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Stranger-Owned Life Insurance (STOLI): What Professionals Need To Know

Stephan R. Leimberg

A. STOLI Defined

1. Stranger-owned life insurance (“STOLI,” investor-initiated life insurance, or “SPIN-Life”) can be defined as the purchase and creation of new life insurance with the intention of assigning or shifting ownership and death benefits to investors with no insur-able interest in the life of the insured.

a. More formally, it is an “act, practice or plan to initiate a life insur-ance policy for the benefit of a third party investor who, at the time of policy origination, has no insurable interest in the insured.”

2. Investor ownership is the driving factor at the time the policy application is signed.

3. An insured who applies for STOLI (typically a senior citizen be-tween ages 70 to 85) is purchasing the policy with the lure of two years of “free insurance” and a profit on the almost immediate sale of the policy after the policy’s contestable period.

Stephan R. Leimbergis CEO of Leimberg Information Ser­vices, Inc., an e­mail and database service providing information and commentary on tax cases, rulings, and legislation for financial services pro­fessionals. The 1998 Edward N. Polisher Lecturer of Dickinson School of Law and 2004 recipient of the National Association of Estate Planners and Coun cils Distinguished Accredited Estate Planner award, Mr. Leimberg is a former Lecturer­in­Law in the Masters of Taxation Program of both Villanova and Temple University Schools of Law, and is on the Editorial Board of Estate Planning Magazine.

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4. The intent of STOLI is to directly or indirectly resell the contract as soon as the contestable period of the policy runs (and sometimes sooner) to stranger-investors who have no preexisting family or business relationship with the insured and who can benefit only from his or her death.

5. Although it is made to appear that the insured (or the insured’s trust or LLC) is the initial owner of the policy, that appearance is a deliberately planned illusion. The insured is in essence acting and posing as owner on behalf of stranger-investors who finance all or most of the insured’s premiums through a nonrecourse or hybrid loan secured by the policy and often bearing interest at the highest legal rate allowed under state usury laws. In fact the high interest rate and fees are structured in such a way that the insured is almost invariably forced to transfer the policy to the lender-investors or sell it to a life settle-ment company to pay off the debt.

6. The insured or policy owner intends and plans at inception for the policy or a beneficial interest in the entity that owns the policy to be sold to speculators, investors who have no familial or business relation-ship with the insured and who have no legally recognized interest in the insured’s life continuing. The true intended owner is purchasing a policy on the life of a stranger in the expectation of profiting from that insured’s death but disguises the transaction so that what is in fact legally impermissible under state insurable interest law. appears legitimate.

7. The cases discussed below and cited in a full version of this article (the author will send the fully cited materials upon request to steve@leimbergservices.com) clearly indicate the deception involved in STOLI.

8. Insurance applicants are asked on their applications questions they are expected to answer completely, honestly, and in utmost good faith.

9. To obtain the proverbial “free lunch,” applicants become complicit in insurance fraud by lying or pro-viding misleading statements or omitting key information in their applications with respect to their (1) intent, (2) wealth, (3) income, (4) other insurance in force or applied for, (5) loans or financing used to pay premiums to obtain the largest possible “free lunch” that STOLI at first glance appears to be, (6) having received no financial incentive to obtain the insurance, and (7) domicile.

10. STOLI is a creature of greed and elicits and co-opts the willing-to-be-fooled mind. There is, of course, no such thing as “free” insurance. (Actually, Mass. Mutual provides for certain very low-income fami-lies temporary free coverage.) Yet such misrepresentations are constantly used to induce elderly indi-viduals to apply for insurance intended for sale to life settlement companies.

11. Speculators will entice individuals who meet their investment profile and who agree to become com-plicit in the arrangement to allow investors to obtain a life expectancy analysis that will enable them to estimate the resale value of the to-be-purchased-and-then-resold policy in the secondary market. The policy will be valued in direct relationship with how soon the proposed insured is expected to die (the sooner the better since the gamble for profit depends on the present value of the expected policy pro-ceeds being greater than the present value of the price paid for the policy plus premiums the investors must pay after they purchase the policy).

a. A typical scenario is that an insured will (with no personal outlay) pay the premiums for a relatively short period (often 26 or 30 months) by means of a presumably “no-risk” loan. If death occurs

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during the first two years, the death proceeds—less the loan, interest, and administration charges—will be paid to a trust, LLC, or FLP the insured has created to hold the policy. After the two-year contestable period expires, the trust sells the policy to the investors.

12. Ostensibly the insured is given three options:

a. The insured (the trust, LLC, or FLP) can keep the coverage by paying off the loan, accrued inter-est, and other charges.

b. The owner can “walk away” from the arrangement, and the lender will accept the policy as the only payment for the loan—no matter how much the total of the premium loans plus interest and other charges exceeds the cash value of the policy.

c. The insured can sell the policy to a life settlement company representing investors.

i. The intent and design of all the parties is that the insured will “forfeit” the collateralized insur-ance to the lenders (who then sell to the investors), or more commonly shortly after the incontest-able period expires the insured sells the policy or all or a majority interest in the policy directly or shifted indirectly to the investors who are represented by a life settlement company.

13. The insured has three major expectations:

a. If I die during the first two years, my family will be paid millions of dollars—for which I’ve paid no insurance premiums.

b. I plan on selling this policy to investors and making hundreds of thousands or millions of dollars, and since I have not invested any money my rate of return on this “investment” is astronomical.

c. I will have no outlay, incur no risk, and have no other costs.

14. The investor group may also make a significant, up-front, cash “sign-up bonus” payment as an ad-ditional incentive for the insured to enter into the arrangement. Cash “sign-here” incentives are often expressed as a percentage of the face amount of insurance purchased.

15. STOLI is a perversion of the traditional altruistic purposes of life insurance, that is, providing cash at the insured’s death to pay for the needs and assure the living standard of the beneficiaries who survive the insured. Life insurance is used to satisfy debts, to serve as a business economic “shock absorber,” or to serve as an effective means of providing estate liquidity and paying debts and death taxes.

16. STOLI is a scheme that uses fraud on and deception of the insurer to avoid the spirit and wording of both time-honored state insurable interest laws and hundreds of years of case law. It violates the viati-cal settlement laws of many states.

B. How Insurance Regulators And Courts Distinguish STOLI

1. Courts and legislators use the familiar “smell” test based on all the facts and circumstances surrounding a case. Among the specifics they examine are:

a. STOLI marketing materials,

b. Party who initiated the transaction,

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c. Terms of all the documents,

d. Identity of party who really pays premiums,

e. Period of time from contact inception to sale or transfer of coverage,

f. Consideration and incentives for assignment, and

g. Expectation of future compensation.

C. What STOLI Is And Is Not

1. By definition, STOLI is the purchase of life insurance intended for ownership by an investor group who will make a profit (1) on the death of an insured or (2) on the future trading and sale of a block of life insurance contracts on a group of lives to other investors who seek to profit in the same way. These arrangements are removed from early cases such as Scioto, discussed below, only in time and sophistica-tion. The overall intent of each of these transactions was and remains the same, that is, to cause the issuance of new life insurance on the life of the insured for the ultimate purpose of ownership by one or more persons who had no interest in the continuation of the insured’s life and had every interest in profiting by the insured’s early death.

2. Appropriate recourse financing of needed life insurance is not STOLI.

3. Appropriate settlement of existing policy is not STOLI.

4. STOLI is not about life insurance purchased by the insured in good faith to meet a personal, business, or charitable need.

5. A STOLI-only plan, arrangement, or act is designed from the outset to put the insurance into the hands of investors or speculators.

D. We Have Been Here Before

1. Straw-into-gold ideas are, like vampires, not only hard to kill, they also inevitably dig themselves up from the grave century after century. STOLI with its many aliases and constantly mutating forms is just such an “undead” Dracula that, like the fabled vampire, reappears after rising up from the casket. It is a prime example of the never-ending quest to do indirectly what centuries of insurable interest statutes and cases will not allow directly: speculators purchasing life insurance on the lives of individuals who are by blood, by business relationship, and economically totally unrelated strangers.

2. Life Insurance Auctioned In Public. Insurance Commissioner Elizur Wright’s horror in 1844 at seeing life in-surance policies auctioned in public to speculators, which he felt was similar to slave auctions, prompt-ed his lifelong crusade for life insurance reform.

3. Warnock v. Davis, 104 U.S. 775 (1881). Henry Crosser, a 27-year-old resident of Springfield, Kentucky, purchased a substantial amount of life insurance from the Protection Life Insurance Company of Chi-cago. That same day, he entered into an agreement with the Scioto Trust Association of Portsmouth, Ohio. Scioto, a group of investors, which agreed to pay all the premiums as well as other fees and costs