell in the secondary market,” he said.
Jensen conceded some abuses do exist. For instance, the dearth of best practices has “encouraged hyperbole” at times, he said. This “invites misrepresentation by some agents or brokers who are either unscrupulous or simply do not fully understand the market themselves,” he said.
Also, there is no certainty that the disposable policy can be sold in the secondary market, particularly if the insured’s health stays the same as at policy issue, Jensen said. “However, if this possibility is explained to the insured, he cannot complain of loss of profits in the event of no sale.”
The associated tax costs may be significant, he said, noting that an agent’s written disclosure to the client will often have a brief suggestion to consult a tax adviser about the tax effects of a disposable policy, “but those potential effects are left unstated.”