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Abstract: A Stranger-Originated Life Insurance (STOLI) transaction arises when a life insurance policy is effectively procured by a stranger, usually a third-party investor unrelated to the insured. Despite the growing frequency and popularity of STOLI transactions, there has been much discussion, but a lack of academic research, on the issues and challenges they have generated. The purpose of this research is to shed some light on this innovative insurance transaction by providing a clearer understanding of the controversy created by the STOLI phenomenon, and to argue that regulatory action aimed at restricting or prohibiting these transactions seems unnecessary. After examining the controversy generated by STOLI transactions from the perspective of consumers, insurance carriers, and state insurance regulators, we review the primary initiatives to regulate STOLI transactions, analyze the concerns that have been raised about these transactions, and conclude with proposals for market-based solutions and other reforms to address these concerns and other issues that have given rise to the STOLI controversy. [Key words: STOLI, life insurance, market-based solutions]
INTRODUCTION
Cash value life insurance serves many critical economic functions. Most importantly, it provides financial protection against premature death to family members and/or business partners. When the need for financial protection no longer exists, however, what viable options does a policy owner have if he or she no longer needs the insurance coverage and decides to cash in the policy? Traditionally, the policy owner's primary option has been to surrender the policy and receive the cash value, if any, from the insurer. Recently, though, with the rise of a secondary market for life insurance policies, an additional option has become available: the policy owner can sell the policy to a third-party investor. The investor becomes the new policy owner, who pays the remaining premiums on the policy and collects the death benefit at the insured's death. This second option has become known as a life settlement.4
Doherty and Singer (2002) describe life insurance arrangements as "a previously inaccessible asset class." Due to the increasing investor demand, the secondary market for life insurance has grown rapidly. The Government Accountability Office (GAO) estimated that the total face value of policies settled in 2008 ranged from $9 billion to $12 billion approximately (GAO, 2010). The Securities and Exchange...