Major life insurance organizations, including the American Council of Life Insurers (ACLI), the Association for Advanced Life Underwriting (AALU) and the National Association of Insurance and Financial Advisors (NAIFA) plan to crack down on companies that pay elderly people to buy life insurance with the intention of selling the policies to investment groups, reports the Insurance News Network. And they're calling for changes in state regulation to help curb the practice.

These types of life insurance transactions, called stranger-oriented life insurance, or STOLI, has in the past been a way for policyholders to receive payment for life insurance policies they no longer need. The problem, notes a recent press release from the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), comes when financial companies seek out people who are insurable but have short life expectancies and who agree ahead of time to sell their policies for a fee.

These kinds of transactions have been around since the 1990s, say the NOLHGA, traced back to AIDS patients who had life insurance policies but wanted access to cash funds while they were living.

A third party paid the insured person a portion of the face value of the policy, knowing that an AIDS diagnosis at that time meant an early death. The buyer paid the premiums and collected the benefit when the person died.

According to a recent press release by the ACLI (viewable here courtesy of the Insurance News Network), The NAIC Viatical Settlement Model Law was enacted in 1993 to govern the sale of life insurance policies by terminally ill policyholders to unrelated third parties. In recent years, however, loopholes in that model were "exploited" by investors and hedge funds to allow STOLI transactions.

The ACLI President and CEO Frank Keating called STOLI arrangements "contrived transactions which circumvent the intent of state insurable interest laws." Other industry critics of STOLI say the arrangements do nothing to protect the insured's family or estate. The National Association of Insurance Commissioners (NAIC) also says STOLI undermines the basic premise of life insurance: that a policy's beneficiary has a "legitimate, insurable interest" in the policyholder's good health.

The challenge for the life and health industry lies in trying to simultaneously prohibit STOLI while not obstructing consumer rights and legitimate life settlements. In 2007, expect to see NAIC working with individual state insurance departments to adopt changes in the aforementioned model law.

Read more about STOLI issues courtesy of the NOLHGA and the Insurance News Network here and here, respectively.