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.