What is stranger-originated life insurance (STOLI) in Florida?
In Florida, people are allowed to sell their life insurance policies on the secondary market. A Florida statute, § 627.422, permits a person to assign a life insurance policy to someone else, unless the policies unless the policy itself prohibits the assignment. This secondary market is a way for policyholders to cash out their policies by selling them an investor at a higher amount than they would receive by surrendering the policies back to the insurance company. Stranger-originated Life Insurance (often abbreviated “STOLI”) policies are a variation on this theme. In a STOLI deal, an insured – often an elderly person – agrees to “free” or “risk-free” insurance with the intent that they will receive a sum of money to transfer the policy after the contestability period to an investor who could not have taken out the policy on their life in the first place because they lack of an insurable interest.
Florida law requires an insurable interest – How does a STOLI policy get around that requirement?
A Florida law – statute § 627.404 – requires that a person who takes out a life insurance policy on another person must have what is called an insurable interest. That means that the one who is buying the life insurance policy must either a) be buying it for themselves or, b) if they are another person or company, they must be “closely related by blood or by law and in whom the individual has a substantial interest engendered by love and affection,” or have some financial interest in their life (like a business partner).
In a STOLI transaction, the “stranger” in the equation lacks a blood or legal relationship or a financial interest in the insured person’s life at the time the policy is taken out. By definition, the stranger lacks an insurable interest. They avoid that problem by setting the beneficiary at the start of the policy as someone who does have an insurable interest. This is most often the insured person’s spouse.
What is the 2-year contestability period in Florida?
Another Florida statute – § 627.455 – states that an insurer may not invalidate an insurance policy issued in Florida after 2 years. This is an important part of STOLI transactions, because the stranger financing the deal is expecting the policy to be transferred to them after the contestability period expires. The transaction is based on a legitimate policy being issued with a true beneficiary who has an insurable interest, but the insured person later sells the policy to the stranger/investor to get cash out of the policy, and as long as that transaction occurs after the 2 year contestability window closes, the insurance company may not cancel the policy to avoid having to pay the benefits.
The key In Florida: the STOLI “stranger” needs a legitimate beneficiary in the deal at the beginning.
In a recent Florida Supreme Court case, Wells Fargo Bank, N.A. v. Pruco Life Ins. Co., 200 So.3d 1202 (Fla. 2016), the Court had to assess whether a STOLI policy could be invalidated by the insurance company after the 2 year contestability period. The case revolved around the interplay between Florida’s insurable interest law (statute § 627.404 ) and Florida’s 2-year contestability law statute § 627.455). In that case, the insurance company claimed that the STOLI policy was void from the very beginning, and argued that it could invalidate the policy after the 2-year window passed.
The elderly person whose life was insured had agreed to the deal based on fraudulent financial statements and had never had to pay premiums. The beneficiary was changed to a trust run by the stranger/investor after the 2-year contestability period, and the insurance company tried to avoid paying benefits saying the policy was never legitimate from the beginning. However, a person with an insurable interest was named as beneficiary at the time the life insurance policy was bought.
The Florida Supreme Court held that the person whose life is being insured must designate a beneficiary that would have an insurable interest when the policy is taken out. In the case, the beneficiary had an insurable interest at the time the policy was issued, and therefore, the policy was valid at that time. The Court held that it did not need to choose which Florida statute controlled over the other, because there was an insurable interest when the policy was bought. Therefore, the Court refused to allow the insurance company to void the policy after the 2-year contestability period on that basis.
The reason most people agree to them is the promise of cash for the policy after the 2-year contestability period passes. But beware: STOLI policies can be scams preying on the elderly. The cash buyout will only happen if the original beneficiary was a valid one with an insurable interest. Of course, if the policy was obtained with fraudulent financial or health documents, it may be voided during the 2-year period, and the legitimate beneficiary may end up with nothing if a policy claim has to be made. Buyers of STOLI policies need to beware. Remember: if it sounds to good to be true, it probably is. However, a legitimate STOLI policy is legal in Florida, and if done properly can help an elderly person inject cash into their life when they may need it most.