One potentially unsavory niche of the life insurance industry has spawned a strange spin-off task – people who call up elderly policy-holders to see if they’re dead yet.

These death-monitors’ employers have a keen interest in this, because the earlier the policyholder dies, the more money they make. That’s how stranger-originated life insurance (STOLI) works. A relatively new twist on life insurance, anti-STOLI bills have swept through state legislatures with encouraging speed, STOLI-watchers say.

About a dozen states have passed laws designed to crack down on STOLI in just the past couple years, said Stephan Leimberg, CEO of financial planning company Leimberg Information Services: Connecticut’s anti-STOLI law, for example, took effect on Oct. 1

That’s a fast turnaround, considering how shortly STOLI has been on the radar, he said. Secondary markets for life insurance have been around for decades, but STOLI has only been around in earnest for the past five years or so.

Roughly a dozen more states are considering such legislation, Leimberg said – but although the state of Massachusetts has dealt indi-rectly with the topic in a recent lawsuit, it hasn’t tried to bring forth legislation on the topic.

Insurance Commissioner Nonnie S. Burnes said in a statement that her office was aware of the problem; it would take appropriate steps, “if necessary,” but didn’t elaborate.

In neighboring Connecticut, regulators and insurers now have more ammunition to use against people who traffic in this type of re-sold life insurance policies. For example, the insurer can put the brakes on a policy or claim if the beneficiaries seem more like investors in-stead of family members or friends.

“It gets rather morbid,” said Joseph Belth, speaking about the details of the STOLI-sellers’ operations, such as the necessity of watch-ing for policyholders’ deaths.

Belth has written extensively on the topic for his periodical The Insurance Forum, and has called STOLI, at worst, an incentive to mur-der – but although a variety of high-profile STOLI cases have gone to court, none have involved murder allegations.

Morbid Maneuvers

This is how STOLI usually works, according to Belth: Brokers will approach prospective policyholders, usually elderly people, and try to sell life insurance policies.

Those brokers offer a large chunk of cash instantly, as long as policyholders agree, either immediately or shortly thereafter, to sign over the death benefit to a third party. That third party will pay the premiums until the policyholder dies.

“The person who acquires the interest in the death of the insured has no insurable interest in the life of the insured – as a matter of fact, he has a financial interest in that person’s death,” Belth said: the faster the policyholder dies the fewer premiums the third party has to pay before collecting.

Massachusetts is one of a few states that have dealt with court cases on STOLI, although life insurance was an indirect part of the case. In April 2007, the state and the Securities and Exchange Commission sued Delaware-based Lydia Capital Investment Fund, a hedge fund, for not telling its investors the whole story on their investments.

Lydia Capital had been buying life insurance policies that were sold to elderly policyholders. An investigation showed that although policyholders said they didn’t intend to re-sell their policies, a suspicious number of them did so as soon as they were able.

Those misstatements made the policies worthless to Lydia investors; Lydia was charged with defrauding those investors by distorting the true value of its assets.

Massachusetts went after the hedge fund for defrauding investors, but for most states, it’s about protecting senior citizens, Leimberg said.

Generally, these policyholders are elderly people who just sign a blank policy or are carefully coached to inflate their own wealth so in-vestors can get bigger premiums and death benefits.

The policyholders can suffer huge tax consequences, be unable to take out another life insurance policy for themselves if they need one and, in some cases, be brought up on charges of insurance fraud because they misrepresented themselves, Leimberg said.