Life SettlementsInsurable
Interest Called Into Question for Financed Policies
by Wm. Scott Page
The concept of insurable interest has been analyzed for years with regard to life settlements. Since the industry's inception, settlement companies and their advocates have cited the landmark Supreme Court case, Grigsby v. Russell. It states that insured individuals have the right to sell their policies to strangers without violating the insurable interest rule.
There are exceptions and challenges as with most matters of law. Many major insurance carriers are scrutinizing certain types of deals and looking for ways to back away from policies they were eager to issue. Insurable interest is under attack in some prevalent financing agreements. The result could mean voided policies and legal problems for agents and their clients.
Understanding insurable interest is key. While state definitions vary, insurable interest must be demonstrated for a life insurance policy to be valid. It must exist at the time of issue of the life insurance policy or it is void as a matter of law. It can be defined in several ways, including the following:
¥ The owner and beneficiary of a life insurance policy are closely related by blood or law.
¥ There is a substantial interest among the insured, the owner, and beneficiaries of the policy, which is based in love and affection.
¥ The owner and beneficiaries have a lawful, substantial economic interest in the continued life, health, and safety of the insured person.
Insurable interest is lacking when life insurance is underwritten in a scenario in which benefits arise or appreciate only from the death, disability, or injury of the insured person. A requirement of insurable interest removes speculation and gaming prospects on the lives of insureds at the time of issue.
The heart of issue for carriers is with non-recourse premium financing arrangements. An agent or financial planner typically initiates the life insurance process. The insured is often advised to create a vehicle to own the policy, such as an irrevocable life insurance trust (ILIT), a limited partnership, or a limited liability company. Instead of the policyowner paying the policy premiums, a lender provides funds to the policy-owning entity to pay premiums for the first several years. As a result, the lender obtains a collateral assignment on the policy.
These arrangements are problematic for a number of reasons and insurance carriers are beginning to call them into question. Although the situation is still being argued and analyzed, certain practices have generated suspicion, including the following:
¥ Because the term of the loan coincides with the policy contestability period, the sale of a policy afterwards appears to purposely avoid issues of wet ink.
¥ The loans tend never to be repaid. These policies are sold into the life settlement market instead.
The terms of the loans tend to involve interest rates far beneath or far above comparable market interest rates, making the option to repay the loan misleading. If the rate is too high, the lender appears usurious. If the rate is too low, the borrower appears to be receiving special inducements to make the loan.
Another red flag is that life settlement companies or their affiliates tend to be involved by earning fees at various times based on seemingly inconsistent events. Privacy concerns abound. Policy owners and the insureds may be subject to insurance department actions, including the loss of insurability.
These issues are drawing the attention of regulators nationwide. Legal departments at major insurance carriers have also weighed in. In late 2005, the New York Insurance Dept. said that premium finance-based insurance transactions violate New York's insurable interest law. The overall opinion is persuasive enough that other states may follow suit.
The lawsuits began even earlier. One major carrier contested the validity of an ILIT in Virginia in early 2005. Later overturned on appeal, the lower court ruled that the trust did not have an insurable interest.
In one case in mid-2006, another insurer claimed that a trust was created at the behest of investors seeking to profit from the demise of the insured. The case was eventually settled and the outcome is not known, but such scrutiny could lead to a voided policy.
Earlier this year, in a case involving a premium financing arrangement, one company issued a notice of rescission on a policy prior to the expiration of the two-year contestability period. Perhaps most interesting, is that the trust in question was created by the insured's children. Despite apparent insurable interest, the collateral assignment raised hackles. The case, which is still pending, sends another warning shot over the bow of the non-recourse premium financing industry.
The outcome of the pending cases and how the insurance regulators will respond is not known. However, the consequences can be significant. The biggest victim is the insured if a carrier voids a policy. Coverage is lost, future insurability is called into question, and the extent of the inevitable legal ramifications is not yet known.
The situation will only get more complicated, and interesting in the coming months as more policies created through non-recourse premium financing arrangements hit the life settlement market.
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Wm. Scott Page is president and CEO of The Lifeline Program. Founded in 1989, the company has pioneered business practices in the secondary market for life insurance policies, led efforts to make life settlements a respected financial tool, and successfully and tirelessly lobbied for intelligent industry regulation. For more information on life settlements, contact The Lifeline Program at 800-252-5282 or visit www.thelifeline.com.
