STOLI stands for STranger Originated Life Insurance. Essentially, a STOLI is when a life insurance policy is taken out by investors with no insurable interest. Investors pay the premium of an elderly person, throw that person some cash, and hope for the insured to pass in a timely fashion. From the Wall Street Journal:
While it rings of vodka, STOLI also stands for "Stranger-Originated Life Insurance"—controversial policies that older people take out and then sell to investors. The investors pay the premiums and collect proceeds when the original owner dies. Mr. Brasner was a sales agent who specialized in such policies. In the years before the financial crisis, he connected aging retirees in need of money with cash-flush hedge funds eager for offbeat investments.
Again, the litmus test is "insurable interest" at the origination of the policy. Clearly, investors are "gambling" on the insured's life which regulators frown upon:
The practice was legal in many states during the prior decade, though disliked by regulators because it skirted the intent of "insurable interest" laws. Those laws prohibit taking out a policy on someone without having a stake in the person's well-being. When hedge funds moved into this area around 2004, however, many insurers did little double-checking of the financial information provided on applications and didn't drill down deeply about buyer's intentions in taking out the policies; they focused on medical underwriting, and some initially welcomed the influx in business, according to insurance-industry executives.
Does that mean an insured can't "cash-in" his insurance policy, assigning the interest to an investor group? Of course not but it depends in the origination of the policy as is shown in the Milwaukee Journal-Sentinel:
The most controversial nook of that peculiar corner is something called stranger-originated life insurance, which runs afoul of the legal principle that a life insurance policy must initially be taken out by someone with an "insurable interest" - an interest in preserving the insured person's life.
You can insure yourself, of course. Your wife can insure you. Your company can insure you if it thinks you're critical to the firm's success. But a stranger can't buy a policy on you, because the law doesn't want to encourage gambling on human lives.
Once you hold a policy, however, you're free to sell it. The courts have long held that life insurance is property that can be transferred. In recent years, such activity has risen sharply as people who no longer need or want their policies sell them for three to four times their cash surrender value, according to the Life Insurance Settlement Association, a trade group.
That leaves the policies - and the death benefits - in the hands of investors such as life settlement companies. But a mere investor isn't supposed to be able to own the policy from the beginning.
The practice of selling off the future insurance claim is permissible on seasoned policies. The late Ed McMahon did it when he found himself in financial trouble and avoided foreclosure on his Los Angeles home. Life insurance is a capital asset. If purchased with an intent to insure against the financial devastation caused by loss of life, and assigned after that threat of devastation is gone, it can be a win-win transaction for the insured and investors alike