Old Couple Share A Moment by James Kendall
I have represented a number of senior citizens who have been victims of a STOLI scams.
This article explains the basics of the STOLI scam on seniors and what they can do to fight back. In short, the seniors should turn the tables on the STOLI businesses to sell the insurance policy themselves rather than let the STOLI businesses reap a windfall.
Before we begin, it’s worth defining and describing some of the terms and concepts in the STOLI and ILIT process.
What is a STOLI?
A “stranger-originated life insurance” (“STOLI”) is life insurance issued on the life of someone as part of a transaction in which they agree to transfer the policy to a “stranger.” The new owner could be one person, or a group of investors. Once the policy is transferred, the owner continues to pay the premium until the seller dies. When the insured dies, the investor gets paid. Those often targeted for this arrangement are seniors, ages 65 to 85, encouraged to sign up for new life insurance policies they will then sell for a buyout.
The STOLI concept is complex so here is more detail. In a STOLI transaction, an investor or its representative induces an individual, typically a senior citizen, to purchase a life insurance policy that the senior likely would not otherwise have purchased. The senior applies for the policy with a prior understanding that, after a certain period of time, the senior will need to come up with the money to pay the premiums or give up the policy to the investor, or some other third party, who would expect to receive the death benefit when the senior dies. The investor generally arranges for financing of the premiums during the time the senior owns the policy by means of non-recourse premium financing; that is, the only collateral for the loan is the insurance policy itself. Thus, the senior is not on the hook for any premium payments.
A STOLI is a premium financed life insurance policy, which simply means that the life insurance policy’s premiums are paid by a third-party. A STOLI is generally in an Irrevocable Life Insurance Trust (ILIT). (What is an ILIT? ILIT explained.)
Seniors Insured STOLIs are Victims
The STOLI broker generally sells the idea to the senior as “free life insurance” because the senior will not have to pay premiums and will get a life insurance policy for a limited period of time (generally 2-3 years). However, the senior is the victim because the senior will not be able to get another life insurance policy during that period and if the senior’s health turns bad during this period, the senior will not be able to get a life insurance policy after the period ends.
Criticisms of STOLI
Critics of STOLI, including state insurance regulators, argue that STOLI is inconsistent with state “insurable interest” laws and the historical social policy of insurance, which is to protect families and businesses from potential economic hardship caused by untimely death of the insured. Other concerns cited about STOLI include that it may encourage insurance fraud; it may result in an insured incurring a tax liability resulting from forgiveness of premium loans or receipt of incentives from the investor for obtaining the life insurance policy; it may make the insured unable to obtain life insurance legitimately needed in the future; and it could make life insurance more expensive and less available for other consumers. From the standpoint of an investor in life settlements, STOLI policies may introduce additional risks, given that insurers may contest them on grounds such as fraud or violations of state insurable interest laws.
Minnesota Outlaws the STOLI Scam
Since 2009, the typical STOLI scam has been outlawed in Minnesota:
STOLI changes become law
A new law prohibits certain contractual arrangements and other activities relating to the purchasing of a life insurance policy that is essentially a wager on someone’s life.Effective with policies issued beginning May 10, 2009, the law codifies insurable interests and prohibits procurement of a policy on the life of another individual unless the benefits are payable to the insured, representatives of the insured’s estate or a person who had an insurable interest at the time the policy was issued.
“We want to protect life insurance interests, and not turn it into a financial investment,” said Rep. Kate Knuth (DFL-New Brighton), who sponsors the law with Sen. Linda Scheid (DFL-Brooklyn Park).
In a traditional life settlement, a person who owns a life insurance policy but no longer needs it sells the policy for an amount less than the death benefit.
Under stranger-originated or -initiated life insurance (called “STOLI”), a third-party investor or hedge fund with no relationship to an individual initiates the policy purchase by paying the premiums and later buying the policy, hoping to profit upon the death of the insured. These are often directed toward senior citizens because the sooner the person dies, the more the speculator profits.
This is in violation of the insurable interest law designed to ensure that a person who is a beneficiary of a life insurance policy has an economic interest in the continued life — not death — of the insured.
The law calls for a four-year prohibition on buying STOLI after a policy is issued, with the stipulation that an investor could not buy those policies if there were signs of STOLI during that time. It also provides for a four-year rebuttable presumption in civil lawsuits in which the insured’s estate seeks to receive the life insurance procceds. “That should be enough to stop STOLI,” Scheid said.
A way for a representative of an insured individual’s estate to recovery policy benefits paid resulting from a STOLI agreement is also in the law.
However, this law does not stop STOLIs that are already in existence.
How Seniors Can Fight Back
A senior who has been a victim of a stranger-originated life insurance (STOLI) policy can fight back. Most importantly, a senior can sell the policy herself and benefit from its current market value rather than let the STOLI businesses reap the benefit.
When to Act
Six months ahead of the loan maturity date, seniors should consider selling the insurance policy. If the senior waits until the loan maturity date, the lender will likely foreclose on the life insurance policy, reaping any windfall for itself.
If the senior’s health is good, the senior will probably make no money by selling the policy, so the senior should let the policy be sold by the lender. If the senior’s health is substantially worse than when the senior applied for the policy, the policy may be valuable (because when the senior dies, the policy will be paid out, so the policy is worth more on the market if the senior is likely to die soon).
Who to Call
Often, seniors contact the insurance agent to help them sell the policy. But from my experience, agents are generally ineffective at selling the policy. It is unclear to me whether agents are ineffective at selling the policy because they are in on the scam, they don’t know how to sell a policy, or some other problem. Rather than contact their insurance agent, seniors should contact a broker who sells these types of insurance policies.
The protector of the trust (ILIT) may be a useful resource for seniors seeking a reputable life insurance policy broker. Seniors should ask their trust’s protector for a reputable life insurance policy broker. Beware, there are unscrupulous life insurance policy brokers.
What to Tell the Broker
The senior should explain to the life insurance policy broker that she has a premium financed life insurance policy. The senior will need to send the life insurance policy broker documentation on the policy including:
- recent medical records
- a current in force illustration showing values to age 100
Ask the broker to determine whether the life insurance policy is worth more than the premiums owed on the policy. If the life insurance policy is worth more than the premiums owed on the policy, have a CPA analyze the income tax consequences of selling the life insurance policy. The income tax rules changed in 2009, and the basis of these policies is much lower than the interested parties assumed at the front end of the transaction.
How to Decide Whether to Sell the Policy
If the senior determines that she will make a profit by selling the policy, after deducting the costs of repaying the premiums and income tax consequences, then the senior should sell the policy through the broker. If the senior will not profit by selling the policy, the senior can let the lender foreclose on the policy.
Other Ideas to Fight the STOLI Scam
A senior who is a victim of a STOLI scam can report the problem to the attorney general in her state. However, I am doubtful that an attorney general can be helpful in this type of situation.
A senior may also consider a lawsuit against the STOLI businesses, including the insurance agent. This may be based on fraud. Keep in mind that there are statutes of limitation the may prevent such a claim. Also note that if the senior engaged in fraud (for example, by inflating the senior’s income on the insurance application), the senior will be opening a can of worms.
Concluding Thoughts on Fighting STOLI Scams
Fortunately, many states are outlawing the STOLI scam. For those seniors who are already STOLI victims, the ideas in this article may help you fight back and benefit (if your health turned worse) by selling your life insurance policy.