What Is a Stranger-Originated Life Insurance (STOLI) Policy?

Understanding Stranger-Originated Life Insurance (STOLI) Policies

Stranger-Originated Life Insurance, commonly known as STOLI, refers to a life insurance arrangement where an investor or a third party initiates and finances a life insurance policy on an individual with whom they have no insurable interest or direct relationship. The primary purpose of such a policy is not to provide financial protection to the insured’s beneficiaries, but rather to serve as a speculative investment for the third-party investor. This type of arrangement fundamentally deviates from the traditional understanding of life insurance, which is rooted in protecting against financial loss due to the death of someone upon whom one is financially or emotionally dependent.

Understanding STOLI Policies

The core concept behind STOLI is the absence of a legitimate insurable interest from the very beginning of the policy. Traditional life insurance requires that the policyholder would suffer a financial or emotional loss if the insured person were to die. In a STOLI scheme, the investor has no such inherent interest, making the policy essentially a wager on the insured’s life. This speculative nature raises significant ethical and legal concerns within the insurance industry.

The Structure of a STOLI Arrangement

A typical STOLI transaction often begins with investors, brokers, or facilitators approaching individuals, frequently seniors between the ages of 65 and 85. These individuals may be offered an upfront payment or other financial incentives in exchange for their participation. The insured individual then applies for a life insurance policy, though they may not intend to retain it or pay the premiums themselves.

The policy is typically structured so that, after a certain period, often coinciding with the expiration of the policy’s contestability period (commonly two years), ownership is transferred to the investor or sold in the secondary market. This transfer allows the investor to become the policy’s beneficiary, ultimately receiving the death benefit when the insured dies. Such arrangements have been marketed under various names, including “zero premium life insurance,” “estate maximization plans,” or “no cost to the insured plans,” all designed to entice individuals into participating.

STOLI Versus Other Life Insurance Transactions

STOLI policies are frequently confused with legitimate life insurance transactions such as life settlements and viatical settlements, but a fundamental difference lies in the timing of insurable interest. A life settlement involves the sale of an existing life insurance policy by its original owner to a third party for a lump sum. The original policy was purchased with a legitimate insurable interest at its inception. The policyholder may sell it because their financial needs have changed, they no longer need the coverage, or they can no longer afford the premiums.

Similarly, a viatical settlement is a specific type of life settlement where the policyholder is terminally or chronically ill and sells their existing policy to a third party. This allows them to access a portion of the death benefit while still alive, providing funds for medical care or other needs. In both life and viatical settlements, the policy was legitimately originated with an insurable interest, and the sale occurs later. STOLI, in contrast, involves the lack of insurable interest at the policy’s very beginning, making it a speculative investment rather than a means of financial protection.

Regulatory Perspective on STOLI

The principle of “insurable interest” is central to life insurance law, mandating that a policyholder must have a legitimate financial or emotional stake in the continued life of the insured. This ensures life insurance functions as protection against loss, not as a tool for speculation or gambling. STOLI policies violate this fundamental principle because they are initiated without the necessary insurable interest at the time of policy issuance.

Many jurisdictions have enacted specific legislation or regulations that prohibit or severely restrict STOLI practices. These laws often deem STOLI arrangements to be against public policy, classifying them as illegal wagering contracts on human life. Such policies may be declared “void ab initio,” meaning they are invalid from their very beginning. Insurance regulators, often through model acts developed by organizations like the National Association of Insurance Commissioners (NAIC) and the National Conference of Insurance Legislators (NCOIL), have actively worked to prevent the proliferation of STOLI transactions, recognizing their negative impact on the industry and the public.