Stranger-originated life insurance (STOLI) has an evil twin, and now regulators have to figure out what, exactly, they should do about it.
STOLI has become a well-known issue in the industry – basically, an investor uses an insurance policy to profit from an elderly or sick policyholder’s death. But cases this year have shown the same method is now being occasionally applied to variable annuities products.
Thomas Sullivan, Connecticut’s insurance commissioner and chairman of the National Association of Insurance Commissioner’s Life Insurance and Annuities Committee, held a hearing recently to tackle the issue, and now, Sullivan said, regulators have to figure out their next step.
Stranger-originated life insurance (STOLI) and stranger-originated annuity transactions (STATs) are broadly similar. Both usually begin with some type of broker approaching an elderly or terminally ill person and suggesting they take out a policy or buy an annuity. The person then gets an up-front payout – in annuities’ case, usually $2,000 to $5,000 – and designates an unknown investor as their beneficiary. The investor, working with the broker, eventually gets a much bigger payout in the annuity or insurance death benefit when the policyholder dies.
Going Rogue
J. Lee Covington II, senior vice president of the Insured Retirement Institute, testified on the annuities scams to the NAIC committee. For annuities, an attorney usually sells the policy and then works with a registered representative – an employee of the insurance company – to invest in the annuity and potentially make millions thanks to annuities’ death benefits.
Financially, he said, it’s the insurance company that gets ripped off by “rogue agents” and attorneys.
“They know these products are designed for long-term investing and they’re really just gaming the system, and violating a loophole, so they’re violating all their contractual and fiduciary duties to the broker-dealer and the insurance company,” Covington told Banker & Tradesman. “In other words, they should know better.”
Still, the elderly annuity holders or their families were duped into making the deal, Sullivan said. In one well-publicized Rhode Island case, the annuity holders believed they were getting money from philanthropic organizations. Families of the elderly or infirm victims often feel that the dignity of their loved one has been sullied after being taken by the scam.
A number of states have enacted anti-STOLI legislation. In Massachusetts, a bill on the matter filed in early 2009 by Rep. Ron Mariano, D – Quincy, has stalled in committee. STATs, however, are less well-known than their life insurance counterpart, and seem to be cropping up less frequently, Sullivan said.
A spokesman from the Massachusetts Division of Insurance said the division has not received any complaints to date of inappropriate STAT behavior.
Brian Carmichael, a spokesman for major annuities dealer John Hancock Financial, said he wasn’t familiar with the scheme. Prudential Financial, based in New Jersey but with significant Boston operations, testified at the NAIC hearing that it hadn’t seen any evidence of this type of transaction – although the company added that, to defend itself against STATs, it should be able to terminate benefits to variable annuities after they’re sold or transferred.
Illegal, Or Just Un-Ethical?
Among industry regulators and observers, there is plenty of controversy on how to handle STATs. Some argue that these transactions are already illegal, and any regulator attempts to create extra diligence requirements will just jack up the costs for selling annuities in general.
Others say they’re merely exploiting perfectly legal loopholes in annuity contracts. Joseph Caramadre, a businessman who stands accused of running the scam in Rhode Island, has used this defense in his own case.
Testimony at the NAIC’s hearing left room for speculation: The American Academy of Actuaries said a number of regulations governing annuities were ambiguous and needed to be strengthened.
However, Caleb Callahan, vice president of investment services for Ohio broker dealer ValMark Securities, argued that STATs do indeed violate several laws, and regulators had merely to enforce laws already on the books. The American Counsel of Life Insurers, the industry’s primary trade association, stated that the annuities involve “material misrepresentations” on applications, similar to STOLI, and violate Unfair Trade Practices Law.
Sullivan said he wasn’t willing to definitely side one way or the other on whether STATs were illegal in all cases.
“It’s an open question,” he said, adding that it depended on various state insurance laws and individual cases. But, he said, many cases involve misrepresentation to elderly victims, which is unconscionable and needs to be addressed.
The Way Forward
The NAIC now needs to decide how aggressively it needs to pursue changes in its guidelines. Once it sets out a new guideline, states can adopt it individually as they see fit, and it’s possible those existing models can be used to better spot and prevent STATs.
One model, recently passed by the NAIC, requires annuity brokers to fill out 12 “suitability” questions on the investment and the involved parties, including one that asks the purpose of the annuity. The broker’s company then does a secondary review of the responses, and can determine if the questions bring up any red flags if the answers seem evasive or aren’t fully documented, Sullivan said. That could help the company police its brokers’ activities.
Also, insurance regulators aren’t the only possible overseers. Because variable annuities fall under the purview of securities regulator FINRA, the broker-dealers who sell them have both insurance and securities licenses. FINRA was present at the hearing and may pursue its own actions to clamp down on the practice, Sullivan said, although he couldn’t speak to the agency’s plans.
