Long-Term Care Insurance

Third-Party Ownership in the Personal Insurance Market Estate Planning

A primary reason for third-party ownership of a life insurance policy in the personal insurance market is to prevent the policy's death benefit from being included in the insured's federal gross estate. When ownership of a third-party life insurance policy is used for this purpose, the policyowner of the life insurance policy is usually an irrevocable life insurance trust (ILIT) created by the insured or an adult child of the insured. Death benefits payable upon the insured's death under a policy owned by a third person are not normally included in the insured's gross estate. Thus, they would not be subject to federal estate taxes. However, the death benefits must not be payable to the insured's estate for this to occur.

Stranger- or Investor-Owned Life Insurance (STOLI and IOLI)

Third-party ownership has made it possible for a questionable investment practice to have emerged: stranger-owned life insurance, or STOLI. Also known as investor-owned life insurance, or IOLI, it is an arrangement in which an investor or investor group convinces a consumer—usually someone between the ages of 65 and 80—to take out an insurance policy on his or her life in exchange for an eventual lump-sum payment. The investor arranges for premium financing—a loan—to pay for the policy for the first few years. (This period usually coincides with the policy's contestable period, typically two years.) At the end of this period, the policyowner assigns the policy to the investor under a life settlement. The investor pays the insured a lump-sum payment to compensate for transferring the policy to the investor. The investor, as the new owner of the policy, names the investor or group of investors as the new beneficiaries and collects the policy's proceeds at the insured's death. Since policy ownership can be changed without the need for continued insurable interest, this practice is legal in the strictest sense. However, the STOLI investor has no interest in the continued life and well-being of the insured; in fact, the STOLI arranger benefits only by the death of the insured. For this reason, a STOLI agreement is nothing more than a wager on someone's life. Accordingly, it has generated considerable controversy with regulators, industry leaders, and legislators, and it is broadly discouraged in most jurisdictions. Many states have declared such arrangements fraudulent and illegal. State law and the courts have held that STOLI arrangements run counter to public policy and have supported life insurers that have refused to pay out death proceeds from policies that were determined to be subjects of STOLI transactions. Life insurance companies have begun to include questions in their applications that seek to determine if it may involve a STOLI arrangement. In an effort to deter and stop the practice of stranger-originated life insurance, industry organizations such as the National Association of Insurance Commissioners have advanced model legislation to eradicate the practice.

In personal insurance, what is the disadvantage to third-party ownership? The insured has no right to name the beneficiary. The insured has access to the policy's cash values The policyowner has no right to name the beneficiary The beneficiary holds rights to the policy's cash values

The insured has no right to name the beneficiary.

All the following statements regarding stranger-owned life insurance (STOLI) are correct EXCEPT The insured retains the right to designate the policy's beneficiary. STOLI and investor-owned life insurance (IOLI) are the same thing. STOLI is financed through premium loans during the first several years, until it is transferred from the insured to the investors. STOLI is an arrangement in which investors convince an individual to purchase a life insurance policy on himself which is transferred to the investor in exchange for a sum of money.

The insured retains the right to designate the policy's beneficiary.

Third-Party Ownership in the Business Insurance Market

Third-party ownership of life insurance policies is far more common in the business market than in the personal market. Life insurance used to meet business insurance needs is normally owned by the business rather than the insured. A typical business use of life insurance is known as key person, or key employee life insurance. In this scenario, the business applies for, owns, and is the beneficiary of the policy covering the life of a key employee. Upon the insured employee's death, the business receives the policy's death benefit. This benefit is intended to compensate the business for the loss of its key employee through death.

Bring-Back rule

To avoid inclusion in the insured's estate, it is best to set up the third-party ownership when the policy is issued. If an existing policy is transferred to a third-party owner after it is issued, it is important to do so at least three years before the insured's death. If the insured dies within three years after the transfer, then the policy death benefits are included in the insured's estate for tax purposes. (This situation is called the bring-back rule.)

Who normally owns life insurance used to meet business insurance needs? the business the business jointly with the insured the employees the insured

the business

Third party ownership

A life insurance policy typically involves two parties: the owner and the insurance company. The owner controls the policy and pays the premium. In this standard arrangement the owner and the insured are the same person. However, in some cases, the insured and policyowner are different. This situation is known as third-party ownership. In third-party ownership situations, the insured (who is not the owner) has no rights in the policy. His or her role is simply that of the person whose death causes the death benefits to become payable. All rights in the policy are held by the policyowner, including the right to name the beneficiary. There must be an insurable interest between the applicant and the proposed insured for third-party ownership to be valid when a life insurance policy is issued. However, after a policy is issued a third-party ownership arrangement can be set up (by transferring ownership to another party) without regard for insurable interest. Third-party ownership of a life insurance policy plays a role in both personal and business life insurance situations.

All of the following statements about key person life insurance are correct, EXCEPT: The business applies for, owns, and is the beneficiary of the policy covering the life of a key employee Key person, or key employee, life insurance is an example of third-party ownership. Life insurance used as key person life is normally owned by the business rather than the insured. Upon the insured employee's death, the surviving family receives the policy's death benefit.

Upon the insured employee's death, the surviving family receives the policy's death benefit.