STOLI is an acronym for “stranger-owned life insurance” or “speculator-owned life insurance.” It is a shorthand reference for transactions in which someone buys insurance on his own life for the purpose of selling it to a third party, often an unrelated investor, once the policy’s contestability period has expired. A recent ruling by a federal court in New Jersey, however, may undermine the security of such investments.
In a STOLI transaction, the insured person typically gets cash for the policy and the investor receives the right to the policy benefits when the insured person dies. Life insurers loathe the transactions because investors are unlikely to let STOLI policies lapse, meaning that insurers will have to pay death benefits on a greater percentage of insurance contracts than they have become accustomed.
On January 27, 2009, the United States District Court for New Jersey became one of the first courts to weigh-in on what may become a recurring topic of litigation—an insurer’s effort to rescind one of its life insurance policies because of the possibility that it would be sold in a secondary market in a STOLI transaction.
In Lincoln National Life Insurance Company v. Calhoun, Lincoln National sued to rescind a $3 million policy on the life of Walter Calhoun. First, the insurer argued that the policy is void because Calhoun intended—at the time he applied for the policy—to sell it to “stranger investors” in the secondary life insurance market, thereby removing the necessary insurable interest. Second, Lincoln National argued that Calhoun made a material misrepresentation in his application by falsely stating that he had not discussed the possible sale or assignment of the policy in a secondary market.
The court held that Lincoln National properly stated a case, noting that a material misrepresentation on the policy application may be reason to void the policy. But more importantly, the court added that Lincoln National’s allegation of no insurable interest could also serve to void the policy. The court held, “Insureds begin to run afoul of the insurable interest requirement, however, when they intend at the time of the policy's issuance, to profit by transferring the policy to a stranger with no insurable interest at the expiration of the contestability period.”
The impact of the court’s insurable interest holding could be enormous. The market for STOLI policies is now estimated to be in the tens of billions of dollars. The court’s ruling that a policy may be void if the insured person intended, at the time of purchase, to transfer the policy to one without an insurable interest may undermine the security of those STOLI investments.