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Stranger & Investor Owned Life Insurance

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

After reading this lesson, you'll learn why stranger- and investor-owned life insurance is something that is frowned upon by insurance companies themselves. You'll also learn why some people still decide to take this route.

Life Insurance

Usually, life insurance is purchased to help a person's family when the person dies. After the person's death, the family needs to pay for end-of-life expenses, such as funeral costs and possibly paying back any existing loans the person has left behind. These loans could be mortgages, car loans, credit card balances, etc. A normal life insurance policy is one that benefits the insured directly, but there are two other kinds of life insurance that benefit others that the insured may not even know.


A normal life insurance policy benefits the insured directly upon his or her death.
STOLI IOLI


Stranger-Owned Life Insurance

The first is referred to as stranger-owned life insurance (STOLI). This is when a person's life insurance policy benefits a stranger, someone the insured person may not know. For example, Ben, a senior who doesn't necessarily need life insurance at the moment, enters into a STOLI transaction because the third party is offering to give him an upfront payment and to pay for the life insurance premiums just for Ben giving up his life insurance benefits.

This practice of selling life insurance policies to strangers has been made illegal in certain states. For example, the Viatical Settlement Act made it illegal for anybody to enter into a STOLI transaction in Illinois beginning July 1, 2010.

Investor-Owned Life Insurance

Investor-owned life insurance (IOLI) is a type of life insurance where an investor pays a person to take out a large life insurance policy for the person. The investor pays the person's premiums in exchange for the person's life insurance benefits. An IOLI transcation is very similar to a STOLI transaction, the only difference being that an IOLI is always initiated by an investor.

There are investor companies that perform IOLI transactions as their main source of income. These companies will call people like Ben and offer him free life insurance for a period of time and a payout in exchange for their life insurance benefits. Then these companies simply wait for Ben and other customers to die and then they'll collect the benefits.

Benefits

It may sound weird for a person to give up his or her life insurance benefits to a complete stranger or investor. So, why would anybody want to enter into a STOLI or IOLI?

It all comes down to how STOLI and IOLI transactions are done. See, what happens is that an investor or other third party proposes to a person that they will help the person get a life insurance policy and pay for their premiums in exchange for the benefits when the person dies. In addition to all these, the person also receives a portion of the life insurance benefits beforehand. This way, the person can use his or her life insurance benefits while still alive.

Imagine a person in her 70s. She is fairly healthy, has no debt, and her kids are all grown and successful in life. She doesn't have to worry about anyone if she happens to die. An investor approaches this person and asks her if she would be willing to give up her life insurance benefits in exchange for a percentage of the benefits up front. This sounds great to her. She can use this money to take a dream vacation with her kids and their families. In addition, she doesn't have to worry about paying the premiums as this is paid for, too.

Lack of Insurable Interest

A problem arises though. Not just anybody can get a life insurance policy. You have to prove that you have insurable interest in the event the person dies, which means that you'll suffer financial loss from this person's death. This means that you can't take out a life insurance policy on an elderly acquaintance just because you expect him to die soon. Also, you can only get life insurance for an amount that would cover the cost of your life.

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