Life settlement transactions, in which a person sells his/her life-insurance policy to a third party, are legitimate ways for people to get rid of unwanted insurance policies that originally were purchased with the intent of using them.
But you should be aware that a stranger-originated life-insurance (STOLI) transaction isn’t the same thing. In fact, it’s a scheme. In February 2012, the insurance industry derailed a Florida insurance-legislation amendment that would have given insurance companies just 90 days to detect such scams and rescind the policies.
In a STOLI scheme, a third party induces you to take out a life-insurance policy and name him/her the beneficiary. The third party pays the premiums and receives the death benefits. (The transaction is legal only if life-insurance beneficiaries are related closely to the insured person.)
You should know that if you’re induced into a STOLI scheme, you might face fraud charges, civil suits and tax liabilities (and be unable to get another policy). At least 31 states have laws against STOLI schemes, according to American Council of Life Insurers.
Time and intent make the difference between a STOLI scheme and a legitimate life settlement transaction, says Adam Sherman, who is the chief executive officer of Firstrust Financial Resources, which is a wealth-management company. He says life-insurance companies try to detect STOLI schemes by asking applicants whether they plan to sell their policies in the next 12–24 months. Companies see that as an indicator that the policy was purchased with fraudulent intent, Sherman says.