Life settlement investments: the risk of stranger-originated insurance policies

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by Jim Orr

The life settlement business—the buying and selling of life insurance policies prior to maturity—is big business. Although sales records are not public, most experts agree that billions of dollars are involved. The growth of the life settlement business has also meant an increase in “stranger-originated life insurance.”

There are, of course, only a limited number of life insurance policies available for sale. Thus, a broker wanting to increase the supply of life insurance policies available for sale on the secondary market might try to do so by inducing someone else to take out a life insurance policy on their life with the intention of later selling the policy. This practice is known as stranger-originated life insurance or “STOLI.”

Many state’s laws do not allow life insurance to be purchased with the intent to later sell it to an individual lacking an insurable interest. Rather, the law requires that a life insurance policy must be bought in “good faith.”

In a STOLI transaction, a broker induces an individual, typically a senior citizen, to purchase a life insurance policy that the senior likely would not otherwise have purchased. The broker or speculator offers incentives to the senior such as “free insurance” (until the policy is sold) and a cash payment (often after the policy is sold). The senior then applies for the policy with a prior understanding that, after a certain period of time, the senior will give up control of the policy to the broker. The broker will then sell the policy as a life settlement to investors.

Life settlement investors need to be aware of the impact of STOLI. Because an investor in a life settlement is often several steps removed from the policy creation stage, it can be extremely difficult, if not impossible at times, to discover the risk with STOLI.

If the life insurer company suspects a STOLI policy, the insurer might refuse to pay the death benefit to the investor on account of fraud. If the life insurance company successfully challenges the validity of a policy on the ground that it was purchased with the intention of re-selling it, the policy may be deemed void. The risk to the investor is that if the policy is declared void, the investor could very likely be the one who will have to absorb the loss. In short, money spent on a life settlement investment could be all for nothing if it turns out you have invested in a STOLI policy that is barred by the law of the applicable state. Each state has its own insurable interest law, and you should check with a legal expert to determine the legal requirements in your jurisdiction.

States are increasingly acting to specifically regulate STOLI transactions. Some states have, for example, enacted legislation based on the Life Insurance Settlements Model Act developed by the National Conference of Insurance Legislators. In general, this model act aims to deter STOLI by specifically defining and prohibiting STOLI transactions. The model act defines STOLI as follows:

‘Stranger-Originated Life Insurance’ or ‘STOLI’ is a practice or plan to initiate a life insurance policy for the benefit of a third party investor who, at the time of policy origination, has no insurable interest in the insured. STOLI practices include but are not limited to cases in which life insurance is purchased with resources or guarantees from or through a person, or entity, who, at the time of policy inception, could not lawfully initiate the policy himself or itself, and where, at the time of inception, there is an arrangement or agreement, whether verbal or written, to directly or indirectly transfer the ownership of the policy and/or the policy benefits to a third party. Trusts, that are created to give the appearance of insurable interest, and are used to initiate policies for investors, violate insurable interest laws and the probation against wagering on life.

The definition follows Grigsby v. Russell, 2 US 149 (1911) in which the U.S. Supreme Court noted that a life insurance policy is void if, at its inception, a person with an insurable interest (the future assignor) and a person without an insurable interest (the future assignee) participate in an arrangement to purchase the policy for speculation. The “preconceived plan,” according to the model act, can be verbal or written, and the plan may even include a trust that is used to give the appearance of an insurable interest. The substance of a STOLI arrangement will be determined by reviewing the intent of the parties at the time a life insurance policy is purchased and various factors will be explored to determine the parties’ true intent at that time.

Heygood, Orr & Pearson has filed numerous lawsuits on behalf of investors in life settlements who, according to the suits, were misled about the value of life settlements investments that they purchased. Our firm has also filed lawsuits on behalf of life settlement companies when life insurance companies have wrongfully refused to pay the death benefits on policies claiming it was a STOLI policy or that there was no insurable interest.  These lawsuits have been filed on behalf of clients located nationwide.

If you or someone you know has been the victim of wrongful conduct on the part of a life settlement broker or provider, or if you are a life settlement provider who has had a claim for death benefits wrongfully denied, then you need a sophisticated and knowledgeable law firm such as Heygood, Orr & Pearson to represent you. For more information and a case evaluation that will help determine your legal rights, please contact us by calling toll-free at 1-877-446-9001, or by filling out the free case evaluation form located on this page.