Secondary Life Policy Market Gets Shot in the Arm from Federal Judge

The U.S. District Court for the middle district of Pennsylvania denied Principal Life Insurance Co.’s bid to have policies declared null and void because they were allegedly part of a stranger-originated life insurance (STOLI) scheme.

Principal Life Insurance Co. vs. Mark DeRose and Matthew DeRose , trustees, and First Priority Bank rejected in part a ruling by a magistrate judge that an insurance interest existed in the case, making way for a ruling that allows for the policies.

"This court is acutely aware of the law’s general distaste for wager policies and recognizes the importance of the insurable interest doctrine," U.S. District Judge Christopher Conner wrote in his decision. "The court notes that this decision does not vitiate the statutory requirement that an insurable interest exist at the time of inception or that the insured must apply for the policy."

Judge Conner added that "there may or may not be a fundamental difference between persons with an insurable interest using life insurance policies as a financial planning mechanism by immediately assigning the policies to third parties and direct wagering by third parties with no insurable interest. It is the job of the Pennsylvania General Assembly, however, and not this court to weigh the competing policy considerations. Neither this court nor the Pennsylvania Supreme Court can engraft an intent or good-faith requirement onto statute 512 based on its own policy preferences."

In December 2008, Principal filed an instant declaratory judgment action against trustees of the JoAnn DeRose Family Trust, alleging that the trustees purchased the policies as part of a STOLI scheme and that the trustees concealed their intended use of non-recourse financing on the application for the policies.

Principal sought a declaration that the policies are void or voidable on grounds that the policies lacked an insurable interest at inception, and/or (contained material misrepresentations.

The case notes that approximately one month before Ms. DeRose applied for life insurance from Principal, Ms. DeRose submitted an application for non-recourse premium.

Principal alleged that the trustees purchased the policies as part of a STOLI scheme and that the Trustees concealed their intended use of non-recourse financing on the application for the policies.

The Principal’s policy explicitly prohibited any form of STOLI.

The federal court held that in the case of the policies, an insurable interest existed at inception and that the relevant state statute defines the insurable interest requirement solely in terms of the relationship between the insured and policy beneficiary.

“Noting that the Pennsylvania insurable interest law is most similar to New York’s, the court cited Kramer v. Phoenix to affirm its view that the insurable interest statute cannot be read to include an intent standard,” said Michael Freedman, senior vice president of government affairs for Coventry.

Freedman noted that the New York Court of Appeals stated that a policy valid at the time of procurement may be assigned to one without an insurable interest in the insured's life. Furthermore, no insurable interest is required when one holds a policy on another's life, so long as the policy was valid in its inception.

However, although a Delaware Supreme Court recently rejected insurers’ attempts to graft an intent analysis into insurable interest laws, it did allow insurers to go after the policy and examine who procured the policy and whether or not that person meets the insurable interest requirements.”

The court did adopt the magistrate judge’s recommendation to deny the trustees’ and First Priority’s motions for summary judgment on the issue of whether Principal can declare the policies void or voidable because of misrepresentations made on the application. The court also adopted the magistrate judge’s recommendation to deny the defendants’ motions for summary judgment on the issue of damages.

The life insurance industry has had several court wins against STOLI where fraud is found in the transfer of the policy. And while the rest of the secondary market – namely life settlements – is quick to distance its products from STOLI, the secondary market continues to suffer from dampened investor enthusiasm. The life settlement industry notes that any comparison made between life settlements and STOLI is merely a smear from the primary insurance market, which sees life settlements as unwanted competition. The primary life industry, meanwhile, considers life settlements dangerous and a gateway to insurance transactions with no legitimate insurable interest.

The insurance industry believe the Pennsylvania decision and the Delaware decision in September punts the questions of principal in these cases to other courts and both decisions are "mixed bags" for both parties. The federal court here focused on the intent in the transfer--that is not the correct question, said a life insurance industry source who preferred to be unnamed.

It should have gone after intent at application, as Delaware did, and looked at whether there was good faith intent in orgination of the policy, the source said, adding that the matter is ripe for adjudication by the Pennsylvania Supreme Court. 

There are now about 300 cases in adjudication across the country, with ever-more increasingly important decisions. Stay tuned for more clarity even as less available liquidity in capital markets dries up new sources for the secondary market. 

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