Last fall, Joe Kristan at Roth and Co told us that "Dead Peasant" insurance was dead. But, much like George Romero’s nightmarish vision, the idea may not be.
Stranger Owned Life Insurance (SOLI) is part of the “premium financing” phenomenon. Although it seems to be “under the radar” at the moment, SOLI threatens to become a potentially bigger issue in the life insurance industry than even COLI.
Because the stakes (and the dollars) are higher, and because the rhetoric is turning nasty. And the financial press loves nothing more than it loves a brutal, knock-down fight among industry insiders.
So, what is SOLI? It’s a potentially dangerous game of financial cat and mouse: an investor (either an individual, or a syndicate, or a commercial lender) approaches a likely mark – er, uh – prospect, almost always a seasoned citizen. He then makes the prospect an offer he can’t refuse:
"You purchase $10 million of insurance on your life. We'll advance the premiums for two years at an interest rate of 12% to 15% and take a collateral assignment on the policy. You pay nothing. You don't even have to pay any interest--it accrues with the loan. At the end of two years, if you want to continue the coverage, you pay us the interest you owe and repay the principal. It's a non-recourse loan. That means you risk nothing. If you don't want the coverage at the end of two years, no problem. We'll take over the policy and you have no liability. You owe nothing. Best of all, we'll pay you $250,000 in cash up-front to sweeten the deal."
If you’re the prospect, this is pretty enticing; after all, what is there to lose? But what’s the incentive for the investor, the one putting up those two years’ worth of premiums?
Well, obviously, there’s the potential of a big windfall if the insured assumes room temperature (although that’s problematic, too, as we’ll see in a moment). But mostly, it’s the “glitch” in how life insurance is priced for those of advanced years. A lot of carriers price these plans with the assumption that many, if not most, will lapse. That’s probably a safe bet, since these plans can pretty expensive. Counterintuitively, though, it’s also what makes this “non-recourse premium financing” so attractive: because the carriers assume that a lot of the plans will lapse, they price them “lower than the amount that would have to be charged to maintain adequate reserves if all policies were held to maturity.” [ibid]
So, by keeping the policy “alive,” it’s pretty likely that it will pay off sooner, rather than later, and provide a nice windfall to the investor. Sweet.
So what’s the problem? Well, first, there’s the little matter of “insurable interest.” That is, the beneficiary of a policy must have some financial stake in the insured (for example, the family breadwinner, or a key employee, or the business owner himself). Heck, even with COLI, at least the employer had an ostensible such interest in the employee. But there is no such relationship in SOLI: these are perfect strangers, looking to make a (potentially) quick buck.
So what’s the harm? Yes, there’s the moral hazard: a danger that the beneficiary may get “impatient,” and hasten the payoff date. And, since there are tax implications, it potentially puts the industry under a microscope (not that there’s anything wrong with that). From the insured’s standpoint, though, I’m not sure I see a downside. The real risk, it seems to me, is to the investor whose money is at risk. And, I suppose, the carrier, but no one forced them to price their policies to make this idea attractive.
RELATED: It gets worse.