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By: Justin Boron
To take out insurance, you almost always need an “an insurable interest” in the risk being insured, such as a financial interest in a home or a car. It’s what prevents strangers to the risk from betting on the occurrence of a casualty, like your neighbor taking out a policy on your house or car in the hopes that either is destroyed in an accident. The requirement takes on heightened importance in the area of life insurance where it prevents strangers to the insured life from betting on someone’s death and discourages worse things, like foul play.
But because life insurance is treated as a transferrable asset—much like a home or car—investors developed a workaround for the “insurable interest” requirement. In arrangements referred to as stranger-oriented life insurance policies—STOLIs, for short—investors fund the premiums for a life insurance policy purchased by the insured who has the insurable interest when the policy is purchased but who intends to re-sell it at a discount to investors without an insurable interest. The insured’s frequent practical purpose is to pay for immediate health care needs or other expenses. The investors’ purpose is to make a profit off the benefit when it is paid. Usually, that means that their profit increases the sooner the insured dies. STOLIs, of course, are controversial. But despite efforts to regulate them, they continue to evolve in one form or another.
Considering New Jersey law, the Third Circuit Court of Appeals recently confronted whether a STOLI involving a $5 million benefit could be upheld under the states’ public policy. Based on certified questions answered by the New Jersey Supreme Court, it concluded that the life insurance policy was void ab initio. Sun Life Assurance Co. v. Wells Fargo Bank NA, Nos. 16-4337, 16-4387, 2019 U.S. App. LEXIS 24916, at *5-6 (3d Cir. Aug. 21, 2019). It reasoned that the STOLI arrangement was intended to benefit the investors whose interest was in the early death of the insured rather than anyone whose interest was in the continued life of the insured. As a result, it was not an insurance policy; it was a gamble on a person’s life.
In so holding, the Third Circuit and the New Jersey Supreme Court joined at least 30 other states prohibiting or regulating STOLIs, so its decision is not particularly remarkable on its own. But it illustrates how determined investors are to bet on the duration of a person’s life when there is a financial incentive and how common the STOLI arrangements might be. Absent a large benefit, they probably go unchallenged.
In fact, there have been multiple recent cases that either voided such policies or precipitated legislative change to the “insurable interest” requirement. See, e.g., Wells Fargo Bank, N.A. v. Pruco Life Ins. Co., 200 So. 3d 1202 (Fla. 2016); Lincoln Nat’l Life Ins. Co. v. Gordon R.A. Fishman Irrevocable Life Tr., 638 F. Supp. 2d 1170 (C.D. Cal. 2009); Sun Life Assurance Co. v. Conestoga Tr. Servs., LLC, 263 F. Supp. 3d 695, 702 (E.D. Tenn. 2017).
Although the New Jersey ruling places it in line with other states’ position on the issue, the Third Circuit decided to refund the policyholder the premiums paid to the insurer. As a result, the ruling might not discourage the practice completely, and it certainly will persist in other states where there is no anti-STOLI legislation.
If you have any questions or would like more information, please contact Justin Boron at [email protected].