#238 | The New Face of STOLI

8/14 Update – It is my understanding that all three companies writing business with Strategy Agency have suspended or severed their relationship. One severed the relationship earlier this year. After this article was published, another carrier received the same documents that I saw and severed their relationship this week. I have been told but can’t yet confirm that the final carrier has suspended accepting premium financing business from Strategy Agency until further notice, although I’ve already (8/18) heard reports that Strategy Agency is now having the clients pay the first quarterly premium so that the transaction isn’t classified as premium financing for the purposes of screening at the final company.

8/17 Update – I’ve come to understand (and see for myself) that there was an arrangement created by Suffusion Collateral and Strategy Agency last year whereby the client could “sell” 50% of the policy interest for $500 to exit the loan obligations. The Funder was supposedly a Suffusion-sponsored Texas LLC that is not in the public records, so it was never created or no longer exists. This arrangement is entirely different from the one discussed in the article below, although there are many similarities.

To say that Stranger-Originated Life Insurance, known by its catchy acronym as STOLI, was a significant part of the independent life insurance market in the mid-2000s would be a gross understatement. STOLI was a veritable geyser of sales and commissions, blowing out the fail-safes and showering the landscape with its inky black droplets so that virtually no corner was left untouched. It was fueled by seemingly endless external capital, sold by many of the highest producing agents in the country, facilitated by virtually every major distribution organization and accepted by large and prestigious life insurers in staggering amounts, whether they’ll admit it or not.  The entire independent side of the industry stank of STOLI in 2007 – so much so that STOLI began appearing in public press and academic papers. Only later did everyone find out the damage that the fumes would cause in the form of high-profile lawsuits, corporate write-downs and, in at least one case, a door-storming FBI takeover of a STOLI funder. These days, STOLI is the closest thing the life insurance industry has to a four-letter word.

What was the genesis of STOLI? The simple answer is that hedge funds and other capital providers became hungry for life insurance policies as an asset class. If they couldn’t find enough policies to legitimately buy in the settlement market, then they needed to figure out a way to get inventory by sourcing policies themselves. Hence, STOLI. The basic STOLI deal structure was for an older-age client to “buy” a life insurance policy, but all premiums and interest would be paid by the investor group under a non-recourse lending arrangement. After the contestable period expired in two years, the plan would be to take over the ownership of the policy and/or sell it to institutional investors in the life settlement market.

Any time there is a gap between the investor valuation of a life insurance policy and the retail valuation of the policy, as represented by the premium cost to put it in-force, then there is the incentive to create a program that will induce people to buy life insurance with the ultimate goal of taking over ownership of the policies and selling them to investors for a profit. The particular type of STOLI from the mid-2000s was geared towards arbitrage in the life settlement market. That produced an investor hunger for policies on older-age clients of dubious health. But if a different valuation gap is created for an entirely different reason, then could it create a whole new type of STOLI that doesn’t trip the fail-safe mechanisms created in response to the old STOLI? It seems that the answer is yes.

Several months ago, I started hearing about a program being offered by a fairly large and quite infamous premium financing vendor – we’ll call them Strategy Agency – using non-recourse financing for Indexed UL. My initial reaction was that it couldn’t be true. Non-recourse financing was the hallmark of STOLI and is categorically excluded by every life insurer. But I kept hearing about the program and, finally, I found someone with first-hand experience with it. Later, and through a different source, I got a peek at the nearly 100-page loan agreement that spelled out every facet of the program in detail. What I saw was absolutely shocking.

The core of the transaction is a straightforward and traditional third-party premium financing arrangement, but with a slight twist. The first step is for the client – the “Borrower” – to apply for a policy to be owned by an LLC created for that exclusive purpose. The premiums for the life insurance policy will be funded by a third-party bank (the “Premium Facility”), with the Borrower paying interest and/or posting collateral as is customary for third-party premium financing arrangements. Strategy Agency serves as the agent for the transaction and receives the substantial commission from the trade, which is shared with the marketing agent who first introduced the strategy to the client. So far, this is all pretty by-the-book except for the LLC, which is not a conventional structure for owning a life insurance policy. It’s not verboten, but it’s certainly not traditional. And as you’ll see in a minute, the LLC structure is key to making the transaction work. Here’s what we have so far:

Simultaneously, the Borrower enters into a transaction with another third-party, an LLC called SC Fund I incorporated in late 2019 in Delaware, who we’ll call the Funder. The Funder agrees to pay the required interest and/or post collateral to satisfy the requirements of the premium financing facility to the Borrower. There are, of course, steep fees for doing so. The Borrower pays an origination fee of 5% of the first-year premium to the Lender, owes interest (LIBOR + spread) on any cash provided to pay interest on the third-party financing arrangement and pays an annual fee of 7% of any required collateral. But the net result is that the Borrower enters the transaction for “free” because all of these costs are simply rolled into the loan provided by the Funder. Here’s what this part of the transaction looks like:

At this point, again, things still look mostly above-board. The only shady part of the transaction is that virtually all life insurance companies require clients to pay interest out of pocket and post their own collateral, which is obviously not what’s going on here. You can bet your bottom dollar that the life insurers who have taken this business don’t know that the third-party Funder is involved and is paying interest and posting collateral for the Borrower to provide to the Bank. But is this really so bad? The way this part of the deal is structured, the full liability owed to the Lender is due when the Bank financing facility expires. It looks like the Funder is primarily stepping in to provide supplemental financing to skirt the rules at life insurers about clients not being able to roll-up interest. Shady, yes, but is it STOLI? Not yet.

The groundwork for STOLI is laid right at the front of the agreement when the Borrower’s entire interest in the LLC is pledged to collateralize the obligations to the Funder. But even that isn’t quite enough. In order for it to be STOLI, there has to be a way to transfer policy ownership on a non-recourse basis. The transfer mechanism in the agreement is a Default, which can be triggered under some 15 conditions outlined in the agreement, including the maturity of the Premium Facility at the Bank. Elsewhere in the agreement, there are references to a specific term of the Premium Facility and a defined Maturity Date. My guess from looking at the loan agreement and some other spreadsheets is that the Maturity Date is somewhere between 5 and 10 years long. The Maturity Date can also be accelerated if one of the other conditions of Default is triggered.

At the Maturity Date which, again, is a date known to all parties at the inception of the transaction, the agreement goes into Default. At that point, all unpaid principal, accrued interest and other fees are immediately due to the Funder. In other words, the deal is done. Two things can then happen – either the client pays the Funder back or, as clearly stated in the agreement, the client has the ability to exercise a Non-Recourse Option where the ownership of the LLC passes to the Funder and the client walks away. In the old STOLI days, a transfer to exercise a non-recourse option required a change of ownership of the policy itself, which had to be facilitated by a life insurer. Here, the transfer of ownership occurs outside of the LLC itself and therefore the life insurer doesn’t see the change. That’s the magic of using an LLC and why it’s key to making this transaction work.

At this point, we can say with confidence that this transaction is STOLI of the same ilk as what was happening a decade ago. It has all of the essential ingredients. The big question is – why? Why would an investor want a heavily funded IUL product on a healthy 50 year old? It’s certainly not for a settlement value. No traditional settlement shop would even make an offer on a policy like that. So what’s the attraction?

At first, I thought that the investors wanted an overfunded IUL product because they thought it would actually outperform the financing cost. In other words, I thought this was a prime example of eating your own cooking. Premium financing vendors have been running around for years touting the benefit of accrued interest IUL financing structures, but this transaction allows them to get in on the “arbitrage” they’ve been touting to clients for years. I still have a sneaking suspicion that my original thought might be correct because it lines up with some of the odd details in the loan agreement, such as the requirement that the client fully allocate to an indexed account and not to the fixed ac count.

But from what I understand from a source intimate with this transaction, the attraction is much more interesting – it’s accounting arbitrage. In the US, the value of a non-guaranteed life insurance policy is generally understood to be its cash value. However, in other parts of the world the value of a life insurance policy can be calculated based on discounting the death benefit. This valuation methodology can lead to a significantly higher figure than the cash value of the policy, which creates a market for buying policies for a premium over the cash value but still at a discount to the book value of the policy. It also makes this new breed of STOLI largely agnostic to the client’s age, which opens up a whole new market for originating policies. Institutional buyers of these policies would also need contracts on an industrial scale, which is why I understand that Strategy Vendor has been pushing a multi-life version of this strategy to corporations, non-profits and even governments. Here’s the structure as it stands so far:

But the picture still isn’t complete. Who is the entity that sets up the fund, works with the capital providers and arranges the funding and transfer of ownership side of the equation? I’m not going to use the actual name, but let’s refer to this firm as Suffusion Collateral, a Texas LLC formed in late 2019. The LLC documents are linked to a registered agent who is probably unrelated to the entity itself, which is fairly common for the formation of the LLC. But a little bit of digging makes it easy to figure out. Suffusion Collateral is a lean operation headed by a non-practicing lawyer in Maryland. Without going into all of the excruciating details, this guy’s record is anything but spotless. He has a trail of sanctions and significant fines at both the SEC and the Maryland insurance department. But perhaps my favorite part about Suffusion is how their former contract accountant describes the company on LinkedIn – a “start-up company on Quick Books Pro.” From the way the dates line up and that description, it’s pretty clear that the sole purpose of Suffusion Collateral is to facilitate their part of these financing transactions. It’s not a real company. It’s a shell.

The connection between Suffusion Collateral and Strategy Agency is a little bit murky, but it’s obvious that they’re working together to promote the overall structure. Pictures on Facebook show the head of Suffusion at Strategy Agency events promoting the transaction. Given that he’s a licensed insurance agent, it’s highly likely that he’s sharing in the significant commissions generated by the life insurance policy – and that’s not the only strange connection in this transaction. I’ve also heard, although I can’t confirm this, that the third-party bank isn’t so third-party and is sharing part of the loan interest with Strategy Agency as some sort of “referral fee.” At last, here’s the full picture of the structure:

Now, here’s the real question – why in the world would a client do this deal? In the original STOLI, the incentive was that the client either retained a share of the death benefit even after exercising the non-recourse option, was compensated up-front for entering the transaction or just liked the idea of getting free insurance for a few years. But in looking at the loan documents, it’s quite clear that the first two (and most compelling) reasons are not a part of the deal. There’s certainly not any compensation for entering the trade and there’s no reference to a shared death benefit after exercising the non-recourse option. So what’s the incentive?

From what I can tell, the allure pretty simple – retirement income. The illustrations for this strategy show an overfunded Indexed UL product illustrated at lights-out rates in the most aggressive accounts available. All fees and loan interest costs are shown as being financed by the Funder. There is no exit strategy, but at some point down the road the pitch spreadsheet shows the equity in the policy being accessed by more external loans to fund retirement distributions. And, of course, there’s a residual death benefit for life. Based on the clients I’ve spoken with, the basic idea is that it’s a free life insurance policy that spits off hundreds of thousands of dollars in tax-free retirement income and, if it doesn’t work out as planned, the client can walk away. As one client said – why would I not do that deal?

There are, in fact, several good reasons why a client shouldn’t do the deal. First, it doesn’t work how the clients think it works. The actual loan documents show an either/or choice – either you pay back all of the loans to both the Bank and the Funder to keep the policy or you walk way and get nothing.  Second, the majority of the administration of the plan must be done by the client and failure to perfectly perform all duties will result in a Default. Third, the strategy soaks up the client’s valuable insurability that can undoubtedly be used in a better way and without the risk of losing it forever. And, finally, life insurers absolutely would not take this business if they actually knew they were getting it, which they likely don’t. That makes the client a party to a transaction that is deceptive at best and fraudulent at worst and might very well could end up in a lawsuit or life insurer action down the road and the client may end up being a party to it, as so often happened in the first round of STOLI.

For all of those reasons, this new breed of STOLI is actually nastier than the first breed. With the original STOLI, the client knew the deal – they were trading their insurability for a check or a small residual death benefit. With this STOLI, the client actually thinks that they are on the right side of the trade to get a free death benefit and tax-free retirement income. Nothing could be further from the truth. Strategy Agency, the Bank and the Funder have every side of the economics of this trade cornered. The only one left holding the bag is the client. The most telling part of the loan agreement is the section specifying that if the Funder is at any point in time ordered to surrender or forfeit the policy by a third-party (say, an insurance company who figures out this fraud), then the client is on the hook for all damages to the Funder even if the agreement itself has long been terminated. If that’s not evidence that the deck is stacked against the client, then I don’t know what is.

What companies are taking this business? Your guess is as good as mine. Well, actually, that’s not quite true. I know the real name of Strategy Agency and I know that they’ve worked with numerous companies over the years who each, in turn, have disavowed and barred Strategy Agency. But life insurers are easily fooled and are most easily fooled by themselves. When Strategy Agency shows up touting their tens of millions of dollars in annual premium, some life insurers are willing to turn a blind eye to their dubious reputation in the industry, at least until the problems become so bad that even a blind eye can see clearly what’s going on.

For the last few years, Strategy Agency has been funneling most of their business to one particular carrier that usually flies under the radar but posted a 90% jump in sales last year and almost assuredly all of it is premium financed. Most companies who have attractive IUL products that can be used for retirement distributions see a lot of mid-size ($750k-ish) face amount policies, but not this one. Instead, this company sold just 200 IUL policies – yes, in the whole year – with an average $150k+ premium and average face of $5M+. That, my friends, is almost exclusively attributable to premium financing. I’ve also heard that Strategy Agency has been pushing some of their business onto another life insurer who saw their 2019 sales spike by nearly 200% while simultaneously seeing a massive jump in average face amount and average premium per policy. Strategy Agency can swing production, that’s for sure – like a wrecking ball.

And that’s exactly what this thing is. STOLI ripped through the industry a decade ago, smashing through the walls of some of the most venerated life insurers in the US and leaving behind a legacy of destruction. This scheme that Strategy Agency has concocted threatens to do the same. Make no mistake about it – this deal is bad for consumers, bad for life insurers and, ultimately, may turn sour even for the investors who are putting up the money to back it, as was the case for many of the STOLI investors in the first round. And it’s even bad for Strategy Agency, who is already just a couple of life insurers away from being completely cut off from the ability to write new business. This could be the end of the road for them because the only way for life insurers to ensure that programs like this don’t grow and spawn a litter of copy-cats is to completely cut off the premium financing vendor. That happened quite a bit in the first round of STOLI and I have no doubt that it will happen in this round as well.

Our industry attracts some of the most honorable and some of the most sordid characters. Our industry bears the scars of the century-long struggle between the honorable and sordid elements. But in the end, the honorable has always managed to maintain the upper hand. That’s the good of our industry – protecting families, preserving capital, providing stability. Programs like this one are the filthy parasites on a healthy host. And it’s our job, as an industry, to rid ourselves of things like this before they have a chance to consume and destroy. That decision lies in the hands of the life insurers writing this business and, in the end, they’ll make the right call. Let’s hope they do it soon.

I’m sure some people will wonder why I didn’t name names in this article. That’s not my goal. This article is a cautionary tale for everyone, not just the companies and people involved in this particular transaction. Their actions will come to light of their own accord.

I also think it’s worth noting that this article shouldn’t be viewed as a commentary on premium financing as a whole. There are certainly legitimate uses of premium financing, as I’ve written about in other articles available for Subscribers to the site.