Guides
Stranger-originated life insurance (STOLI): what it is and why it is restricted
How stranger-originated life insurance works, why courts and regulators treat it as lacking insurable interest, and what the NAIC and NCOIL waiting periods say.
Stranger-originated life insurance, or STOLI, is a policy taken out on a person, often an older adult, with the plan from the start to transfer it to investors who have no real connection to that person. Those investors are the "strangers." Regulators, courts and most state legislatures treat STOLI as an end run around the requirement that the owner of a policy have an insurable interest: who can buy life insurance on whom in the insured's life, and the NAIC and NCOIL models restrict it with waiting periods between issuing a policy and selling it.
How STOLI is arranged
A typical STOLI arrangement, as described in court cases and regulatory materials, works like this:
- Recruitment. An agent or promoter approaches an older person, often with a promise of free insurance or a cash payment, and offers to arrange a large policy.
- A trust or straw owner. The policy is applied for through a trust or other entity that nominally has an insurable interest, with the insured as the person whose life is covered.
- Premium funding. A lender or investor pays the premiums, often through non-recourse loans, so the insured is not meant to pay.
- Sale to investors. After issue, the policy is sold or the trust's interest is transferred to an investor who has no tie to the insured. The investor keeps paying premiums and collects the death benefit.
What makes it different from a legitimate life settlement is intent at the time of application. In a life settlement, an owner who bought a policy for genuine protection later chooses to sell it. In STOLI, the sale to an outside investor was part of the plan before the policy was issued. The application may therefore misstate who is buying the coverage and why.
Why insurable interest matters
A life insurance policy must be supported by an insurable interest: a real reason, such as a family relationship or financial stake, for the owner to want the insured to stay alive. People can generally buy insurance on their own lives and name anyone as beneficiary. State statutes spell this out; for example, California (Insurance Code section 10110.1), Florida (section 627.404) and New York (Insurance Law section 3205) each define it.
The law distinguishes the interest needed at issue from who may own the policy later. In the U.S. Supreme Court's 1911 decision in Grigsby v. Russell, a valid policy could be assigned to someone without an insurable interest. That is why legitimate life settlements are lawful. STOLI is challenged because the policy was not validly procured in the first place, not simply because it was sold.
Courts have addressed this in several states. In PHL Variable Insurance Co. v. Price Dawe 2006 Insurance Trust, 28 A.3d 1059 (Del. 2011), the Delaware Supreme Court held that a policy procured without an insurable interest is void from the start, and that the insurer could challenge it even after the contestability period (see the two-year contestability period) had ended. Other courts have decided these disputes differently depending on the state's statutes and facts, so the outcome varies.
What the models say: NAIC five years, NCOIL two years
State legislatures responded with laws restricting STOLI, using two main templates.
| Model | Waiting period between policy issue and settlement | Notes |
|---|---|---|
| NAIC Viatical Settlements Model Act (#697) | Five years | Exceptions the seller must certify, such as terminal or chronic illness, death of a spouse, divorce, retirement, disability, bankruptcy, or conversion of an earlier policy |
| NCOIL life settlements model | Two years | NCOIL's subcommittee kept a two-year prohibition with exceptions after the NAIC adopted five |
The NAIC model also includes a narrow exception for a settlement more than two years after issue if the policy's premiums were paid exclusively with unencumbered assets, there was no agreement to guarantee a loan or to buy the policy, and the policy was not evaluated for settlement during the two years. Premium-financed arrangements that involve non-recourse loans therefore do not fit the exception.
The NAIC model also requires a settlement broker or provider to disclose to the insurer any plan, or series of transactions, to originate, renew, continue or finance a policy for the purpose of viatical settlements, at any time before or during the first five years after issue. Each state's statute can differ, so check the one that applies to your policy through your state insurance department.
Risks for the insured and the family
- Voided coverage. If a court finds the policy was procured without insurable interest or through a misrepresentation, the policy may be rescinded or void. The family might receive nothing.
- Debt. If premiums were financed through a loan and the arrangement collapses, the insured or trust may face repayment demands. Recourse terms are in the loan documents.
- Legal exposure. Signing an application that states there is no plan to sell, when there is, can be a misrepresentation. State life insurance fraud: what it is and how it's caught laws apply to false statements in applications.
- Tax and benefit effects. Cash received for participating may be taxable, and the sale of a policy can affect other benefits.
- Privacy. Medical information is shared with investors and their agents.
- Lost protection. A policy meant for the investor does not protect your family.
Warning signs and what to do
Ask questions if someone offers any of the following.
- "Free" life insurance, or cash for applying
- A large policy that does not match your income or family needs
- A trust you did not design with your own attorney
- A promise that you will never pay premiums, or a loan with no personal liability
- Pressure to sell the policy soon after it is issued
- An agent who will not put arrangements in writing
If you are unsure, steps worth taking:
- Do not sign until you have read every document, including trust and loan agreements.
- Ask a lawyer who is not connected to the promoter to review it.
- Check licensing with your state insurance department for the agent and any settlement broker or provider.
- Report concerns to the state insurance department's fraud or consumer division. Insurers also have special investigations units.
- If you already hold such a policy, speak with an attorney before taking action such as selling, surrendering or stopping premiums, and compare options with the keep, surrender or sell your policy?.
If you own a policy for genuine protection and want to sell later, that is a regulated life settlement, not STOLI. Observe waiting periods, disclosures and rescission rights under your state's law.
Key takeaways
- STOLI is a policy obtained with the plan, from the start, to transfer it to investors who have no insurable interest in the insured.
- A later sale of a policy bought for real protection is a legal, regulated life settlement; intent at application is the dividing line.
- The NAIC model sets a five-year waiting period with exceptions; NCOIL's model uses two years.
- Courts, including the Delaware Supreme Court in 2011, have held that policies lacking insurable interest can be void, even after the contestability period.
- Be wary of "free" insurance offers and non-recourse premium loans, and get independent legal advice.