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Stoli, Ioli, Beneficial Interest Sale, 3% Deal, What is it?

One of the most talked about aspects of the secondary insurance market is the sale of the beneficial interest in a newly originated insurance policy for 2-5% of the face amount. Also know as STOLI (stranger owned life insurance) or IOLO (investor owned life insurance) it is one of the best kept secrets in the world of insurance. A beneficial interest sale involves wealthy seniors, above the age of 70, who have excess insurance capacity. Insurance capacity is the amount of insurance a person can purchase on their life based on their net worth and annual income. These high net worth seniors have no interest or need in purchasing any additional life insurance on their lives but would like to benefit from their ability to qualify for the coverage.

These wealthy seniors will apply for a high value policy, usually with a face amount of above $2 million. The owner and beneficiary of this new policy will be a an irrevocable life insurance trust with the insured as Grantor and a person with insurable interest in the insured, such as a spouse or a child will be the Beneficiary. Once the policy is issued by the insurance carrier, the insured will put the policy inforce by paying the first quarter premium. After the policy is put issued and put inforce, the client will get an offer of usually between 2-5% of the face amount of the policy plus a reimbursement of the quarterly premium, from a funder with institutional capital to purchase the beneficial interest in the trust that owns the policy.

Both the Beneficiary, as well as the Trustee, sign over their interest or ownership in the trust to the funder. The owner of the policy remains the trust. The funder will continue to pay the premiums through the life of the policy and will collect the entire death benefit upon the death of the insured.

Much the same as the life settlement market this transaction came into existence when the banks and hedge funds that purchase these policies found the arbitrage that is created by the lapse based pricing that insurance carriers use as well as the favorable underwriting that large insurance producers can get for their clients and the actual life expectancy of the client as determined by outside actuaries. When you have a favorable insurance offer and an unfavorable life expectancy an insurance policy has a value on the open market that far exceeds any cash value in the policy on day one.

In the recent months and especially with the Larry King lawsuit there has been much debate about the legalities of the beneficial interest sale. The funders maintain that the Supreme Court case Grigsby v. Russell gives the client the ability to transfer any active and inforce policy to a third party no matter when the policy was put inforce. The insurance carriers state that this practice usurps insurable interest laws and due to the lapse based pricing that insurance carriers use they will need to either raise premiums for senior citizens or stop selling policies to them all together.

A little known secret in the insurance industry is that 99% of term policies and over 85% of permanent policies are either cashed out or terminated before a death claim is paid. The insurance carriers maintain that they use this information to lower premiums for all clients. They state that when an institutional investor buys a policy that a death claim will be paid. They have come to accept that a policy that purchased years ago and is sold in a life settlement is part if the insurance business and some carriers including AIG, Phoenix Life and TransAmerica have made strides to start buying policies on the secondary market. However, all the insurance carriers state they are opposed to a policy being taken out for the sole purchase of selling it to a third party.

In an effort to thwart this industry, the insurance carriers have begun asking question on their insurance applications regarding the intent of the insurance, how the premiums will be paid, if they have received any offer from a third party for the policy and whether a life expectancy valuation has been done. If the client answers these questions in any way that may indicate their intent to sell the policy at anytime in the future, the insurance carrier may not issue the policy. In addition, within the past few weeks the National Association of Insurance Commissioners have tried to put an end to this practice by asking the states to increase the contestability period, or the time period the insurance carriers has to determine if their was fraud on the application and rescind the policy from two to five years.

The funders argue that insurance carriers should stop using lapse based pricing for clients 70 and older and should re-price their product with the anticipation that a death claim will be paid. Those in favor of beneficial interest sales argue that while the carriers state that they are opposed to the transaction and write questions on their applications to try and stop it they are secretly in favor of the practice. The average premium for a male age 70 or older with standard nonsmoker insurance underwriting is $50,000 per million of coverage. These types of transactions bring in huge revenues for insurance carriers and help them meet their numbers. That if they priced their policy correctly the premiums paid would far outweigh the death claim that will be paid.

Unfortunately, it is too early to know who the real winners and losers of the beneficial interest sale debate will be. The practice has not been around long enough for any real data to be put together as to the ramifications to the insurance carriers or the funders. The only thing that is certain is that clients will continue to want to benefit from their insurance capacity while they are still able to enjoy it. Insurance carriers will continue to fight the practice by raising premiums and adding more questions to the applications and the funders will continue to find value in these policies.