The sick business of betting against people’s lives.

Just as the overheated market for securities backed by people's homes created a wave of subprime mortgages, the market on people's lives has created a boom in fraudulent insurance policies known as stranger-originated life insurance. STOLI is illegal. It begins with a life insurance agent, who, in many cases, is now also a life-settlement broker. The agent convinces seniors to take out large policies by offering meals, trips, and cash. The agent or life-settlement firm agrees to pay the premiums. Ownership is then quickly and quietly transferred, often to a trust, where it can be sold on the open market.

In the retirement communities of West Palm Beach, Fla., the practice of flipping life insurance for cash is common. "I think I first heard about it from friends on the golf course, maybe four or five years ago," says Wally, a retired doctor from New York. "A few years later a friend said her son was in the business and could be trusted." Wally passed that time as well, but he still gets offers. "Around here it's a very common thing, an easy way to make some money." Many seniors are unaware that participating in STOLI is illegal and may endanger their ability to collect on real insurance in the future.

A recent industry study found that more than 50 percent of life settlements were on policies less than four years old, and many were on policies two to three years old. "STOLI has to be the reason for the vast majority of this activity," says James Avery, president of Individual Life for Prudential. "And that is a major concern." Avery says the policies, which are big losers for the insurance companies, drive up prices and threaten insurance companies' ability to cover valid policies.

As regulators struggle to deal with the expanding life-settlement industry, the distinction between the worlds of insurance and investment becomes problematic. Circuit courts around the country have ruled both ways on the question. On the flip side, state insurance departments have seen their efforts to learn more about the industry challenged on the grounds that policies bought in one state and sold in another are exempt from local authority.

Some states have passed new legislation requiring brokers to register and expanding access to companies' books. But up-to-date legislation has yet to pass in New York, California, Florida, and Illinois—four states that, according to recent industry data, account for more than half of all life-settlement transactions. "In public, the life-settlement industry has come out against obvious problems like STOLI," says Mary Beth Senkewicz, deputy of insurance regulation in Florida. "But behind closed doors they are fighting against increased regulation tooth and nail."

Industry participants believe they are being unfairly targeted. "It's interesting, because STOLI is basically nonexistent," says Robert Stark, a life-settlement broker and president of Melville Capital in New York. Stark, a former mortgage broker, deals only with institutional, accredited investors. "These guys do incredible amounts of due diligence. If I tried to pass off STOLI policies to them, I wouldn't have any customers."