Tennessee Insurance Practice Exam

Stranger Originated Life Insurance (STOLI) has been found to violate which contractual element?

1. Legality of the contract

2. Insurable interest

3. Mutual assent

4. Capacity to contract

The correct answer is: Insurable interest

Stranger Originated Life Insurance (STOLI) primarily violates the principle of insurable interest, which is a fundamental requirement in insurance contracts. Insurable interest means that the policyholder must have a legitimate interest in the life of the insured; this interest is typically seen in relationships such as family ties or business partnerships. In STOLI arrangements, a third party—often a stranger to the insured—acquires a life insurance policy on that individual's life without any real connection or vested interest. This setup undermines the purpose of life insurance, which is designed to protect against the risk of loss due to the death of someone in whom the policyholder has an insurable interest. By lacking insurable interest, STOLI contracts can lead to moral hazard, where the policyholder may have motivation to see the insured person die, thereby resulting in a payout. This violation raises significant ethical and legal concerns, which explains why insurable interest is crucial for the validity of life insurance contracts.