A life insurance policy is valid only if the insured has an “insurable interest” in the person covered by the policy at the time it is issued. Where no insurable interest exists, the policy is void and the policyholder has no right to recovery. The insurable interest requirement is grounded in public policy so as to discourage the use of insurance for illegitimate purposes, and mitigate the risk that a beneficiary will intentionally harm the covered person in order to wrongfully recover benefits.
In 1876, the United States Supreme Court held that “[a] man cannot take out insurance on the life of a total stranger, nor on that of one who is not so connected with him as to make the continuance of the life a matter of some real interest to him.” Conn. Mut. Life Ins. Co. v. Schaefer, 94 US. 457, 460 (1876). In New Jersey, the insurability of interests in persons is principally governed by statute. Pursuant to N.J.S.A. 17B:24-1.1, in addition to the named insured, close relatives, corporations, charities, and other persons with certain ties to the insured may have an insurable interest in the insured’s life. A stranger with no ties to the insured would not qualify under the statute.
The United States Supreme Court has made clear that, as long as the insured procured the policy in good faith—i.e., with the intent to obtain financial protection for those with an insurable interest in his life—that interest need not exist throughout the duration of the risk period nor exist at the time of the loss. Grigsby v. Russell, 222 U.S. 149, 157 (1911). Thus, subject to certain requirements, an insured may assign the benefits of his life insurance policy to someone who lacks an insurable interest in his life, provided there was no pre-existing assignment agreement at the time of issuance. Id. at 157; Howard v. Commonwealth Beneficial Ass’n, 98 N.J.L. 267, 268 (E. & A. 1922); Meyers v. Schumann, 54 N.J. Eq. 414, 417 (E. & A. 1896).
Over the past few decades, there has been significant growth in the secondary, “life settlement” market. A traditional life settlement generally involves the sale of an existing life insurance policy, after the contestability period has expired, to someone without an insurable interest in the insured’s life in exchange for cash in excess of the policy’s surrender value, but less than the policy’s death benefits. This type of transaction gained popularity in the 1980s, amidst the AIDS crisis, as it allowed terminally ill patients to fund their health care or settle accounts while they were still alive. See Life Partners, Inc. v. Morrison, 484 F.3d 284, 287 (4th Cir. 2007); Afonso V. Januario & Narayan Y. Naik, Empirical Investigation of Life Settlements: The Secondary Market for Life Insurance Policies 6 (June 10, 2013). Life settlements continued to grow not only with terminally ill patients, but the elderly, as well. Indeed, billions of dollars worth of policies are sold annually on the secondary market. Lincoln Nat’l Life Ins. Co. v. Calhoun, 596 F. Supp. 2d 882, 885 (D.N.J. 2009).
Life settlements for terminally ill patients are called “viatical settlements,” and are strictly regulated by statute in New Jersey. The statutory definition specifically provides that a “viatical settlement contract includes an agreement with a viator to transfer ownership or change the beneficiary designation at a later date regardless of the date that compensation is paid to the viator.” N.J.S.A. 17B:30B-2.
Traditional “life settlements” are legal insofar as they do not violate the insurable interest requirement. However, issues with respect to the insurable interest in a life insurance policy arise “when [insureds] intend at the time of the policy’s issuance, to profit by transferring the policy to a stranger with no insurable interest at the expiration of the contestability period.” Calhoun, 596 F. Supp. 2d at 889 (D.N.J. 2009). This non-traditional transaction, called “stranger-owned life insurance” or “STOLI,” has been summed up by the court in Calhoun as where:
[a]n agent attempts to sell a life insurance policy to an elderly insurable candidate, and offers the candidate up-front cash in exchange for promising a future sale of the policy. The agent informs the candidate that the candidate will be able to obtain the policy at virtually no cost to himself, because the agent has secured [third-party] non-recourse financing to purchase the policy. The candidate then acts as a “nominal grantor” of a life insurance trust that is used to apply for the policy. “At that time, the agent will tell the insured that, in all probability, the policy will be sold to investors for a price that will pay the loan and accrued interest, leaving a profit to split between the agent and the insured . . . . If the insured survives [the two-year contestability period on the policy], the owner (the life insurance trustee) typically has two options in addition to the sale of the policies to investors: (1) have the insured pay the outstanding debt with accrued interest and retain the policy; or (2) transfer the policy to the lender in lieu of foreclosure.
Id. at 885 (citing, J. Alan Jensen & Stephan R. Leimberg, Stranger-Owned Life Insurance: A Point/Counterpoint Discussion, 33 ACTEC J. 110, 111 (2007)). Thirty states have enacted anti-STOLI legislation. At least ten anti-STOLI bills have been introduced in New Jersey, but none has passed or was enacted.
In Sun Life Insurance Company of Canada v. Wells Fargo Bank, N.A., 2019 WL 2345444 (N.J. June 4, 2019), the New Jersey Supreme Court finally addressed the validity of STOLI policies. The court concluded that stranger owned life insurance policies, which it referred to as stranger originated life insurance policies, are not valid if they were procured with the intent to benefit persons without an insurable interest in the life of the insured. The court further held that such policies are void ab initio and, therefore, a later purchaser who was not aware of the illegal conduct may be entitled to a refund of any premiums it paid.
By referring to the policies as stranger “originated” as opposed to stranger “owned” insurance policies, it appear that the court was making a distinction beyond policies that are properly obtained and then transferred to a third party at a later date versus policies in which the intent from the outset is to transfer the policy to a third party. The former are still valid in New Jersey subject to certain requirements.
In Sun Life, the plaintiff/life insurer commenced an action against the transferee of a STOLI policy seeking to avoid its obligations to pay the death benefit under the policy. It also argued that it was not required to return the premiums paid by a subsequent transferee that was not involved in the procurement of the policy.
In that case, Nancy Bergman, an 82 year old retired middle school teacher, applied for a $5 million life insurance policy from Sun Life Assurance Company of Canada. In the application, Ms. Bergman grossly overstated her annual income and net worth. She also claimed that she had no other life insurance policies. In fact, five life insurance policies were taken out on her life, providing over $37 million in coverage.
The sole beneficiary under the policy was the Nancy Bergman Irrevocable Trust. The trust had five members, Ms. Bergman’s grandson and four investors who were strangers to Ms. Bergman. The four investors deposited money in the trust to pay the policy premiums. The original trust agreement provided that any policy proceeds would be paid to Ms. Bergman’s grandson, but that was changed five weeks after the policy was issued. At that time, the grandson resigned as trustee and appointed the four investors as successor co-trustees. In addition, the trust was changed so that the benefits would go to the four trustees, who also were given authority to sell the policy.
As required by law, the policy at issue contained an incontestability clause, which barred Sun Life from challenging the validity of the policy for anything other than the non-payment of premiums after it had been in effect for two years. Two years after the policy was issued, it was sold to SLG Life Settlements, LLC. The policy subsequently was transferred to a company named LTAP and then to Wells Fargo Bank, N.A. After Ms. Bergman passed away, Wells Fargo made a claim under the policy, which was denied by Sun Life. Sun Life then commenced a declaratory judgment action in federal court in New Jersey seeking a declaration that the policy was void ab initio. Wells Fargo counterclaimed, seeking recovery of the $1,928,726 it paid in premiums, both directly and indirectly.
On certified questions from the Third Circuit, the New Jersey Supreme Court held that STOLI policies are void ab initio. According to the Court, “a life insurance policy procured with the intent to benefit persons without an insurable interest in the life of the insured does violate the public policy of New Jersey, and such a policy is void at the outset.” Id. at *22. The Court further held that the incontestability clause would not preclude a challenge to the policy. Finally, the court held that “[d]epending on the circumstances, a party may be entitled to a refund of premium payments it made on a void STOLI policy, particularly a later purchaser who was not involved in any illicit conduct.” Id. at *22. The factors to be considered in making that determination “include a party’s level of culpability, its participation in or knowledge of the illicit scheme, and its failure to notice red flags.” Id.
While the Court’s holding is not surprising, this recent decision highlights the state legislature’s surprising lack of anti-STOLI legislation, which has allowed litigation concerning the enforcement of such policies to drag on for many years. STOLI policies are a form of wagering contract in which investors gamble on how long a person will live. The shorter the period of time, the more money the investors earn. Such wagering transactions have long been banned. To get around that ban, life settlement companies tried to disguise the transactions. However, time and time again courts and state legislatures have seen through the disguise. Of course, by the time that happened, many of the initial investors had long since cashed in and left subsequent transferees holding the bag.
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