In an important victory for the multi-billion dollar life settlements industry, the United States Court of Appeals for the Eighth Circuit issued a landmark ruling on March 13 that makes it much more difficult for life insurance companies to void policies under the so-called “insurable interest” doctrine. The ruling, which came in the case PHL Variable Insurance Company v. Bank of Utah, endorses the validity of the secondary market for life insurance policies and strengthens the position of policyholders and investors alike.
The case concerns a life insurance policy that PHL Variable Insurance Company issued on the life of an individual who set up an irrevocable life insurance trust to hold the policy and named his wife as the beneficiary of the policy proceeds. With PHL’s knowledge and approval, the trust borrowed money to pay the premiums on the policy. The trust eventually defaulted on the loan and surrendered the policy to the lender in lieu of repayment. After the insured individual died in November 2011, the owner of the policy submitted a claim for the death benefit to PHL. Rather than pay the claim, however, PHL filed a lawsuit in federal court in Minnesota against the policy owner, claiming the policy was void for lack of an insurable interest. The “insurable interest” doctrine requires that the person who obtains a life insurance policy have an interest in the continued life and health of the insured, based on either a family or economic relationship. PHL charged that this policy was obtained by a hedge fund that did not have an insurable interest in the individual’s life as part of a stranger-originated life insurance – or “STOLI” – scheme. Bank of Utah, the securities intermediary that currently holds the policy, filed a counterclaim against PHL seeking to recover the full death benefit plus interest. The district court found the policy to be void for lack of insurable interest at inception.
In Friday’s ruling, the Eighth Circuit reversed the district court and held that the policy is valid. Addressing a question of first impression under Minnesota law, the court articulated a broad principle that an insurer cannot use the insurable interest defense to declare a policy void if that policy was purchased by the insured on his own life, regardless of whether the policy is subsequently transferred to an entity that lacks an insurable interest in the insured’s life.
In another important holding, the Court of Appeals rejected the district court’s interpretation of Minnesota law and held that an insurer seeking to contest a policy under the insurable interest doctrine (a more difficult task now under the court’s first holding) must bring such a challenge within the two-year contestability period mandated by statute.
The Eighth Circuit’s two holdings will ensure that insurers fulfill their obligation to pay the death benefit on insurance policies that are purchased on the secondary life insurance market, including premium financed policies. This will give lenders and investors greater confidence in the value of their investments, and therefore make the secondary market for life insurance more reliable and efficient. And that, in turn, will give seniors and others who wish to sell their life insurance policies on the secondary market the best value for those policies.
While the Bank of Utah decision was decided under Minnesota law, it could have national implications. The relative lack of precedent on insurable interest means that courts often look to decisions from other jurisdictions to determine the bounds of the insurable interest requirement.
Orrick partner Stephen Foresta is lead counsel to Bank of Utah. Orrick partner Robert Loeb argued the appeal. The Orrick team also included Khai LeQuang, Marc Shapiro, Alec Orenstein, Nancy Harris, Philipp Smaylovsky, Shaila Rahman Diwan, Jamie Shookman and Aaron Rubin.