Beware “Zero Premium” or “Stranger Originated” Life Insurance

State insurance departments are warning citizens to beware so-called “zero premium” or “stranger originated” life insurance arrangements. If you receive such an offer and it sounds too good to be true, it could be.

Sellers of zero-premium life insurance might refer to it by other names, such as investor-owned life insurance or stranger-owned life insurance. In these schemes, a salesperson approaches someone, usually between the ages of 65 and 85, and induces them to apply for a life insurance policy that they might not have bought otherwise, often for a high face value. An investor pays the premiums and the applicant names the investor as the policy beneficiary. In exchange for participating, the applicant either gets a percentage of the policy benefit immediately, or his/her heirs receive a percentage upon his death and the investor/owner gets the balance.

Many states ban this type of arrangement, called stranger-originated life insurance (SOLI or STOLI). They require the owner of a life insurance policy to have an “insurable interest” in the life of the insured, such as a family or employer relationship. In other words, they should have a greater interest in having the insured be alive than dead.

In testimony to the Special Committee on Aging of the U.S. Senate in 2009, James Avery Jr., president of individual life for Prudential Financial, spoke on behalf of the American Council of Life Insurers against SOLI. He said that these arrangements “…are fraudulent and they are contrary to both public policy and State law, which require life insurance policy owners — or beneficiaries, for that matter — to have an initial insurable interest in the continued life of the insured. Quite to the contrary, STOLI policy owners and beneficiaries have an interest only in the death of the insured. Quite frankly, the sooner the better.”

Some investors try to get around legal or insurer prohibitions on SOLI by providing a two-year loan to the policy applicant in exchange for a collateral assignment on the policy. At the end of two years, the policyowner can either repay the loan plus interest and keep the policy, not repay the loan and let the policy lapse, or sell the policy on the open market.

The Risks of SOLI

Participating in a SOLI scheme poses several risks to consumers:

1. No state laws prohibit a life insurance policy obtained in this way from being sold multiple times. This exposes your health records to multiple third parties.
2. Applying for a SOLI policy could affect your future insurability, as life insurers generally cap the amount of coverage on a single individual’s life from all sources.
3. SOLI arrangements could create tax liabilities. Unlike a life insurance policy’s death benefit, which beneficiaries generally receive tax-free, a payment you receive for participating in a SOLI scheme could affect your tax liability.
4. In many senses, you are trusting your life to total strangers.

SOLI Versus Viatical Settlements

SOLI differs from viatical or life settlements, which became popular during the AIDS crisis in the 1980s. Policy owners have a legal right to sell (or “assign”) their life insurance policy. In a life settlement, a chronically or terminally ill insured assigns a life insurance policy he/she already owns to a life settlement company. The policy owner typically receives more than the policy’s cash value, but less than the full death benefit. In exchange, the life settlement company becomes the policy’s beneficiary and receives the death benefit when the insured dies. As insurance transactions, life settlements fall under state insurance law.

Stephan Leimberg, an estate and financial planning attorney, told the committee, “Legitimate, appropriate life settlements can benefit seniors,” but noted that abuses occur. In addition to “unscrupulous settlement companies” that cheat sellers, some sellers go into the transaction without a clear understanding what their policy is really worth. In many instances, the policy could be worth much more to the policyholder than the value of the settlement. A “hold/fold” analysis could help policyholders better understand the financial tradeoffs of a settlement.

Leimberg also says that 42 percent of all 2008 settlements occurred in states with no settlement law. “…few states have modern settlement laws … so, rogue brokers change the legal location of a transaction to avoid a tough state’s laws.”Be

As with SOLI, a life settlement could affect your tax liabilities. And since you are selling your life coverage, your beneficiaries are losing valuable life insurance protection. If you have a whole life policy that has built cash value, it might make better financial sense to take a policy loan or withdrawal against cash value and retain your valuable life coverage.