Stranger-Owned Life Insurance (STOLI): Understanding, Risks, and FAQ
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Summary:
Stranger-Owned Life Insurance (STOLI), also known as investor-owned life insurance (IOLI), is a controversial policy purchased on another individual without an existing relationship. It bypasses the insurable interest requirement and is generally considered illegal due to its unethical nature. This article delves into what STOLI is, why it’s illegal, its criticism, and the regulations surrounding it.
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What is stranger-owned life insurance (STOLI)?
Stranger-owned life insurance (STOLI) is a unique form of life insurance that is purchased by someone, typically an investor, on the life of another person with whom they have no prior relationship. Unlike traditional life insurance, which serves to provide financial support to beneficiaries in case of the insured person’s death, STOLI policies are acquired as investments, making them legally contentious.
Understanding stranger-owned life insurance (STOLI)
Life insurance is a financial product designed to provide a lump-sum death benefit to beneficiaries upon the insured’s death. To purchase life insurance for someone else, you typically need to demonstrate an insurable interest in their life. This means that you would experience financial loss or hardship as a result of their passing.
Family members naturally have an insurable interest in each other’s lives, allowing spouses or parents to buy life insurance for one another. Business owners also have an insurable interest in key employees.
Stranger-owned life insurance (STOLI), also known as investor-owned life insurance (IOLI) or stranger-originated life insurance, attempts to circumvent the insurable interest requirement. Essentially, it involves buying life insurance on someone whose death would not financially affect the policyholder.
STOLI arrangements are widely illegal and often involve fraudulent financial practices. For example, a senior citizen may use falsely inflated financial data to purchase a sizable life insurance policy. In return, a third-party investor agrees to cover the policy’s premiums.
Eventually, the senior citizen might sell the policy to the investor for a cash payment, benefiting from what seems like “free” money. However, such arrangements are ethically questionable as they essentially allow gambling on the lives of others.
What constitutes a stranger-owned life insurance arrangement?
The core characteristic of a STOLI arrangement is that the life insurance policy is entirely bought as a speculative investment by individuals who have no personal connection to the insured. It doesn’t aim to provide financial support to the insured’s loved ones or beneficiaries.
STOLI arrangements are illegal today, with many states enacting laws specifically prohibiting the practice. Previously, they were sometimes marketed to older individuals under deceptive names like “zero premium life insurance,” “estate maximization plans,” or “no cost to the insured plans.”
STOLIs vs. viaticals
It’s essential to differentiate between STOLIs and viaticals, which are often confused. In a viatical settlement, a person who already owns a life insurance policy on themselves agrees to sell it to a third party, usually a group of investors. These investors pay all remaining premiums on the policy and become its sole beneficiary upon the insured’s death.
Viaticals are typically marketed to individuals without heirs or those with terminal illnesses who require immediate cash. While viaticals are legal in the United States, they are illegal in most parts of Canada.
Criticism of stranger-owned life insurance
STOLIs create an unethical situation where the policy owner lacks an insurable interest in the insured individual’s life. Typically, someone with an insurable interest would wish for the insured to live a long, healthy life, as their well-being is directly tied to it. However, without such interest, the policyholder might have a vested interest in the insured’s death.
Having insurable interest is what keeps corporate-owned life insurance (COLI) legal and, for some, ethical. In COLI, the financial value of an employee or insured individual to the company gives the employer a legitimate interest in their well-being. However, even COLI can make some employees uneasy, as historical cases like H. H. Holmes, a 19th-century businessman and serial killer, purchasing life insurance policies on his employees, illustrate the potential for abuse.
It’s important to note that acquiring life insurance typically requires the consent of the insured. In most cases, someone cannot buy insurance on another person’s life without their agreement.
Stranger-originated life insurance arrangement regulation
STOLI arrangements are not legal, and they have faced significant regulatory scrutiny. The National Association of Insurance Commissioners (NAIC) proposed sample legislation in 2007, urging states to adopt regulations to prohibit STOLIs. Given that insurance is regulated at the state level in the United States, many states have implemented STOLI-related laws in line with NAIC recommendations.
Moreover, several states have provisions that allow the retroactive cancellation of existing life insurance policies if they are discovered to be STOLIs, often due to a lack of insurable interest.
Special considerations
A common method of bypassing the insurable interest requirement is to artificially create it. An investor who wishes to take out a life insurance policy on a stranger may immediately manufacture insurable interest by providing that person with a loan. In this scenario, the stranger’s death would result in an unpaid loan, creating a financial loss and satisfying the minimum requirement for insurable interest.
Despite the Internal Revenue Service’s and state governments’ disapproval of STOLIs, as well as insurance companies’ increased vigilance, this practice continues to persist.
Frequently asked questions
Is stranger originated life insurance legal?
No, STOLI arrangements are largely illegal because they lack the insurable interest between the policy’s owner(s) and the insured individual, which is a fundamental requirement for legal life insurance.
Can someone buy a life insurance policy on you without your knowledge?
If you are an adult, the answer is generally no. You typically need to provide your consent for a life insurance policy, often requiring a medical examination to qualify. An exception is that a parent can take out life insurance on a minor child without the child’s signature, which may result in the child being unaware of the policy.
For what reasons will life insurance not pay out?
Life insurance may not pay out if the application contains fraudulent
Is stranger-owned life insurance legal?
No, STOLI arrangements are largely illegal because they lack the insurable interest between the policy’s owner(s) and the insured individual, which is a fundamental requirement for legal life insurance.
Can someone buy a life insurance policy on you without your knowledge?
If you are an adult, the answer is generally no. You typically need to provide your consent for a life insurance policy, often requiring a medical examination to qualify. An exception is that a parent can take out life insurance on a minor child without the child’s signature, which may result in the child being unaware of the policy.
For what reasons will life insurance not pay out?
Life insurance may not pay out if the application contains fraudulent
Key takeaways
- STOLI, or stranger-owned life insurance, involves purchasing life insurance on someone with whom you have no personal relationship.
- STOLI policies are typically acquired by investors looking to profit from the insured person’s death, and they are considered illegal and unethical.
- Legitimate life insurance requires an insurable interest between the policyholder and the insured person.
- STOLIs differ from viatical settlements, which involve the sale of an existing life insurance policy to third-party investors.
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