Highlights of the Fall 2011 Issue of New Appleman on Insurance: Current Critical Issues in Insurance Law

The Fall 2011 issue of the New Appleman on Insurance; Current Critical Issues in Insurance Law quarterly features three articles on the cutting edge of insurance law:

•  On the Cusp of Change: the Intersection of Social Media and Insurance

•  An Overview of Seven State-Sponsored Property Insurance Programs

•  The Clash of Insurable Interest and the Evolving Secondary Life Insurance Market: The Rise of Stranger-Originated Life Insurance Lawsuits

"On the Cusp of Change: the Intersection of Social Media and Insurance" by Carrie E. Cope and Keith Mandell of Schuyler, Roche & Crisham, P.C., discusses the evolution of social media, its multifaceted impact upon the insurance industry to date and predicts what insurers likely may face in the future in terms of exposure and regulatory change.

The article addresses the logistical sale of insurance through social media as well as its use in the promotion and marketing of insurance products. The authors comment on the use of social media for consumer education purposes as well as to address consumer complaints which, given advances in technology, may reach tens of thousands of people at a moment's notice. The article also addresses the risks and benefits of using social media as both an underwriting and claim investigation tool.

The article highlights some of the risks that businesses face in using social media and how insurers are changing their policy forms in response to those emerging risks. Applicable existing insurance products and endorsements are surveyed. The article observes, "As the use of social media continues to grow and new forms of media are developed, the risks involved with its use will similarly continue to proliferate. As a result, we undoubtedly will see more insurance policies addressing the risks of social media in the next few years." The authors further contemplate continued advances resulting from the social media revolution and how insurers may best position themselves to maintain or increase their market share in light of such advances.

"An Overview of Seven State-Sponsored Property Insurance Programs" by Douglas Scott MacGregor first observes that "[t]wo horrendous natural disasters a decade apart shocked America: the 1994 Northridge earthquake in Southern California and Hurricane Katrina which struck the Gulf Coast in 2005." The article notes that California and Louisiana both faced, and continue to face to varying extents, a property insurance crisis. Private insurers either fled the states, limited coverage, or substantially increased premiums. Many homeowners and commercial property owners were forced to seek coverage from state-sponsored property insurers of last resort either because they could not find or could not afford coverage in the private market. The idea of state-sponsored property insurance programs was not new, but those two catastrophes highlighted the potential problems for these plans. The article provides an overview of the property insurance programs of seven states: California, Florida, Louisiana, Massachusetts, North Carolina, South Carolina, and Texas. These programs are as follows:

•  The California Earthquake Authority which is authorized to transact insurance to sell policies of "basic residential earthquake insurance," because the private market largely reacted to the state's requirement that all homeowner's insurers must offer earthquake insurance by refusing to issue homeowner's insurance;

•  The Florida Citizens Property Insurance Corporation which was created because the voluntary market was unable to provide windstorm-only insurance in high-risk coastal areas;

•  The Louisiana Citizens Property Insurance Corporation which was formed to place under one umbrella the state's "FAIR" (Fair Access to Insurance Requirements) Plan and its Coastal Plans;

•  The Massachusetts Property Insurance Underwriting Association which was formed because in many parts of the Massachusetts seacoast, private insurers have completely withdrawn coverage so that the MPIUA was intended to be an insurer of last resort;

•  The North Carolina Insurance Underwriting Association which reflects the North Carolina legislature's finding that adequate insurance on property in beach and coastal areas is necessary and the need for it is increasing while the private market for it is inadequate and likely to become more so in the future;

•  The South Carolina Wind and Hail Underwriting Association which was formed to assure an adequate market for wind and hail insurance in the coastal areas of the state; and

•  The Texas Windstorm Insurance Association whose purpose is to provide an adequate market for windstorm and hail insurance in the seacoast of the state by serving as a residual insurer of last resort.

The article begins with the history of government-sponsored property insurance programs. Following that is an outline of the legislation governing the program of each state addressing the history of the applicable legislation, the organization and authority of the governing association, the status of member insurers, insurance policy requirements, funding mechanisms, and liability of the programs. Interpretive appellate case law is incorporated in each outline. The article compares the programs and discusses their current financial status. The article then turns to the proposed federal Homeowners' Defense Act as a possible national solution to the fiscal perils faced by the state programs.

"The Clash of Insurable Interest and the Evolving Secondary Life Insurance Market: The Rise of Stranger-Originated Life Insurance Lawsuits" by Brian T. Casey and Rachel B. Coan of Locke Lord Bissell & Liddell LLP first states, "Life settlements have garnered attention in recent years from life insurance companies, state insurance regulators, members of Congress, the Securities and Exchange Commission, the General Accountability Office and the Internal Revenue Service.  Many participants in the world of finance, including banks, investment banks, hedge funds and money managers, have also become involved with life settlements."  The article attributes this attention to the enormous size of the U.S. life insurance market, the vast amounts of money represented by in-force policies and the fact that such policies constitute a significant asset for many families, so that any potential threat to the market or abuse of the product can have major financial, political and social implications.  The article notes that proponents of life settlements claim they can be an attractive investment, capable of generating double-digit returns over the long term that are largely uncorrelated with the ups and downs of the equity and debt markets. In addition, they provide seniors with a valuable alternative to the lapse of their policies or the return of their policies to the insurers for their cash surrender value. On the other hand, the article observes that detractors argue that life settlements are a perversion of life insurance, which should be used to protect the family or business of a provider in the event of untimely death, rather than as a means by which unscrupulous investors can gamble on the longevity of unrelated persons.

The article focuses on one of the phenomena that has prompted so much public discussion of life settlements - so-called "stranger-originated life insurance"  or "STOLI"- in which a life insurance policy is originated primarily or solely for the purpose of resale.  STOLI transactions are undertaken by third-party sponsors and investors with the expectation that the proceeds they will receive when the insured individual dies will significantly exceed the costs of purchasing the policy from the original owner and paying all or a substantial part of the premiums during his or her lifetime.  The insured is typically induced to enter the transaction by the promise of an attractive cash settlement for merely applying for a life insurance policy and agreeing to pay a fraction of the premiums (often by way of a financing charge) for a two-year period until the policy is sold.  For the life insurance agent, who receives a sizable commission from the insurance company upon issuance of the policy, there is a strong incentive to generate new policies, and the larger, the better.  The life insurance companies have competing interests:  while they are eager to obtain new business and receive the resulting premiums, they have sometimes been forced to pay out large sums in death benefits to previously unknown investors holding policies that turn out to have been fraudulently procured based upon gross misrepresentations in the applications.  In some instances, the seniors who have been persuaded to apply for the policies have also been duped by the producers and are unaware of the misstatements contained in the applications.

The article finds that STOLI transactions raise a myriad of legal issues.  These range from the extent to which life insurance policies should be freely transferable under state insurable interest laws to questions of conflicts of law to disputes regarding the rights of an insurer to retain premiums upon a policy rescission and to challenge the validity of a policy after expiration of the contestability period.  Because insurance is regulated under the laws of the 50 states, state insurance departments and legislators, as well as the courts, have responded differently to these issues.  The article traces the development of STOLI and describes these responses as the debate, and the disputes, continue.  It also examines a parallel phenomenon - stranger-originated annuities - that has emerged within the past year or so and raises similar legal questions.

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