Life settlements vs. STOLI: Let's get the debate straight
By Chris Orestis
Life Care Funding Group
The life insurance industry and the life settlement industry are in agreement on the issue of legitimate life settlement transactions vs. illegitimate stranger-owned life insurance (STOLI) transactions. Both sides recognize the market efficiency and legal rights of a policy owner to benefit from a life settlement if they have outlived the insurable interest upon which a life insurance policy was purchased. When owners no longer need a life insurance policy, they have the option to turn to a vibrant secondary market to liquidate that policy for the highest possible value a competitive bidding process can derive. But, in the case of a STOLI transaction, where a person is induced with the promise of compensation to serve as a front for the purchase of a life insurance policy, both sides are in agreement as well. If this kind of transaction is engaged to financially benefit a third party, then it is a total violation of the principles of insurable interest and thus constitutes fraud.
Acting in good faith
The life settlement industry has acted in good faith and moved to support action among the states to eliminate STOLI, and it is time for the life insurance industry to act in good faith as well. The life insurance industry is on the record differentiating between life settlements and STOLI, and acknowledging the legal standing and legitimacy of life settlements. But it is time that they stop conveniently painting the debate with a broad brush to color life settlements the same shade of red as STOLIs for their own bottom line-driven purposes.
Both sides agree to the following definitions: A life settlement is the legitimate liquidation of a life insurance policy by an owner who has outlived the insurable interest upon which the policy was originally purchased. On the other hand, a STOLI transaction is initiated by a third party that will offer monetary inducements to entice someone to purchase a life insurance policy with no legitimate insurable interest with the intended recipient of the policy's value being the third party actually paying the premiums.
The right of a policy owner to engage in a life settlement was guaranteed by U.S. Supreme Court Justice Oliver Wendell Holmes in 1911. In this landmark case he ruled that life insurance is personal property and the owner is protected by all the same inalienable rights that any owner of real estate, stocks or any other assets enjoy. In this final ruling he drew a very clear distinction between insurance transactions based on insurable interest and those where none exists. (U.S. Supreme Court GRIGSBY v. RUSSELL, 222 U.S. 149 (1911) 222 U.S. 149)
Both the life insurance and life settlement industries have spoken out on the STOLI issue and made their concerns clear. The circumvention of insurable interest and the prospect of Congress revoking the tax-deferred status of inside build-up for life insurance -- if the perception of insurance changes from income protection to life expectancy speculation -- is at the root of their fears. The tax-free exemption for inside build-up of a life insurance policy is constantly under scrutiny by lawmakers. If it is ever concluded that life insurance has changed from its original function of providing a death benefit for beneficiaries to an investment vehicle for third parties to place "wagers" with no insurable interest on the insured, then the tax-free exemption could be revoked.
Industry action and results
A number of insurance industry organizations such as the National Association of Insurance Commissioners (NAIC), National Council of Insurance Legislators (NCOIL), American Council of Life Insurers (ACLI), National Association of Insurance and Financial Advisors (NAIFA), American Association of Life Underwriters (AALU) and the Life Insurance Settlement Association (LISA) have all spoken out against STOLI transactions. Each organization has also clearly differentiated between these illegitimate transactions and the legitimacy of life settlements. More than 90 million Americans aged 65 and older own life insurance with a combined face value of approximately $500 billion. And with the "Silver Tsunami" wave of baby boomers about to crash on our shores with much more life insurance in their hands, it is obvious that the stakes in this growing secondary market are very high.
Legislative activity in the states has picked up over the last year as bills designed to stop STOLI transactions have been introduced and passed. The governor of Ohio signed into law a bill extending the time that a policy must be owned by the policyholder from two years to five before it can be settled. It is important to note that this law recognizes, and does not impede, life settlements done for legitimate changes in personal circumstances, such as an adverse turn in health, loss of a job or the death of the beneficiary. In September 2008, California passed an anti-STOLI bill and sent it to the desk of Governor Schwarzenegger for his signature. Governor Schwarzenegger subsequently vetoed the measure and stated, "I am also concerned that the final version of the bill may unfairly exclude some companies from participating in the legitimate life settlement market," and that he wants to be sure that life settlement legislation "does not unfairly discriminate against legitimate companies trying to compete in the life settlement business."
At the conclusion of the 2008 legislative session in California, Brad Wenger of the Association of California Life and Health Insurance Companies was asked to comment about the differences between a life settlement and STOLI, "When people with existing life insurance policies that they no longer need are approached by a life-settlement company that will offer them an amount of money if they assign their policies to the company -- that is a legitimate transaction." Wenger emphasized, "STOLIs are different."
The Life Insurance Settlement Association also opposes the practice of STOLI. They are on the record stating, "A STOLI transaction circumvents insurable interest laws and is, therefore, illegal. STOLI transactions abuse uninformed senior consumers and damage the reputation of the life settlement industry. Public policymakers should understand STOLI, its consequences, and the best methods to effectively prevent this practice."
In the midst of these concerns and legislative developments surrounding STOLI, the life insurance industry is on the record acknowledging the legitimacy of life settlements. The American Council of Life Insurers (ACLI) is on the record saying that the anti-STOLI legislation they support would not "affect the property rights of policy owners who acquired life insurance in good faith." Rather, they are combating transactions where, "the intent at the outset is to transfer the death benefits to investors." During a panel session at ReFocus 2008, jointly presented by the ACLI and the Society of Actuaries, industry CEOs agreed that there is a need for life settlements. Stuart Reese, chairman, president and CEO of MassMutual Life Insurance Company said that if a policy is purchased with protection in mind and is no longer needed after a period of time, then a contract holder does have property rights and "there is a legitimate life settlement business which is consistent with the purpose of insurance." Jessica Bibliowicz, chairman and CEO of National Financial Partners of New York, a distributor of financial services products to the high-net-worth market explained that life settlements do make people feel more relaxed about their options. Bibliowicz added, "It is not just a matter of surrender or die."
Life settlements have been a growing marketplace for the last ten years. With the leading trade groups representing both the insurance and life settlement industries in agreement that STOLI must be stopped, and the legitimacy of the life settlement market can bring value to consumers, we are witnessing a transitional time in the development of this important secondary market. As NAIC and NCOIL model legislation continues to work its way through state Houses of Representatives around the country, a necessary balance is emerging that will prevent STOLI without impeding the life settlement market. The Ohio law is a good example of that, and the veto by Governor Schwarzenegger is another great example of the more thorough analysis that is being done to make sure language that would impede life settlements is not snuck into anti-STOLI bills. The life insurance and life settlement industries must agree to work together in good faith. If so, then together they will be able to very quickly make STOLI transactions almost impossible, while allowing the life settlement industry to continue to help those who would be best served by a vibrant secondary market.
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