Covered for Life -- by a Stranger

Many seniors sell their life-insurance policies to raise cash. When you (or a family member who may own the policy on your life) sell the insurance, the buyer becomes the owner and beneficiary. On your death, this stranger stops paying premiums and collects the death benefit.

Investors and middlemen make such big profits buying seniors' life-insurance policies that they are enticing people to take out unneeded insurance expressly for quick resale. But their greed may be catching up with them.

Stranger Owned Life Insurance (STOLI) resembles playing the lottery when you know the winning numbers in advance. A broker or investor persuades an affluent person in his or her 60s or 70s to apply for a large life-insurance policy with the agreement to sell it soon, usually within two years. The investor lends the money to pay the premiums. So anything you clear would seem to be free and out of nowhere.

STOLI got attention a few months ago after word spread that talk-show host Larry King had bought two policies totaling $15 million in death benefits and flipped them for $550,000 and $850,000. The investors clearly expect that King, who is 74 and has had serious heart problems, won't meet many more presidents before he dies. Yet King wasn't thrilled with his $1.4 million payoff; he sued for breach of fiduciary duty, claiming that he didn't realize the broker would get almost as much out of the transaction as he did, that he didn't know how the sale would be taxed, and that he didn't know creating and transferring the policies would make it difficult to buy additional life coverage (life insurers set limits based on income and assets).

But commissions aren't the only problem. Deals with strangers are just one more type of policy clamoring for investors, and they lower the amount people can get for legitimate life settlements. It's also against the point of insurance: to protect those who would suffer financially if you die. Several states are changing their laws to put an end to STOLI.

Insurance companies are trying to stem STOLI sales by asking applicants whether they plan to sell the policy. Saying no and then doing so is fraud and could invalidate the insurance. Some companies are refusing to sell large life policies to anyone over a certain age.