Certified Questions on Insurable Interest, Delaware Supreme Court Raises
On September 20,
2011, the Delaware Supreme Court answered three certified questions
directly impacting life settlement investments. The questions were
presented to the Supreme Court in two companion cases pending in the
federal district court of Delaware, PHL Variable Ins. Co. v. Price
Dawe 2006 Insurance Trust and Lincoln Nat'l Life Ins. Co. v.
Joseph Schlanger 2006 Insurance Trust.
First, the Delaware
Supreme Court held that an insurer can contest a life insurance policy
for lack of insurable interest even after the contestability period
expires. This ruling aligns Delaware with the majority of states
that have considered the issue (New York being the major exception).
Second, the Court
held that the Delaware insurable interest statute, 18 Del. Code § 2704,
does not prohibit an insured from obtaining a policy on his or her own
life and immediately transferring the policy (or a beneficial interest in
a trust that owns the policy) to a person without an insurable interest,
even if the insured never intended to keep the policy. However, the
Court held that "if a third party financially induces the insured to
procure a life insurance contract with the intent to immediately transfer
the policy to a third party, the contract lacks an insurable interest."
The Court explained that the decisive issue is not whether the insured
intended to transfer the policy, but whether the insured actually
procured the policy or was merely an "instrumentality" used by
a third-party investor to procure the policy.
Third, the Court
held that a Delaware trust established by the insured has an insurable
interest in the insured as long as the insured actually established the
trust, which requires that the insured both "create and initially
fund the trust corpus." The Court held that the insurable
interest requirement is not met "if the trust is created through
nominal funding as a mere formality" or if the trust is funded by a
third party "as part of a pre-negotiated agreement."
The answers to the
second and third certified questions raise a number of significant
questions. For instance, the Court explained that an insured does
not "procure" a policy (i.e., is merely an
"instrumentality") if a third party provides "the insured
the financial means to purchase the policy" by funding the premium
payments. This holding calls into question whether a policy
originated through premium financing is procured by the insured or a
third party. In such cases, it would seem that the insured (not the
third party lender) funds the premium payments; the insured simply does
so with funds borrowed from the lender. The Court appeared more
concerned about premium payments made by a third party as an advance on a
pre-arranged purchase than with premium financing, which is expressly
authorized by Delaware statute.
Although the full
implications of Dawes and Schlanger are impossible to
predict, what is clear is that a court applying Delaware law in an
insurable interest dispute will need to "scrutinize the
circumstances under which the policy was issued and determine who
procured or effected the policy." This inherently
fact-specific inquiry, coupled with the right of insurers to contest a
policy for lack of insurable interest after the contestability period,
adds uncertainty to policies governed by Delaware law and will
undoubtedly lead to more litigation involving life settlement
For more information
on this case and its potential impact, please contact Steve Foresta
or Khai LeQuang.