Stranger Originated Life Insurance

Stranger Originated Life Insurance

STOLI is an acronym for Stranger Originated Life Insurance (often referred to as Investor Owned Life Insurance). The main characteristic of a STOLI transaction is that the insurance policy is purchased solely as an investment vehicle, rather than for traditional life insurance needs. STOLI is typically an arrangement whereby an insured or investor owns a life insurance policy in hopes of selling it quickly in a life settlement transaction for a large profit.

In the early 2000s, there existed arbitrage in the life insurance market whereby an elderly individual, over age 70, could pay a lump sum premium equal to 10% of a policy's death benefit to issue a policy that would stay inforce for just over the policy's two-year contestability period.  Immediately after the two-year period expired, the insured could (or were promised they could) sell the policy in a life settlement transaction for an estimated 40% of the face amount.  As an example, an elderly insured could fund a $10,000,000 life insurance policy with a lump sum of $1,000,000, then sell that policy for $4,000,000 two years later.  That's a quick profit of $3,000,000 in only two years.

Since these sales generated large commissions, insurance agents would often illegally rebate a portion of the commission to encourage the insured's participation and use additional commission dollars to pay the first-year policy premium.  These schemes were commonly marketed as "free insurance" to elderly clients at country clubs across the U.S.
The requirement for a cash premium quickly evolved into a "non-recourse premium financing” transaction allowing the insured to contribute a small amount of the lump sum in cash with the remainder being financed by a commercial lender.  Though these loans often had high interest rates and high fees, insureds were promised they could repay the debt from the future life settlement proceeds.

However, selling the policy for 40% of the death benefit after two years was not guaranteed – a detail often not explained to clients. The sales price was a best guess only and the 2008 mortgage crisis dampened the life settlement market preventing many STOLI policy owners from selling at the prices they were promised.  Since the premium financing loans were often non-recourse, the insured was told they could “walk away” from the loan with no obligations.  This was often untrue and insureds were surprised to learn this non-recourse feature created “forgiveness of debt” income resulting in large tax liabilities.   

Over the years, STOLI policies have been the focus of many lawsuits involving insurance companies, promoters, brokers, agents and insureds.  Many believe a second wave of STOLI litigation is now just beginning to develop.