My last post discussed one form of betting on your death – “stranger oriented life insurance” (“STOLI”) –a practice which is illegal in Massachusetts. However, another variation of betting on your death – life settlements – is trending towards legitimacy. Unlike STOLI, which involves third party solicitation of a person to purchase then “flip” a life insurance policy, the life settlement industry focuses on persuading people who already own life insurance policies to sell their policies. Though heavily regulated, life settlements are legal in most states, including Massachusetts.
In a life settlement, a life insurance policy holder can sell rights to the payout of his insurance policy in exchange for a lump sum. Since the buyer also agrees to take on the cost of premiums upon a sale, how much a buyer is willing to pay for the policy depends in part on the cold reality of how soon the buyer thinks the seller is likely to die. In order to value a life insurance policy, prospective buyer companies do actuarial research and request medical examinations of policyholders to try to determine whether the policy holder’s life expectancy will likely to be short enough to make the deal worth it. Owners of life insurance policies may be able to “shop” the policy among potential buyers various and entertain multiple offers from interested investors.
Proponents of life settlements argue that allowing people to sell their life insurance policies gives them another opportunity to lead financially comfortable and self-sufficient lives. This opportunity is especially powerful since prospective sellers of life settlements are often elderly or infirm individuals who see the sale of their policy as one of the only means available to them of generating significant funds in a short amount of time. Critics of the industry counter that a life settlement reduces the value of the assets that would otherwise be passed onto loved ones after the insured’s death – funds which may be needed by the survivor. Further, life settlements subvert the traditional model of the insurance industry. While traditional insurers benefit from having their policy holders living and paying their premiums as long as possible, companies buying policies perversely benefit from an earlier death of the original policy holder. There can also be significant tax consequences for the insured which must be carefully considered.
Ultimately, the decision to sell a life insurance policy to a third party is a highly personal decision and one that may be replete with significant legal and tax consequences. Speak with a trusted elder law attorney, accountant or financial adviser before moving forward with such a sale.
Imagine that you are an elderly retiree who has recently been hit with a sizable amount of debt. One day you receive a phone call from an insurance agent who proposes the following deal:
1. You take out a good-size life insurance policy.
2. For the first two years, the insurance company would pay your premiums and allow you to name your beneficiary on the policy.
3. After two years pass, you would be required to sell your insurance policy to the insurance company in exchange for a sizable lump sum.
Even though this plan seems vaguely macabre, you appear to benefit either way: Either your loved ones would get the policy payout upon your death, or you would get the lump sum sales payment after two years seemingly for free – all you would have to give the insurance company is your name and some personal information about your health. The company may even sweeten the deal by offering you a cash sign-up bonus. Would you accept the agent’s offer?
The above scenario illustrates an increasingly common example of “stranger oriented life insurance” (“STOLI”). Massachusetts and several other states have banned STOLI because life insurance contracts specify that a life insurance policy must be taken out in order to benefit the policy holder and his loved ones. When a policy holder is persuaded to take the policy out for a third party’s benefit, the “life insurance” no longer serves its intended purpose of financially protecting the insured’s loved ones after the insured’s death.
There are several risks for seniors who get involved in a STOLI scheme. For one, if the insurer is told that the STOLI policy is void because it is illegal, the insurer may turn around and sue the policy holder or her estate for damages even though it was not the policy holder’s idea to take out the insurance policy in the first place. (However, since these policies are illegal in Massachusetts, the policy holder or his estate would have a strong counterclaim against both the insurer and the salesman under our state’s consumer protection laws.) Also, since insurance companies who buy STOLI policies benefit after the policy holder dies, these companies often want to keep careful records of the policy holder’s health status. Consequently, many elders involved in STOLI schemes complain of being harassed by insurance companies demanding that they complete frequent and lengthy surveys about personal health questions long after they sold their policies. Finally, the purchase of a STOLI insurance policy might create a disincentive to taking out a legitimate insurance policy, which could become problematic if the senior’s health declines and the senior becomes uninsurable. Thus, even if these policies were legal in Massachusetts, I wouldn’t recommend them to my clients.
However, there is another way to bet on death that is legal in Massachusetts – life settlements. I’ll explore this issue in my next posting.