CNN talk show host Larry King — he of the ubiquitous andcolorful suspenders — is, by all accounts, pretty savvy. However,for all his experience in ferreting out ne'er-do-wells, heapparently is as susceptible to financial schemers as the next guy.In October 2007, King filed suit against an insurance servicescompany and the people who steered him into a Stranger OriginatedLife Insurance (STOLI) deal. In the suit, King claimed that notonly was he not informed of the full financial and tax implicationsof the life settlements, but that the venture caused him to "useup" his insurability, making it difficult to secure life insurancein the future.

King is simply a celebrated example of a burgeoning problem thatthe National Association of Insurance and Financial Advisors(NAIFA) has been warning about for years and working to addresslegislatively at both state and national levels. NAIFA was a keybacker of a recent bill signed into law by California Gov. ArnoldSchwarzenegger (SB 98) to regulate life settlement transactions andban STOLI deals in that state.

In a STOLI scheme, investors induce seniors to purchaseexpensive life insurance, loan them money to pay the premiums and,after the two-year contestability period, assume ownership of thepolicy. The sooner the person dies, the more profitable the deathbenefit the investor collects. Consumers lured into such deals,such as King, are usually unaware of the tax consequences,commissions, and legal fees involved. They also seldom understandthat the deal compromises or completely exhausts their insurancecapacity (insurance capacity is the maximum amount of insurancethat you are allowed to purchase on your life).

In an even more nightmarish scenario, people are lured intothese deals and pay the premiums themselves, based on promises thatthey will make a hefty profit after two years of payments. The PalmBeach Post reported that an 81-year-old man is suing a Boca Ratonfirm that advised him to purchase a $5 million life insurancepolicy with promises that he could make a huge profit by selling itto investors. After two years and $322,000 in premium payments, thefirm told the policyholder that there was no market for the policy.Worse, the person who allegedly lured him into the deal reportedlyconducted seminars where he pitched similar deals to hundreds ofseniors. As we have seen in other insurance markets, bad economicconditions lead to increased instances of fraud, unauthorizedentities, and various scams. STOLI is ripe for such activity.

STOLI Legislation

STOLI deals are not to be confused with legitimate viaticalsettlement arrangements where there was a genuine insurableinterest at the time the policy was purchased and the policy wasintended to provide benefits to the beneficiary if the insureddied. In legitimate viatical arrangements, insureds pay their ownpremiums, but come to a point where they need to sell the policyfor causes such as death of a spouse, divorce, disability,bankruptcy, loss of job, financial distress, or terminalillness.

Unlike legitimate viatical/life settlement deals, STOLI schemesinvolve purchasing life insurance for no other reason than tomarket the policy and wager on the life of the insured once thetwo-year contestability period has ended.

Insurance Commissioner Kevin McCarty correctly pointed out in aneditorial in The Gainesville Sun decrying STOLIs that they are notlegal in Florida as they violate the insurable-interest law,intended to discourage individuals from wagering on other people'slives with whom they have no vested interest. An insurable interestexists when the beneficiary has a reasonable expectation that hewill benefit — by love, affection, or finances — from the continuedlife and health of the person who is insured.

NAIFA-Florida joined in the push during the 2007 legislativesession for a bill that boosted Florida's insurable interest law bycreating standards for the sale of personal insurance policies toindividuals who are seeking to insure people other than themselves.In 2008, we joined CFO Alex Sink, McCarty, the American Council ofLife Insurers, and others in support of unsuccessful legislationthat would have disallowed the sale of life policies purchased withloaned funds for a period of five years after issuance.NAIFA-Florida and other stakeholders are currently consideringoptions for the 2010 legislative session.

Impact on the Industry

The fact is, today's difficult economy has led many financiallystrapped seniors to consider selling their legitimately procuredlife insurance policies. These are complex transactions with oftenunseen consequences, and people considering them need to meet withtheir financial advisors and/or agents to consider whether this isthe best avenue. In addition to the cautions mentioned above,sellers of policies could lose eligibility for Medicaid and othergovernment programs. Their advisors may be able to point to otherfinancial options that do not involve selling the policy, such astaking a loan against the policy or getting a partial payoutthrough an accelerated death benefit.

NAIFA's biggest concern is the effect STOLI deals will have onthe life insurance industry as a whole. A recent congressionalanalysis estimated the tax-free buildup in life insurance over thenext five years at $1.5 trillion. The report referred to this moneyas lost revenue, but for Florida's widows and retirees this islifesaving revenue. If through STOLI deals life insurance becomes aproduct of Wall Street rather than one of Main Street, thenlawmakers will tax it and deliver a body blow to our industry.

In 2007, individual life insurance coverage purchased byFloridians totaled $120 billion. Group coverage amounted to over$400 billion; residents have $1 trillion in death benefit coverage.The life insurance industry employs an estimated 75,000 people inFlorida. We must protect this vital industry, which is why stoppingSTOLI is so important.

Bob Lotane is communications and politicalaffairs director for the National Association of Insurance andFinancial Advisors-Florida. He may be contacted at 850-544-9446 [email protected].