Principal Life Insurance Co. v. Rucker: Carrier Wins Substantial Victory in Beneficial Interest/STOLI Transaction Case

   By Stephan Leimberg and Howard Zaritsky

The decision in Principal Life Ins. Co. v. Lawrence Rucker 2007 Ins. Trust, 2010 U.S. Dist. LEXIS 89243 (D. Del. Aug. 30, 2010) is important for three reasons.   First, most of the prior insurer victories have been limited to surviving a motion to dismiss, and these cases still must proceed to trial and opinion.  Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust, on the other hand, held that the policies issued were void from their inception, relieving the insurer of any obligation to pay a death benefit. Second, the case expressly rejects the theory of the major STOLI victories, which is that the initial owner has an insurable interest unless he or she plans, at the policy’s issuance, to sell the policy to someone the identity of whom the owner knows. Third, the policy itself was not sold but rather, beneficial interests in the insurance trust were sold.  The court refused to be swayed by this change in form, and treated the sale of beneficial interests as the equivalent of the sale of the underlying policy.

STOLI promoters have gone to great lengths to obscure what’s really going on underneath the transaction. So-called BI, or “Beneficial Interest” transactions as they became known in the industry, involve the sale of interests in the trust that owns the life insurance policy as opposed to the policy itself.

As Tools & Techniques of Life Settlement Planning points out:

To obfuscate the true intent of the transaction, some promoters utilized an FLP, LLC or statutory business trust as the policy owner. There are many reasons why promoters turned to these so-called "intervening entities." First, the use of an FLP, LLC or business trust allows the participants to mask what is really happening from the insurer. Many application questions ask only whether a “life insurance trust” was the owner of the policy. If the policy were owned by a business entity, the transaction could avoid detection.

In addition, many carriers ask whether the applicant intended to transfer ownership of the life insurance policy to a third party. These questions were obviously designed to detect whether the policy would be sold in a settlement transaction. If a policy is owned by a partnership, LLC or business trust, in the stealth leg of the transaction, the policy itself is not sold on the secondary market. Rather, a “beneficial interest” in the entity owning the policy is sold to investors. Once the investors own the entity that owns the policy, the investors can sell the policy or wait to collect the death proceeds.

By claiming that a “beneficial interest” would be sold, as opposed to the policy inside the entity, promoters counseled insurance applicants to answer questions such as “do you intend to transfer ownership in the policy”  in the negative. In response, some carriers added new application questions that are designed to catch beneficial interest transactions. The question that follows is an example of an updated carrier application question designed to detect “beneficial interest” transactions: “Have there been any discussions about selling the proposed life insurance policy, trust or limited liability company that will own this policy to a life settlement company or group of investors within the next five years?”

Now comes Howard Zaritsky, who provides LISI members with a front-row seat where a BI transaction took a serious hit from the U.S. District Court for Delaware.

Here is Howard’s commentary:

EXECUTIVE SUMMARY:

The U.S. District Court for Delaware held, on a motion for summary judgment, that an insurance trust that bought a policy on the grantor’s life lacked an insurable interest at the time of purchase, because the beneficiary planned to sell all of the beneficial interests in the trust to someone else, even though the beneficiary did not then know the identity of the purchaser.

BACKGROUND:

In Principal Life Ins. Co. v. Lawrence Rucker 2007 Ins. Trust, 2010 U.S. Dist. LEXIS 89243 (D. Del. Aug. 30, 2010), a U.S. District Court granted a summary judgment to the insurer, voiding ab initio a life insurance policy issued as part of a STOLI arrangement, on the grounds that it lacked an insurable interest.  The insured, Lawrence Rucker, began the process of obtaining life insurance by working with two insurance agents.

The insured executed the Lawrence Rucker 2007 Family Trust, an irrevocable life insurance trust, naming Christiana Bank as the trustee.  The trustee was designated the original owner of the insurance policy and the trust was named the original beneficiary.

The insurer issued a $3.5 million Flexible Premium Universal Life Insurance Policy pursuant to the application and Confidential Financial Statement.  Shortly after the policy was issued, the trust executed an agreement to sell all of the beneficial interests in the insurance trust to another trust, the Gill Accumulation Trust for $105,000. The insurance trust remained the named beneficiary of the policy, but the GIII Trust was the actual beneficiary and would receive the death benefits under the agreement.

The insurer brought an action for a declaratory judgment that the policy was void for lack of insurable interest and material misrepresentations.  Both parties moved for summary judgment.

COURT HOLDS FOR THE INSURER ON KEY ISSUE

The District Court for Delaware (Judge Thynge) granted the summary judgment to the insurer on the issue of insurable interest, denied the insurer a summary judgment on the issue of material misrepresentations, and denied the trust’s motions for summary judgment.

The court explained that, under applicable state law (Delaware), one may not procure an insurance policy on the life of another without an insurable interest in that person's life.  The court discussed the 1911 decision in Grigsby v. Russell, in which the U.S. Supreme Court recognized a distinction between life insurance policies and wagering contracts, and ascribed to the later a “sinister counter interest in having the life come to an end.”

The Grisby Court explained that an insurance policy lacking an insurable interest at inception “serves as a cover for a wagering contract, contradicting the purpose of life insurance.” [footnote omitted] The insurable interest requirement, therefore, “curtail[s] the use of insurance contracts as wagering contracts by distinguishing between contracts that [seek] to dampen the risk of actual future loss, and those that instead [seek] to speculate on whether some future contingency would occur”  [footnote omitted]  The insurable interest requirement and the prohibition on wagering contracts have existed in accord with Grisby for nearly a century.

The court also explained that every individual has an insurable interest in his or her own life, and may insure that life in good faith for the benefit of another, even if the beneficiary lacks an insurable interest.  Furthermore, the court explained, a validly issued policy may be assigned to another person who lacks an insurable interest in the insured.

On the other hand, the court noted, a life insurance policy procured at the behest of another, however, may lack an insurable interest.

The court discussed Sun Life Assurance Co. of Canada v. Paulson, in which the District Court for Minnesota stated that a life insurance policy is void as against public policy if the policy was “procured under a scheme, purpose or agreement to transfer or assign the policy to a person without an insurable interest in order to evade the law against wagering contracts.”  Therefore, the District Court for Minnesota concluded that, where an insurance company can establish a “scheme, purpose or agreement to transfer or assign a life insurance policy” to subvert the law prohibiting wagering contracts, the policy is itself void.

In this case, the court noted, the policy lacked an insurable interest at inception because the insured always intended to sell the beneficial interest in the policy for $105,000.  The trustee of the insurance trust contended that an agreement to sell the policy could not have existed at inception because the insured did not know the identity of the buyer at that time.

The court noted that the insured’s and the agent’s depositions made clear that the two had a pre‑negotiated agreement to transfer the beneficial interest in the policy, but for which the insured would not have applied.  Therefore, the court stated,  “[r]egardless of whether Rucker knew the identity of the future purchaser, he clearly intended to sell the beneficial interest in the Policy at the time it was procured.”

The trustee of the insurance trust also argued that a legal interest in the policy was never actually sold, because the insurance trust remained the designated beneficiary and the insurance trust had an insurable interest in the insured.  The court disagreed, stating that the use of a trust and the assignment of beneficial interests could not avoid the public policy concerns inherent in the insurable interest rules.

COURT PUNTS ON OTHER ISSUES

The policy application required several disclosures, including Question 6(a), which asked whether the applicant had an intention that “any group of investors will obtain any right, title, or interest in any policy issued of the life of the Proposed Insured(s) . . . “ and Question 6(b), which asked whether the applicant would “borrow money to pay the premiums for this policy or have someone else pay these premiums . . . in return for an assignment of policy values back to them . . . “  The insured answered both questions in the negative.

The insured also submitted a Confidential Financial Statement (“CFS”) that represented his yearly income at $425,000 and his net worth at $4.85 million.  Rucker's actual income was approximately $120,000, and his actual net worth significantly less than represented.  It was not clear how this false information came to be included in the CFS, but the parties agreed that it was incorrect and not directly attributable to the insured.

The court found an issue of fact for the jury on whether these representations were made by the insured or an agent of the insurer.  The court also stated that a jury would need to determine whether the loans of premiums were made in exchange for the future assignment of the policy.

The trustee of the insurance trust also argued that Principal had waived its right to rescind the policy by continuing to accept premiums after becoming aware of the alleged STOLI scheme.  The court stated that this analysis was inapplicable, however, because, rather than unilaterally rescinding the policy, Principal notified the trust that it believed that the policy was void and sought a declaratory judgment to that effect.  The court explained that rescission might be affected by continuing to accept premiums, but declaring that the policy was always void and bringing a declaratory judgment action was not.

COMMENT:

The courts have been inconsistent in their views regarding the validity of STOLI transactions.  The investors and promoters of STOLI arrangements had notable successes in Sun Life Assurance Co. of Canada v. Paulson (D. Minn.) and First Penn Pacific Life Ins. Co. v. Evans (D. Md. and 4th Cir.).

The insurers have had successes in:

•   Life Products Clearing, LLC v. Angel,

•   American General Life Ins. Co. v. Schoenthal Family, LLC (11th Cir.),

•   Lincoln National Life Ins. Co. v. Calhoun (D.N.J.),

•   Phoenix Life Insurance Co. v. LaSalle Bank, N.A. (E.D. Mich.),

•   AXA Equitable Life Ins. Co. v. Infinity Fin. Group, LLC (S.D. Fla.),

•   Principal Life Insurance Co. v. Minder (E.D. Pa.),

•   Lincoln National Life Ins. Co. v. The Gordon R.A. Fishman Irrevocable Life Trust (C.D. Cal),

•   Sun Life Assurance Co. of Canada v. Moran (D. Ariz);

•   Ashkenazi v. AXA Equitable Life (E.D.N.Y.);

•   Lincoln National Life Ins. Co. v. Snyder (D. Del.);

•   Penn Mutual Life Ins. Co. v. Wolk (S.D.N.Y.); and, now,

•   Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust. (D. Del.).

The decision in Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust is important for three reasons.

First, most of the prior insurer victories have been limited to surviving a motion to dismiss, and these cases still must proceed to trial and opinion.  Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust, on the other hand, fully holds that the policies issued were void from their inception, relieving the insurer of any obligation to pay a death benefit.

Second, Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust expressly rejects the theory of the major STOLI victories that the initial owner has an insurable interest unless he or she plans, at the policy’s issuance, to sell the policy to someone the identity of whom the owner knows.

The District Court in Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust, on the other hand, found it sufficient that the initial policy owner intends to sell the policy.  The policy owner need not know to whom the policy will be sold.

Third, the policy itself was not sold in Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust.  Instead, the beneficial interests in the insurance trust were sold.  The court refused to be swayed by this change in form, and treated the sale of beneficial interests as the equivalent of the sale of the underlying policy.

All-in-all, Principal Life Insurance Co. v. Lawrence Rucker 2007 Ins. Trust is a major victory for insurers and a major loss for the promoters and investors in STOLI arrangements.

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