Life Settlements vs. STOLI

Understanding the Differences between Stranger Owned Life Insurance (STOLI) and Life Settlements

Executive Summary

The origins of Life Settlements can be traced back to a landmark Supreme Court ruling in 1911 that established the property ownership rights of a life insurance policy holder. By the end of the century, the conditions were right for a secondary life insurance market to emerge and flourish. The continuing debate around this evolving market has been the pros and cons to the overall health of the life insurance industry. Effective arguments, supported by market evidence from both sides, have been made about the benefits and threats of Life Settlements to the broader insurance industry. Both the Life Settlement and the life insurance industries have mobilized forces to bolster their position in what has become a vigorous debate. The major threat to the industry, and driving factor of the friction between the two camps, has been around Stranger Owned Life Insurance (STOLI). The NAIC and NCOIL have developed model regulations that are being introduced and adopted in some states to address STOLI abuses. Both the insurance and Life Settlement industry are opposed to STOLI, and the life insurance industry is on the record acknowledging the legal rights and market efficiency of policy holders’ ability to liquidate unneeded policies through a Life Settlement.

A robust secondary market will increase customers’ valuation of life insurance policies. Economic theory holds that an active and efficient secondary market for a good improves the liquidity of the good as an asset, and thus increases
the value of the good to consumers.
The Benefits of a Secondary Market for Life Insurance Policies
The Wharton School, University of Pennsylvania

Introduction: Evolution of a Market

In 1911, United States Supreme Court Justice Oliver Wendell Holmes ruled that life insurance possesses all of the inherent characteristics of personal property giving a policy owner the right to dispose of this asset as they see fit. By the end of the 20th Century, Viaticals emerged as an opportunity for AIDS patients to cash out of a life insurance policy while still alive to cover the high costs of care not covered by health insurance. The Life Settlement market became an offshoot of Viaticals and has been growing rapidly ever since, with $30 billion in transactions projected in 2007. In a 2003 study conducted by Conning & Co, they estimated that 90 million senior citizens owned approximately $500 billion worth of life insurance in 2003, of which over $100 billion was owned by seniors eligible for Life Settlements.

With this kind of market potential it is no surprise that Wall Street is now paying attention. In a Business Week article published in July of 2007, it was observed, “Wall Street sees huge profits in buying policies, throwing them into a pool, dividing the pool into bonds and selling the bonds to pension funds, college endowments, and other professional investors. If the market develops as Wall Street expects, ordinary mutual funds will soon be able to get in on the action, too.” But, with these kinds of numbers and market potential it should be no surprise that regulators and law makers are paying attention as well.

The secondary market for life insurance policies gives the policyholder the economic freedom to choose between a number of buyers and, in so doing,
to receive the fair market price for their policy.
The Benefits of a Secondary Market for Life Insurance Policies
The Wharton School, University of Pennsylvania

Fundamental Property Rights

Life Settlements involving policies that were purchased based on a sound insurable interest premise are the foundation of a legitimate transaction. In fact, this type of a transaction is supported by the landmark Supreme Court decision, Grigbsy v. Russell. In Justice Holmes’ final opinion it was codified that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner could transfer without limitation.

This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
· Name the policy beneficiary
· Change the beneficiary designation
· Assign the policy as collateral for a loan
· Borrow against the policy
· Sell the policy to another party

Justice Holmes makes a clear distinction between a policy based on insurable interest and one where none exists, “A contract of insurance upon a life in which the insured has no interest is a pure wager that gives the insured a sinister counter interest in having the life come to an end. The very meaning of an insurable interest is an interest in having the life continue…”, his decision clearly considers an insurance policy to be the same as real property and does not oppose transferring the property/policy to an entity without an interest in the life of the insured, and to this point he is very clear, “…life insurance has become in our days one of the best recognized forms of investment and self-compelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner's hands”.

Life insurance policies are typically assignable, which means that a policyholder is free to transfer their ownership of the policy to another person. A policyholder’s right to assign their policy to someone other than the insurance carrier has existed for some time.
The Benefits of a Secondary Market for Life Insurance Policies
The Wharton School, University of Pennsylvania

The Insurable Interest Debate

The right of a policy owner to transfer ownership interest is a guaranteed right under Constitutional law established by one of the greatest legal minds in our country’s history. But the difference he recognized between policies based on insurable interest and one where none exists is a problem that the Life Settlement industry must address. In the case of STOLI are we looking at what Justice Holmes defines as, “a pure wager”? If that is the case, then this practice could threaten not only the long term future of the Life Settlement marketplace but also the foundation of life insurance itself.

Both the Life Insurance and Life Settlement industry 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 law makers. 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 in the insured-- then the tax free exemption could be revoked.

Legislative activity in the states has picked up over the last year as bills have been introduced and passed designed to stop STOLI transactions. The Governor of Ohio signed into law a bill that extends the time that a policy must be owned by the policy holder 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 job or death of the beneficiary. In September, 2008, California passed an anti-STOLI bill and sent it to the desk of Governor Schwarzenegger for 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, “STOLI’s are different.” The Life Insurance Settlement Association 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 policy makers 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) are 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 CEO’s 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.”

Viatical and Life Settlement firms allow policyholders who have experienced a negative shift in life expectancy to obtain the fair market value for their life insurance assets. The flexibility offered by the secondary market for life insurance policies gives a policyholder the ability to respond to changes in their life situation.
The Benefits of a Secondary Market for Life Insurance Policies
The Wharton School, University of Pennsylvania

Conclusion

The market is still evolving and the insurance industry is effectively wielding its considerable clout with regulators and law makers to ensure practices such as STOLI that game the system are curtailed. Third party sponsored life insurance transactions initiated for the sole purpose of flipping them in the Life Settlement marketplace is not a practice that is in the best interest of consumers or the industry. Conversely, in light of the long standing Supreme Court ruling on the transferability of insurance as property, the ability for those holding a policy based on insurable interest that they no longer need will always be able to maximize the value of that property through a Life Settlement transaction. The Life Settlement industry provides an important and efficient function to the insurance marketplace-- and it is a practice defended by the Supreme Court. But what constitutes insurable interest and ownership rights, and how that defines the key differences between STOLI and a Life Settlement, are important for the industry and consumers to understand.

A consumer now knows that if they should experience a decline in life expectancy and no longer need (or no longer be able to afford) their life insurance policy, they will be able to sell it for its market value instead of having to surrender it for the low price offered by the insurance carrier.
The Benefits of a Secondary Market for Life Insurance Policies
The Wharton School, University of Pennsylvania
Bibliography


“The Benefits of a Secondary Market for Life Insurance Policies”; Doherty, Neil and Singer, Hal; Wharton Financial Institutions Center
U.S. Supreme Court GRIGSBY v. RUSSELL, 222 U.S. 149 (1911) 222 U.S. 149; A. H. GRIGSBY, Petitioner, v. R. L. RUSSELL and Lillie Burchard, Administrators of John C. Burchard, Deceased. No. 53. Argued November 10 and 13, 1911. Decided December 4, 1911.

"Life Settlements: Additional Pressure on Life Profits”; Conning & Co., 2003

“Life Settlements: Betting on Death”; Goldstein, Matthew; Business Week; July 23, 2007

“Little Known Insurance Practice Targets the Elderly”; Howard, John; Capitol Weekly; September 11, 2008

“Press Release”; State of Ohio, Department of Insurance; September 11, 208

“Life Settlement Advisory”; Morris, Manning & Martin, LLP; October 2, 2008

“Issues: STOLI”; Issues; American Council of Life Insurers; http://www.acli.com/

“STOLI Poses Danger to Industry”; Connolly, Jim; National Underwriter; March, 2008