Besides the potential for committing fraud by misrepresenting the state of one’s health or finances, a life insurance customer can be hurt by a stranger-originated life insurance policy (SOLI or STOLI), a subject I blogged about earlier this week.
The STOLI agent or broker’s sales pitch does not inform the customer of the risks. I heard a spiel last summer from someone in the STOLI business. I’m not sure this particular person saw any downside to a STOLI arrangement.
As he put it, the investor pays the premiums for two years (the period in which an insurance company may contest a policy), so there’s no out of pocket cost. After two years, the insured person gets a lump sum payment he or she wouldn’t otherwise get. The insurance companies issuing the policies are often players on the secondary market themselves, so it isn’t as though they don’t know the policy might be sold. Nobody is hurt, no one’s out any money, and the purchaser walks away with a lump sum risk-free. I’d have to be crazy to talk my grandmother out of purchasing a STOLI.
So where is the harm? Consider these points:
- There may be hidden income tax ramifications for the insured person resulting from of the lump sum payment and from the payment of premiums on his/her behalf (if you’ve purchased a STOLI policy, speak to your tax professional).
- Turning life insurance policies into easily traded commodities may induce Congress to strip life insurance policies of the tax benefits they now enjoy, which hurts everyone.
- Pricing for policy premiums takes into account that a percentage of policies will eventually lapse because the policy owners stop paying premiums; in order to make up for STOLIs, which are investor backed and won’t lapse, premiums for all policies would have to increase.
- If an insurance company succeeds in rescinding a policy, the insurance company is not back to where it was before. It’s out the huge commission it paid to the broker. If it can’t find the broker or the broker is judgment proof, the insurance company might try to recover the commission from the estate of the original policy purchaser.
- There’s a public policy behind the statute. Remember how short sellers were being blamed for causing the financial crisis by betting against the market and driving down stock prices? When someone buys your life insurance policy, they’re betting against your longevity. How well will you sleep at night knowing that some stranger somewhere has no idea what a wonderful, caring person you are but has a very profitable, multi-million dollar incentive in seeing you dead? (Cue up the horror soundtrack.) You might want to join a self-defense class or get a licensed weapon.
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