The Bakersfield Californian
February 10, 2012
In this struggling economy, people are seeing their savings disappear and their retirement hopes dashed. Risky investment schemes – maybe even illegal ones – are starting to look pretty darn good to those among us who are desperate.
My advice: When you already are in a hole, don’t dig it deeper. Guard your money and resources as if your life depended on it. And, actually, your long life in retirement does.
I have a boomer client, who I will call Robert, who did not take “saving for retirement” seriously until he hit 50.
For the past several months, Robert and I have been engaged in the tedious process of identifying his existing and potential resources to provide an income stream beyond a modest Social Security check in his senior years. To his credit, Robert is now “serious” about saving for retirement.
So you can imagine my surprise when Robert came into my office a few days ago with a great idea he heard about from his “buddy.” And his buddy heard about it from a friend of a friend. It seemed to stem more from coffee shop chatter, than from serious research.
Robert and his friend heard that they could make tens of thousands of dollars by acquiring multi-million dollar life insurance policies and then selling the policies to investors for sizeable fees.
My response: Don’t even listen to anyone pitching this get-rich-quick scheme. It is generally considered fraud and in many states, including California, it is illegal. In addition, there are numerous financial and legal risks in what is commonly called stranger-originated life insurance (STOLI), or speculator-initiated life insurance (SPINLIFE).
The concept for this scheme has roots in 18th century England, where it became so prevalent that investors transformed the insurance industry into a gambling racket. Policies were taken out on the very rich, often without their knowledge.
Fearing the scheme could inspire some get-rich-quick investors to commit murder, the British courts developed the concept of “insurable interest,” which also was adopted in the U.S. Basically it means that anyone taking out an insurance policy must have an “interest” in the insured person staying alive.
For example, the beneficiaries of an insurance policy taken out on the life of a head of household usually are the person’s spouse or children. Presumably, these beneficiaries would not want to kill the insured person just to collect a sizeable chunk of money. Of course, there have been cases of familial insurance murder.
In addition to the “insurable interest” concept, most companies require clients to declare that they are purchasing policies for typical “insurance” reasons and not for a cash pay-off after the policies are resold to speculators.
But despite these safeguards and the passage of laws in states prohibiting stranger-originated life insurance, this scheme seems to keep hanging around. Why? Because promised “rewards” are large, and because the line is blurred between these illegal transactions and the legal, but still sometimes risky “life settlement.”
What’s the difference?
In a STOLI, a person – often a wealthy senior citizen – is approached by a “salesperson” with a proposal to pay the senior a large amount of money for taking out a life insurance policy and, within a period of time, assigning the policy to an investor, or group of investors. The investors continue to make the premium payments and receive the benefits when the senior dies.
Because it is considered illegal in California, the scheme operates in the “shadows,” with targets often approached in social settings. “Marks” are often identified by unscrupulous people working in legal and financial offices, who are paid finders’ fees.
Legal “life settlement” is the sale of an often long-held insurance policy to investors for cash. In many cases, the money is used to pay living expenses or medical bills.
In a 2009 column, personal finance adviser Saul Friedman cited the following example: A male policyholder who is 75 and has a $1.5 million policy with a surrender value of $72,000 may get a life settlement of $455,000. Since such factors as the age and health of a policy holder enter into the amount investors will pay, people are advised to “shop around” before selling their policies.
The big difference between STOLI and life settlement is intent. From the get-go, a STOLI is intended to be “flipped.” The original intention of a policy in a life settlement is to provide life insurance. The sale of the policy is an after-thought.
Insurance companies consider STOLI to be fraud because they are based on misrepresentation. And the insurance industry’s bottom line is hurt when policies are sold to investors. After all, insurance companies are counting on a large number of the policies it sells to lapse or be cashed in for a small surrender value.
What are the risks?
- Legal. If the scheme is a STOLI, the insured may be accused of fraud and required to pay for a legal defense.
- Identity Theft. STOLI documents require disclosure of medical records, and wide ranging personal and financial information. Very sensitive information is placed in the hands of criminals.
- Costs. Whether it’s a STOLI or life settlement, there could be hidden costs from transaction fees or unanticipated events. For example, in 2010, an 81-year-old Florida man was lured into buying a $5 million life insurance policy with the promise that he could make a huge profit selling it. After making $322,000 in premium payments for two years, the man was told that investors were not interested in buying his policy. Seminars targeting seniors are ripe with stories about similar scenarios.
- Taxes. Taxable income may result from the sale of an insurance policy to investors. Consult an attorney, accountant or financial advisor to discuss the consequences and alternatives. Insurance limit. Buying mega-million dollar policies to flip for profit can exceed a person’s insurance limit, leaving them unable to buy additional coverage for legitimate purposes.
Besides being against the law and placing people at financial risk, a STOLI scheme is just plain creepy. It leaves a stranger somewhere rooting for you to die.