Stranger-owned life insurance (STOLI) is exactly as it sounds – life insurance originated by a stranger. The originally intent of STOLI is to eventually change ownership of a life insurance policy – typically to an investor – and profit from the death benefit.
Please note that the STOLI has been banned in at least 25 states, and the majority of the remaining states are considering banning it.
So, what are the impacts on life insurance companies because of stranger-owned life insurance?
There is some debate as to what the bottom-line impact will be to life insurance companies.
There will be some impact due to the way that life insurance companies price their policies. The pricing of a life insurance policy is dependent upon a number of actuarial-based assumptions, one of which is expected lapse rates.
A majority of life insurance policies in-force today were sold and priced, prior to the secondary life insurance marketplace. Therefore, when the products were designed, companies took into historical lapse rates (this includes surrenders).
Lapse rates impact the premiums since insurance companies assume that a certain number of policyholders will lapse – discontinue paying premiums – rather than retaining the policy until death.
Life insurance product pricing is a function of three pricing factors: cost of insurance costs (COIs), policy expenses, and policy interest earnings.
This is a delicate balance for companies to be both competitive and profitable.
Life settlements make estimating lapse assumptions more difficult because policyholders are opting to sell their policies rather than allowing them to lapse.
If insurers price policies based on significantly lower lapse assumptions than are realized, insurers lose.
Furthermore, the insurers cannot raise rates on guaranteed premium policies to make up the shortfall. Consequently, they could be compelled to hoard more reserves to pay claims.
This will impact profitability and could upset the delicate balance.