United States
Hong KongSTOLI and investor-owned life insurance
Stranger-originated life insurance is an arrangement where investors fund a policy on someone they have no insurable interest in, using the insured as a front, and take ownership later. It is not a life settlement, because the intent to transfer existed before the policy was ever issued.
The insurable interest rule has a seam in it, and this is what crawled through. Interest has to exist when a life policy is bought and not afterward, so anyone who can arrange for the right person to be the applicant can transfer the policy later to somebody with no interest at all.
How the arrangement works
- An older person is approached and offered money, or free coverage, to apply for a large policy on their own life.
- The premium is funded by investors, often through a non-recourse loan.
- The insured owns the policy at issue, which makes the insurable interest requirement look satisfied.
- After a waiting period the policy is transferred to the investors, who then collect the death benefit.
Everything in that sequence except the intention is lawful in isolation. The intention is what makes it STOLI, and it is why the exam question is nearly always about when the plan to transfer was formed.
The separation from a life settlement
| Life settlement | STOLI | |
|---|---|---|
| Why the policy was bought | A genuine need at the time | To be sold on |
| When the intention to transfer arose | After issue, as circumstances changed | Before the policy existed |
| Who funded the premium | The owner | Investors, often by non-recourse loan |
| Insurable interest at inception | Genuine | Manufactured |
| Status | Lawful, and regulated | Prohibited, and a fraud on the insurer |
A life settlement is the lawful cousin: an owner who no longer needs a policy sells it for more than its cash value. The outline lists life settlements separately in section IV. Both end with an investor holding a policy on a stranger. Only one of them started that way.
Why insurers care so much
Life insurance pricing assumes some policies lapse. A block of investor-owned policies never lapses, because the investors are paying premiums precisely to collect, so the insurer's mortality experience on those policies is worse than it priced for. It also puts the insurer in the position the insurable interest doctrine exists to prevent, with strangers holding a financial interest in a death.
An agent who knowingly writes a STOLI case has helped procure a policy by misrepresentation, which reaches the licensing consequences in the Texas portion. Grounds for license denial and disciplinary action at TIC 4005.101 include wilfully violating an insurance law of this state and intentionally making a material misstatement in an application.
A seventy-eight-year-old is offered a payment to apply for a large policy on his own life, with the premiums funded by a third party who will take ownership after two years. How should this be characterized?
- A life settlement, since the policy is sold after issue
- A viatical settlement, since the insured is elderly
- Stranger-originated life insurance, because the transfer was planned before issue
- A valid third-party ownership arrangement
Where it sits
- Section
- III, completing the application and underwriting, 12 questions
- Listed as
- Underwriting, sub-item 5: STOLI and IOLI
- Neighboring sub-item
- Insurable interest, sub-item 1 of the same heading
- Lawful counterpart
- Life settlements, section IV
The placement is informative. Pearson files STOLI under underwriting rather than under ethics or law, because the harm it does is to the underwriting process: the insurer priced a risk on facts that were not true.
The opinion, and the concession
This is a one-question topic with a memorable story, which makes it the cheapest mark in section III. Learn the sequence and the one test that separates it from a settlement, and move on. Candidates who try to learn the regulatory history of STOLI are studying a subject rather than a syllabus item.
The concession: how Texas polices these arrangements sits partly in the Insurance Code and partly in case law and market conduct enforcement. We hold the Code and can point at the licensing consequences. We are not in a position to tell you how a Texas court would treat a particular structure, and any prep material that claims to is going beyond what the outline asks.
Common questions
What is STOLI?
Stranger-originated life insurance: an arrangement in which investors fund a policy on someone they have no insurable interest in, with the insured applying as owner so the policy can be issued, and ownership transferred to the investors afterward as planned from the start.
How is STOLI different from a life settlement?
Timing of intent. A life settlement sells a policy that was bought for a genuine need when circumstances later changed. In STOLI the intention to transfer existed before the policy was applied for, which means the insurable interest at inception was manufactured rather than real.
Why do insurers object to investor-owned policies?
Pricing assumes a proportion of policies will lapse, and investor-owned blocks do not lapse because the investors are paying premiums to collect. Mortality experience is therefore worse than priced, and strangers end up holding a financial interest in somebody's death.
What happens to an agent who writes a STOLI case?
It exposes the agent to licensing action. In Texas, the Department may deny an application or discipline a license holder under TIC 4005.101 for wilfully violating an insurance law or intentionally making a material misstatement in a license application, among other grounds.