Florida regulators targeting Stranger-Originated Life Insurance as illegal

Feb 23, 2009

Palm Beach Daily News--February 21, 2009

By GAIL LIBERMAN, Special to the Daily News

Free steak lunches?

They continue to pitch financial services – despite a Securities and Exchange Commission crackdown on them in 2006 and 2007.

Now the Florida Office of Insurance Regulation is cracking down.

At least one newspaper ad invited readers to Ruth’s Chris Steakhouse in Palm Beach Gardens. The luncheon was for a “Free Premium Financed Life Insurance & Life Settlement Conference.”

The ad was among the pitches contained in a report released earlier this month by the Florida Office of Insurance Regulation on “Stranger-Originated Life Insurance (STOLI).”

Stranger-Originated Life Insurance sounds like a great deal. Older, high-net-worth seniors are invited to apply for life insurance in exchange for an incentive, such as a cash payment. Often, the investor even pays your premium. But under the agreement, your policy is “sold” to investors, generally complete strangers, after a period, of say, two years. The investor collects the proceeds of the policy upon your death.

The Office of Insurance Regulation contends these types of deals are illegal in Florida and seeks to clarify the law accordingly. Other states have taken or are considering similar action.

“STOLI schemes often rely on misrepresentation, falsification or omission of material facts in the life insurance application,” warns Florida Insurance Commissioner Kevin McCarty. “There are undisclosed risks to our seniors who participate in these transactions.”

What can be so terrible about Stranger-Originated Life Insurance? It seems like a participating senior has nothing to lose. But often, serious issues are glossed over. Among those raised in the report:

* Incentives, especially any cash payments you receive, are taxable as ordinary income. Plus, although life insurance proceeds to a beneficiary are not taxable, selling a policy to a stranger could wind up raising a “discharge of debt” tax issue.

* Once you participate in this transaction, you may exhaust your capacity to buy insurance. If you really need life insurance down the road, you may not be able to get it.

* Life insurers are rooting out these transactions by asking applicants questions such as, “Is there intent to sell the policy?” Under Florida law, a misrepresentation, omission, concealment of fact or incorrect statement may prevent recovery of policy proceeds.

* Some insurance companies already are rescinding these transactions. If this happens, you could find yourself liable to all parties for costs, including the insurance agent’s hefty commission. AXA Equitable Life Insurance Company, American General Life Insurance Company and West Coast Life Insurance are asking federal courts to rescind policies in which they contend false representations were made by the insureds. Total face value of those contested polices, according to the report: $133 million.

Also, life insurance agents, agencies or brokers licensed by Florida’s Department of Financial Services, may risk suspension or revocation of their licenses or appointments if they’re involved in these deals.

The Office of Insurance Regulation adds that these types of deals could result in an increase in insurance rates for all persons over age 65.

Don’t confuse Stranger-Originated Life Insurance with viatical settlements, in which an investor invests in the life insurance policy of another person – often with a short life expectancy.

Viatical settlements sometimes provide a way for terminally ill policyholders to get immediate cash. The investor’s return depends upon the seller’s life expectancy and the actual date he or she dies. Investors obtain a higher return if the seller dies before the estimated life expectancy.

While these deals may have some of the same negative consequences as STOLI deals, there are differences, according to the Office of Insurance Regulation. Those include: The intent of the person at the time of purchase, the purpose of the sale of the life insurance product and the fact that some “strangers encourage fraudulent misrepresentation on the life insurance application for STOLIs.” With STOLIs, seniors, it says, often are encouraged to exaggerate their net worth on life insurance applications to obtain a larger payout.

The other less talked-about issue with Stranger-Originated Life Insurance: How wise is it to arrange for a complete stranger to profit so handsomely from your death – especially in this lousy economy?