Stranger originated life insurance (STOLI) policies aren’t legal in the US. While insurance laws vary from state to state, all states require the owner of a life insurance policy to have insurable interest in the insured individual.
That sounds complicated, and like everything else related to insurance, it can be difficult to understand. This unbiased article will teach you all you need to know about stranger originated life insurance plans, also called “stranger owned life insurance,” “investor originated life insurance,” or STOLI.
- What is stranger originated life insurance?
- What is insurable interest?
- Investor originated life insurance scams and seniors
- Other ways seniors can get burned on stranger originated life insurance policies
- Can you sell a life insurance policy?
- Why are stranger owned life insurance policies illegal?
- How can seniors protect themselves from STOLI scams?
What Is Stranger Originated Life Insurance (STOLI?)
A STOLI policy exists when the owner of the life insurance policy doesn’t have genuine financial interest in the person whose life is insured.
Let’s illustrate that with two stories. First, we’ll talk about two individuals starting a STOLI arrangement, and details about insurable interest. Then, we’ll talk about group sales pitches and life settlement arrangements.
A STOLI Story About Peter and Kate
Let’s imagine Peter, a normal guy. He works in a warehouse, has two kids and lives in an apartment. One day, Peter is grocery shopping when he’s approached by a homeless woman who calls herself Kate. Unfortunately, Kate has struggles with opioid addiction.
Kate needs immediate funds, and she suggests that Peter take out a life insurance policy on her in exchange for a few hundred dollars.
Peter is intrigued! He doesn’t know STOLI policies are illegal and unethical. He believes Kate’s lifestyle is risky, and her life might be cut short due to drugs or disease. He imagines himself spending a few hundred dollars today, and some small monthly premium payments for a while, for a life insurance policy that might pay out soon.
Peter thinks this will be a great investment, and a quick way to get tens of thousands of dollars of tax-free income.
Insurance Companies Are Way Ahead of This Game
Life insurance companies know this game. When Peter calls his insurance agent, he cannot prove insurable interest. Kate is not a relative, a key employee, a business partner, or someone Peter would trust to care for his children if he passed away.
Their application for life insurance is denied.
Peter tries again. This time, he tells another life insurance company that Kate is his children’s nanny. “There’s no one like Kate,” he explains. “If she passed away, I’d have a hard time finding and training a replacement, and it would be expensive.”
The insurer accepts this answer and sends a medical questionnaire to Peter and Kate. But their plan is spoiled again when the insurance company sees Kate’s medical history. She’s been hospitalized for overdoses and gets other addiction treatments. Wisely, the insurance company denies her coverage.
Peter is disappointed, but lucky. He didn’t get involved in a stranger originated life insurance plan. That’s good news, because if Peter were to get caught, he’d face serious consequences, and we’ll explore those shortly.
And that’s why life insurance companies are strict about insurable interest.
What is Insurable Interest?
Insurable interest is a condition that must be discussed on any life insurance application. In short, the owner of a life insurance policy must have a financial interest in the life of the insured.
Using our story above, Peter has no real insurable interest in Kate. They’re strangers. If she passes away, it doesn’t affect his family in any way.
Peter does have insurable interest in other people, though. These could include his:
- Biological children and adopted children
- Extended family
- Spouses, and even ex-spouses if they supply financial support or care for the kids
- Business partners
- Key employees of his small business
Insurable interest applies to property insurance, too. For example, you cannot buy a homeowner’s insurance policy on a house you don’t own. Nor could you buy a car insurance policy for your neighbor’s vehicles. These aren’t your belongings, and you’d experience no financial loss if something happened to them.
Investor Originated Life Insurance Scams and Seniors
Another illegal STOLI practice happens when investors invite seniors to high-pressure sales meetings to sell them life insurance with the intent to buy the policies back in a few years.
These sales pitches usually occur in an upscale setting, like a fancy restaurant or even on a yacht. The presenters use attractive words like “no-cost” and “risk-free.” Sometimes the senior is promised a significant cash bonus for signing up.
But in the end, it’s not the senior’s heirs who will receive a death benefit, nor will the senior cash in an early life settlement. The winner in this arrangement is an investor with no insurable interest in your life.
Let’s imagine how it could happen to someone you know.
Audrey Suffers a STOLI Scam
Audrey is a 68-year-old widow. She’s barely making ends meet with Social Security and spends her afternoons at a local senior center for entertainment and a free lunch.
One day, a respectable-looking gentleman shows up at the senior center and invites everyone to a free lunch at the lobster restaurant across the street tomorrow. He’s clean-cut, well-dressed, and looks trustworthy. He explains to the seniors that he’s planning on talking about “investments” and life insurance tomorrow. He says it’s “risk free” and involves “zero commitment.”
Audrey’s friends are excited about a nice lobster lunch, so they all go. Once seated, the salesperson begins a long sales pitch, complete with fliers, PowerPoint presentations, applications and more.
The marketing materials are well made, and the agent is well-spoken. He explains to the seniors that they’ll sign up for life insurance, get a cash bonus now and maybe a cash bonus in three years when they sell the policy.
Hungry Seniors Are More Likely to Sign Papers
The hours tick by and seniors are getting hungry. A team of salespeople starts pressuring them to sign paperwork and fill out details so they can get fed. Hungry, concerned about their medication schedules, and even excited about the cash bonus, most of the seniors comply.
In this story, we’ll assume that 90% of the seniors submit to the pressure. They might leave with a full belly and a signing bonus in cash. But it’s the investors who will profit from this stranger originated life insurance plan.
Are Stranger Owned Life Insurance Policies a Victimless Crime?
Even though they’re illegal, some people might believe stranger owned life insurance policies are a victim-less crime. After all, the senior gets their cash bonus and a luxury lunch, and no one is getting hurt or losing money, right?
Wrong. The problem with STOLIs is that insurance companies will eventually pay out life insurance benefits to an investor. Do you know who shoulders that cost? Future life insurance policy owners will. If an insurer pays an extra $20 million in death benefits, you can be sure the next generation of customers will pay more for their insurance policies.
And remember, several investors can make money on one life insurance policy multiple times. Once they own it, they might cash it in, or sell it to other investors for a profit. The next investor can sell it again. It’s not uncommon for these policies to be sold a handful of times before someone like Audrey passes away. The investor holding the policy at that point wins the game.
So yes, our Audrey got a little cash bonus and a lobster lunch. But investors — people she’ll never meet — are making thousands of dollars repeatedly wagering on her life expectancy. And there are more ways a senior can be financially injured by STOLIs.
Other Ways Seniors Get Burned on Stranger Originated Life Insurance Plans
Legally, life insurance companies can only bind a life insurance policy if insurable interest exists between the owner and the insured. Thinking about our story of Peter and Kate, above, you know that’s a select group of people.
When the life insurance company discovers an illegal contract, they will void it. They don’t need to refund any money to someone like Audrey who might be making the first few years of premium payments herself (while the policy builds a cash value.)
That’s money Audrey needed to survive, and it will be very difficult to get it back.
So, Audrey suffers the loss of those premiums. But even worse, when other insurers learn of her actions, they can choose not to insure her. They may consider her a moral hazard: someone who does the wrong thing when it comes to insurance applications.
- (And by the way, our friends Peter and Kate could also be considered moral hazards by insurers if they get caught in a STOLI.)
Know that insurance companies all invest in tremendous databases, and they share information with one another. Once a life insurance company believes you are a moral hazard, it’s likely all the other insurers will believe the same.
Ultimately, Audrey may find herself unable to buy life insurance at all, and she may find herself paying more for property insurance and car insurance.
Now, you’ve heard about people selling life insurance policies by themselves, and you’re wondering if that was a scam, too.
Can You Sell a Life Insurance Policy? Life Settlements Explained
Whole life insurance policies build a cash value over time, and it takes a few years for the cash value of a policy to be worth much.
But that cash value can be significant in an emergency, and these policies can be sold. Many people buy whole life policies with the intent of cashing it in later, perhaps to help fund their retirement or a vacation.
Life Settlement Brokers
Life settlement brokers are state-licensed individuals who can buy your whole life policy, and they’ll usually give you more than the current cash value. They’ll continue making the premium payments on your policy or sell it to an investor. That’s completely legal.
How Does a Life Settlement Broker Differ from a STOLI Scam?
The illegal or unethical point of STOLIs is that a stranger starts the sale and owns the policy. They have no insurable interest in your life, they’re only wagering on how long it takes for you to pass away so they can collect death benefits. T
Why Are Stranger Owned Life Insurance Policies Illegal?
A life insurance policy — no matter which type — should exist to financially protect the heir or named beneficiary of an insured individual. True, life insurance policies can come with other bells and whistles, like cash values on whole life policies or extra accidental death benefits on a term life policy.
Still, the primary point of any life insurance policy is to supply funds for someone that matters after you pass away. When people purposely buy life insurance on someone they don’t know, in hopes they’ll pass away, it’s unethical.
How Can Seniors Protect Themselves from STOLI Scams?
First, know that nothing in life is “free,” especially when it comes to insurance! Well-dressed, smooth-talking salespeople are making money somewhere, or they wouldn’t be offering a free lobster lunch or an afternoon of boating.
- Avoid high-pressure sales meetings and luncheons, unless you truly have the internal fortitude to say NO.
- Take a friend you trust to any free lunch meeting and ask their advice.
- Eat a good meal early in the day, so you aren’t starving at lunch time.
- Upon arriving, tell the hosts you won’t be signing anything and see how they react.
- Don’t drink any alcohol at the event.
Also, if you’d like to put a halt to lunch scams that target the elderly, the American Association of Retired Persons(AARP), has a “Free Lunch” monitor program that always needs volunteers. You’ll get to attend these types of meetings and report back to AARP about the goings-on. You can also call the National Elder Fraud Hotline at 1-833-FRAUD-11 / 1-833-372-8311 if you see spot something fishy.