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Insurance Law

PHL Variable Insurance Company v. Morello – STOLI Policy Rescinded

 By Stephan Leimberg and Howard Zaritsky

"where the insurer is induced to enter into a contract for insurance by the actual fraud of the insured, the insurer is not required to return the premiums paid."  The reasoning is that "a contrary rule would be an invitation to commit fraud."

A life insurance company, Phoenix Life, sued Morello for rescission of a STOLI policy. PHL Variable Ins. Co. v. Lucille E. Morello 2007 Irrevocable Trust, 2010 U.S. Dist. LEXIS 29501 (D. Minn. Mar. 2, 2010). A joint motion for partial judgment would have allowed both rescission of the policy and the insurer's retention of premiums. But the investor-owner of the insurance, New Stream Insurance, LLC opposed entry of that partial judgment. The Court found for the insurer.[ii]


On March 6, 2007, the Lucille E. Morello Trust applied in writing to Phoenix seeking a life insurance policy on the life of Lucille E. Morello ("Morello").

The application contained the following affirmation:

I have reviewed this application, and the statements made herein are those of the proposed insured and all such statements made by the proposed insured in Part I or and in Part II of this application are full, complete, and true to the best knowledge and belief of the undersigned and have been correctly recorded.

The Trust application represented that Morello had a net worth of $33,995,250 and income in excess of $800,000 per year.

When Phoenix received the Trust application, it also received a complete Statement of Client Intent form (SOCI), which acknowledged that some of the policy premiums would be borrowed from CFC of Delaware, LLC (CFC).  The SOCI represented that there was no intent to transfer an interest in the policy to a third party and that the policy was intended as a tool to conserve Mrs. Morello's estate.

Because of the size of the policy sought, a third party inspection report was ordered to confirm the veracity of the representations made in the Trust application.  Examination Management Services, Inc. (EMSI) was engaged to complete this report.

An EMSI representative called Mrs. Morello and was told to talk with her son, Defendant Jeffrey Chiaro, and to Mrs. Morello's financial advisor. Mrs. Morello's son verified that her assets were valued at $34 million and that her annual income was $800,000.

The EMSI representative was told Mrs. Morello's CPA was John Abrams, and her investment consultant was Defendant David Claus. Claus also verified the information contained in the Trust application.  The representations by Chiaro and Claus were also consistent with a financial statement signed by John Abrams of Abrams Financial Services.

The application was submitted to Phoenix by Wholesale Life Insurance Brokers (WLIB), along with a producer's report, indicating Mrs. Morello had a net worth of $34 million.

Phoenix's underwriter relied on the Trust application, financial statements and confirmations gathered as part of the application process in determining that Morello qualified for the insurance policy issued.

Phoenix thereafter issued a $10,000,000 life insurance policy and paid commissions to two insurance agents: $370,771.831 to Rick Smith of The Producers Group Advantage, for whom Bruce Burns acts as a sub-producer; and $199,6346.372 to William Stansbury of Life Insurance Concepts, Inc., an affiliate of CFC, the lender of premiums.

Mrs. Morello died within two years of the issuance of the Policy, i.e. during the Policy's contestability period.

After an investigation, Phoenix discovered that the Trust's application included fraudulent information.


Morello's son, Jeffery Chiaro, a 47 year old part-time hairdresser was approached in 2006 by one of his hair clients, Jason Mitan, about the possibility of obtaining insurance coverage on his mother. According to the Court in this case,

"Mitan is a disbarred lawyer, with a felony conviction for tax evasion and bankruptcy fraud"[iii]. 

David Claus is one of Mitan's business associates, and Mitan put Morello in contact with Claus. Claus is the President and Mitan is the CEO of Cambridge Financial Group, Ltd, an affiliate of another Mitan company, Cambridge Management Group, Ltd.

Claus contacted Morello with an offer to provide her with free life insurance. Their understanding was that any insurance policies placed would eventually be sold to third parties.


Claus enlisted the services of WLIB to act as Cambridge's insurance broker. Claus also provided WLIB and Chiaro with the financial statement allegedly drafted by a CPA named John Abrams.   But the Illinois Department of Financial and Professional Regulation has no record of a John Abrams or of his accounting business.


Cambridge requested that WLIB obtain as much standard rate insurance coverage as possible, purportedly to preserve Mrs. Morello's estate. Ultimately, the Trust obtained the following life insurance policies:

  • Phoenix issued $10 million in coverage;
  • The Metropolitan Life Insurance Company issued $175,000
  • Protective Life Insurance Company issued $8 million

Mrs. Morello had a heart attack and was in the hospital on September 28, 2007, at which point WLIB closed its file.

In the meantime, Claus and Chiaro were working with financing companies to establish trusts that would own the policies sought on Morello's life. A total of four trusts were established, but only two ultimately used. The Trust at issue here named BNC National Bank ("BNC") as trustee and Claus as trust protector.

Another trust was drafted with respect to the Protective Policy and designed to allow for an early transfer of the trust's beneficial interest, which would allow it to sell the Protective Policy to investors without disclosing the change to the insurance company. In fact, it was sold for $268,873.31 to an investor less than a month after it was issued.

This purchase price was paid directly to Claus's bank account. Cambridge Management in turn paid Morello and Chiaro $74,608.00.

Ultimately, it was the plan to sell the Phoenix Policy as well.

CFC entered into a Term Financing Facility Agreement with the Morello Trust under which CFC loaned the Morello Trust $542,062 which included the $518,562 to pay the premium on the Policy; $10,00 to be paid back to CFC as an origination fee; $4,000 to BNC as trustee fees; and $2,000 to be paid to the law firm that drafted the trust agreement.

Although New Stream did not take an assignment of the financing agreement until June 2009, Phoenix asserted that New Stream was involved in this agreement from the outset, as evidenced by the Note Purchase Agreement between CFC and New Stream dated June 9, 2006.

Phoenix further asserted that New Stream was the source of the $542,062 CFC loaned to the Trust for purposes of the Policy premiums.

In November 2007, attorney Stephen McMullen wrote to Phoenix advising that he represented the estate of Lucille Morello and all interested parties regarding the Policy.

In December 2007, BNC submitted paperwork related to the claim, along with an affidavit from CFC stating that the amount owed to CFC, subject to collateral assignment, was $604,048.

Through the routine investigations conducted by the insurance companies following Morello's death, many discrepancies were revealed which ultimately lead to the discovery of the fraud.

For example, in February 2007, before Phoenix received the Trust application from Morello, Morello and her husband executed a Confidential Living Trust Fact Finder which detailed the couples' assets. This document showed that the couple

  • had assets of approximately $800,000 - not $34 million as represented in the Trust application,
  • had average income for the years 2004-2006 of $31,476.33, as compared to the $800,000 amount listed in the Trust application.

Phoenix then brought this action, seeking rescission of the Policy and damages arising out of and relating to the fraud resulting in the Policy's issuance.


In their joint motion to enter partial judgment, the Settling Parties stipulated:

  • the Trust made material misrepresentations on the Trust application regarding Mrs. Morello's net worth and income, and
  • such material misrepresentations were willfully false or intentionally misleading.

Subsequent to the initiation of this lawsuit, the Trust's trustee, BNC, purported to resign as trustee.

Defendant Claus, as the designated trust protector, represented that he has the authority to act on behalf of the Trust in settling this litigation. Claus, individually and as the trust protector, and Chiaro, the Trust's sole beneficiary, have agreed to settle this litigation.

Pursuant to the terms of the settlement, the parties have agreed that:

  • judgment be entered in favor of Phoenix;
  • the Trust take nothing by way of its claims against Phoenix;
  • the Phoenix policy is rescinded ab initio (from inception);
  • no recovery exists under the Policy and that death benefits will not be paid;
  • Phoenix shall offset the Premium Amount tendered to the Court against the aforementioned damages suffered by Phoenix to partially offset the damages suffered, including attorneys fees and costs; and
  • the rescission of the Policy, is in all respects, effective and binding notwithstanding Phoenix's retention of the Premium Amount.


New Stream opposed the joint motion for partial judgment, arguing that the remedy of rescission typically requires that each party return to their pre-contract position.[iv] As applied in this case, New Stream asserts that if the Policy is rescinded, Phoenix would have to return the premium paid for the Policy.


Under Minnesota law, a life insurance policy should be declared void when there is a statement made, in procuring the insurance, that is willfully false or intentionally misleading.[v]

Here, there was no dispute between the Settling Parties that willfully false and intentionally misleading statements were contained in the Trust application with the intent to deceive the insurer. So the Court held that the Policy should be declared void.

Minnesota law also provides that, where the insurer is induced to enter into a contract for insurance by the actual fraud of the insured, the insurer is not required to return the premiums paid.[vi]   The reasoning is that "a contrary rule would be an invitation to commit fraud."

If all moneys thus voluntarily paid can be recovered or must be returned by the insurer as a condition precedent to pleading the fraud as a defense, a party who contemplates obtaining insurance by false representations may well feel that he is taking no chances of loss, but is entering upon a transaction in which he stands to gain large returns without any possibility of endangering his investment. If the fraud is never discovered, the beneficiary under the policy which will be issued to him will receive the full benefit of the contract. If it by chance is discovered, his estate will receive back all that has been paid by the guilty party, and the trouble and expense attending upon the transaction will be thrown upon the innocent party.

Under the particular facts of this case, the Court found that rescinding the Policy, without any premium refund, is an appropriate remedy and consistent with Minnesota law. Should Phoenix be required to make the Trust whole would, as the Court found in Taylor, be an invitation to fraud.[vii]


The Court found for Phoenix and against the Trust.  It held that the trust had no valid claims against Phoenix and rescinded the policy ab initio so that it never existed and has no legal effect.

It also held that no recovery exists under the Policy, at law or in equity, and the Policy's death benefits will not be paid to the Trust, the Trust's beneficiary, the Trust's creditors, or any other entity or individual and that Phoenix could retain the premium amount to partially offset the damages it has suffered, including its attorneys' fees and costs incurred in this litigation.

The result in this case should be compared with a New York State Court's decision to reject Lincoln Life & Annuity Company of New York's attempt to rescind a $5,000,000 policy, ruling the company waived its rights to do so by accepting premium payments after it filed its lawsuit.  Lincoln had alleged that the third party owner-investor had lacked an insurable interest in the policy but the court granted summary judgment in favor of the policy owner - probably because of acceptance of premium payments after filing the suit.


Steve Leimberg

CITE AS:  LISI Estate Planning Newsletter #1625 (April 7, 2010) at   Copyright 2010 Leimberg Information Services Inc. (LISI).  Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission.

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[i] In a legitimate life settlement, a policy is purchased in good faith but sold by its owner when no longer wanted or needed. But in STOLI transactions, financial speculators or their representatives financially induce seniors to purchase life insurance, policies the seniors otherwise would not obtain or pay for, with the intent of transferring the death benefits to the speculators. Many of these cases, as in the present situation, involve insurance fraud, and the insureds can be left vulnerable to unexpected taxes, fees, and policies they can not sell at the prices they anticipated. See Zaritsky and Leimberg, Tax Planning With Life Insurance - 2nd Edition - Analysis With Forms (800 950 1216).

[ii] PHL Variable Ins. Co. v. Lucille E. Morello 2007 Irrevocable Trust, 2010 U.S. Dist. LEXIS 29501 (D. Minn. Mar. 2, 2010)

[iii] (See In re W. Jason Mitan, 75 Ill.2d 118 (Ill. 1979); United States v. Mitan, 966 F.2d 1165 (7th Cir. 1992).)

[iv] Hatch v. Kulick, 211 Minn. 309, 1 N.W.2d 359, 360 (1941) (rescission requires restoration of the status quo).

[v] Peggy A. Lebus v. Northwestern Mut. Life Ins. Co., 55 F.3d 1374, 1377 (8th Cir. 1995); Useldinger v. Old Rep. Life Ins. Co., 377 N.W.2d 32, 36 (Minn. Ct. App. 1985).

[vi] . Taylor v. Grand Lodge A.O.U.W. of Minn., 96 Minn. 441, 453, 105 N.W. 408, 413 (1905).

[vii] This case is similar to the facts in Lincoln Life and Annuity Co. of N.Y. v. Teren, No. 37, 2008, 83905 (Cal. Sup. Ct. Aug. 27, 2009) (Ganer Aff. Ex. DD.) In that case, the court found that the Teren Trust and Trustee were not entitled to a return of premiums paid on the life insurance policies owned by the Teren Trust, where the application for insurance included false statements and was supported by a fraudulent document.