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Circuit court issues new ruling on stranger-originated life insurance

Life Insurance and Annuities
by Glenn Tobleman
Convertible life insurance is useful for many people.
Convertible life insurance is useful for many people.

In the past several years, there has been an increase in the number of life insurance policies acquired by third parties unrelated to the people the policies cover. These have been the subject of hundreds of lawsuits between life insurers and these third parties since the turn of the century, often in an attempt to void the payout of death benefits.

Recently, an appellate court in New Jersey ruled that stranger-originated life insurance policies - also known as STOLI policies - are void, but parties that have made premium payments on them are also eligible for refunds on the funds they have contributed toward those policies. The decision was rendered by a panel of three judges and upheld the previous court's ruling in a case between a Canadian life insurer and a U.S.-based bank.

Aspects of the decision were also certified by the state's Supreme Court.

A New Jersey appeals court has issued a noteworthy ruling on STOLI policies.A New Jersey appeals court has issued a noteworthy ruling on STOLI policies.

The facts of the case
In 2007, a life insurance application was filed with the Canadian company listing the Nancy Bergman Irrevocable Trust as owner and beneficiary of a policy with a death benefit worth $5 million in the event of Bergman's passing. Bergman's assets were listed at $9.235 million on that application, but in actuality, were well under $1 million, with only a condominium worth $285,000 among her major assets. Her entire estate was valued between $100,000 and $250,000.

The policy was, however, funded by a group of three investors, who were signed onto the trust alongside Bergman and her grandson, the latter of whom resigned as a trustee within a month of the policy being issued, and instead named the investors as co-trustees. About two and a half years later, the policy was sold by the Trust to a life settlement company, and the investors pocketed much of the money from that sale. Later, the bank that brought the suit loaned money to another company that purchased the policy, then acquired the policy as part of bankruptcy proceedings.

The bank then continued to make payments on the STOLI policy until Bergman died in 2014, at which point the life insurer refused to pay the death benefit, saying the policy had been fraudulently obtained. That decision ultimately led to the lawsuit.

The ruling
The American bank sought to recover at least some of the more than $1.2 million it made in premium payments in the time it owned the policy, while the Canadian life insurer wanted to affirm the illegality of the acquisition of the policy in the first place, given that the information in the application was false.

The appeals court found that the life insurer was correct: There was no dispute that the STOLI policy was obtained specifically to benefit the investors and not anyone who had an insurable interest in Bergman's life. On the other hand, it also found that the bank was correct in arguing that if the policy was void the second it was written, all premium payments the financial institution made were to be refunded.

This was not a blanket consideration, however: the ruling called for a "fact-sensitive approach" in determining whether refunds should be issued, based on whether the party in question knew of the policy's fraudulence. In this case, the bank would have had no way of knowing the policy should have been void.

What's the takeaway?
Of course, the legalities surrounding STOLI policies vary from one state to the next. Most revolve around the question of "insurable interest" in the person for whom the policy is being obtained. For instance, family or other loved ones may have a provable interest, but so too would a business partner or someone else with a pre-existing financial interest in their well-being. In this way, the "stranger" in question is typically not a stranger at all, but it is also possible for an insured to work with a third party so that a policy can be sold to a life settlement company (or similar entity) once the period in which the policy can be contested comes to an end.

In many states, even if the latter situation is how the STOLI policy originated, the insured will have to name a beneficiary with an insurable interest when applying (as with the Bergman situation) to ensure it is valid. In short, had the facts of Bergman's financial situation not been falsified on the initial application, it's likely the policy would never have been voided.

The facts of such cases are something life insurers will have to examine in-depth on an ongoing basis to ensure they know the various legalities surrounding their underwriting standards. In addition, it might be important - from an outreach perspective - to help people understand what they are getting into when they enter into STOLI-related agreements concerning their long-term finances.

Whatever additional information insurers or brokers can provide to help people get the full picture of transactions will likely go a long way toward ensuring people have coverage that works for them and potential future issues don't arise.

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