Secondary Life Policy Market Gets Shot in the Arm from Federal Judge

The federal court held that in the case of the policies, an insurable interest existed at inception and that the relevant state statute defines the insurable interest requirement solely in terms of the relationship between the insured and policy beneficiary.

"Noting that the Pennsylvania insurable interest law is most similar to New York's, the court cited Kramer v. Phoenix to affirm its view that the insurable interest statute cannot be read to include an intent standard," said Michael Freedman, senior vice president of government affairs for Coventry.

Freedman noted that the New York Court of Appeals stated that a policy valid at the time of procurement may be assigned to one without an insurable interest in the insured's life. Furthermore, no insurable interest is required when one holds a policy on another's life, so long as the policy was valid in its inception.

However, although a Delaware Supreme Court recently rejected insurers' attempts to graft an intent analysis into insurable interest laws, it did allow insurers to go after the policy and examine who procured the policy and whether or not that person meets the insurable interest requirements."

The court did adopt the magistrate judge's recommendation to deny the trustees' and First Priority's motions for summary judgment on the issue of whether Principal can declare the policies void or voidable because of misrepresentations made on the application. The court also adopted the magistrate judge's recommendation to deny the defendants' motions for summary judgment on the issue of damages.

The life insurance industry has had several court wins against STOLI where fraud is found in the transfer of the policy. And while the rest of the secondary market – namely life settlements – is quick to distance its products from STOLI, the secondary market continues to suffer from dampened investor enthusiasm. The life settlement industry notes that any comparison made between life settlements and STOLI is merely a smear from the primary insurance market, which sees life settlements as unwanted competition. The primary life industry, meanwhile, considers life settlements dangerous and a gateway to insurance transactions with no legitimate insurable interest.

The insurance industry believe the Pennsylvania decision and the Delaware decision in September punts the questions of principal in these cases to other courts and both decisions are "mixed bags" for both parties. The federal court here focused on the intent in the transfer–that is not the correct question, said a life insurance industry source who preferred to be unnamed.

It should have gone after intent at application, as Delaware did, and looked at whether there was good faith intent in orgination of the policy, the source said, adding that the matter is ripe for adjudication by the Pennsylvania Supreme Court. 

There are now about 300 cases in adjudication across the country, with ever-more increasingly important decisions. Stay tuned for more clarity even as less available liquidity in capital markets dries up new sources for the secondary market.