The Arizona Supreme Court is taking up an issue that has not had consensus among the states that have considered it. The Court’s impending decision will resolve a conflict between two laws affecting cases where the enforceability of life insurance policies is contested and a decision is necessary to resolve questions for current beneficiaries.
The issue stems from an Arizona case where a life insurance company sued to have a second-to-die policy[i] held “void ab initio” (or void from the start) as an “illegal wagering contract.”[ii] The life insurance policy in the amount of $2.5 million was taken out in May 2004 by a Mr. and Mrs. Peterson.[iii] The policy was not paid for, and the proceeds were not distributed to them or their heirs.[iv] After a series of transfers, the policy ended up with the defendant, Wilmington, a securities intermediary, which is a clearing corporation or business that maintains securities/investments for others.[v] The policy contained a clause that the insurer would not contest the policy after two years for issuance (other than for unpaid premiums).[vi] Arizona law provides for the same in its incontestability statute, ARS § 20-1204.[vii] All premiums had been paid (to the tune of $1.5 million).[viii] It thus appeared the insurer could not contest the policy under the contract and Arizona law.
After Mr. and Mrs. Petersons’ deaths in 2018 and 2020, respectively, the policy matured and Wilmington sought death benefits, which the insurer refused to pay.[ix] The insurer alleged that Wilmington and prior owners of the policy were speculators on the Petersons’ deaths and did not have an insurable interest in their lives and, thus, would not have been allowed to legally enter into the policy, making it void from the start.[x] As the district court noted, in Arizona, life insurance policies are not to be issued to anyone on the life of another unless the benefits are “payable to the individual insured or his personal representatives, or to a person having, at the time the contract was made, an insurable interest in the individual insured.”[xi]
Faced with these contradictory laws on the issue of whether the life insurance policy was enforceable, and with no controlling precedent, the district court certified the following question to the Arizona Supreme Court: “Does Arizona law permit an insurer to challenge the validity of a life insurance policy based on lack of insurable interest after the expiration of the two-year contestability period required by A.R.S. § 20-1204?”[xii] The Arizona Supreme Court heard oral arguments on the issue on March 14, 2023, and a decision is awaited.
Why the Court’s impending decision is important
The Court’s decision will impact the way life insurers in Arizona write policies, if they write certain policies, and how they can defend from third party fraud. “Since the initial creation of life insurance during the sixteenth century, speculators have sought to use insurance to wager on the lives of strangers.”[xiii] Thus, states including Arizona, enacted laws to protect individuals (largely seniors and the ill) from these speculators. Enter illegal stranger-originated life insurance (“STOLI”) promotors, who, while they cannot legally take out life insurance policies for the benefit of their investors who lack an insurable interest, they concocted various schemes to conceal arriving at the same endgame.[xiv] This is often done by approaching the elderly with high promises in glamourous settings or with substantial economic incentive to entice them to purchase life insurance that in a couple of years (after the two year incontestability clauses and/or statutes expire) will be transferred to an investor(s).[xv]
Possible Impacts of the Decision
If the court finds life insurance carriers cannot challenge a life insurance policy’s validity based on the lack of insurable interest after the contestability period, carriers will be faced with potentially underwriting fewer life policies to suspect applicants or making it harder to get policies generally or, perhaps, attempting to find other applicable contract clauses to avoid STOLIs and other death wagerers as eventual beneficiaries. It is difficult for life insurance carriers to determine exactly who is legitimately applying for a life insurance policy and if they have and will continue to have an insurable interest versus who has been taken in by the STOLI who wants to later wager on their lives. One red flag is said to be when the beneficiary is a trust at the outset of the policy. But for the elderly, the predominant STOLI targets, it is not unusual to have their assets placed in trusts as an estate planning measure. Some of these individuals may not be insured for that reason. But there is always legislative intervention, which several states have enacted to overcome case law.[xvi]
On the other hand, if the court finds insurers can challenge the validity of a life insurance policy based on lack of insurable interest even after the two-year contestability statute has expired, it will provide much needed arrows in the life insurance companies’ quivers to protect against STOLIs and similar illegal life policies entered as a means of wagering on and investing in someone’s death. Of course, this leaves the issue of the premiums already paid on the void contract for a later decision.
The Arizona Supreme Court faces a tough decision on whether life insurance carriers can challenge the validity of a life insurance policy based on lack of insurable interest even after expiration of the two-year incontestability statute for which it will find no consensus across the country as a guide. Will the Court leave the regulation of STOLIs to the legislature? Carriers should pay close attention to see how the Court addresses this complex issue.
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[i] Second-to-die life insurance or survivorship life insurance, covers two people under one policy, and the death benefit is paid only when both have died. https://www.forbes.com/advisor/life-insurance/survivorship-life-insurance/#:~:text=Survivorship%20life%20insurance%2C%20also%20called,after%20the%20first%20spouse%20dies.
[ii] Columbus Life Ins.Co. v. Wilmington Tr. NA, CV-21-00734, unpublished Order (D. Ariz. August 10, 2022).
[v] Id.; Arizona Supreme Court Oral Argument Case Summary, Columbus Life Ins.Co. v. Wilmington Tr. NA, CV-22-0202-CQ, https://www.azcourts.gov/LinkClick.aspx?fileticket=JxDDSMy0XXo%3d&portalid=45.
[vii] “There shall be a provision that the policy, exclusive of provisions relating to disability benefits or to additional benefits in the event of death by accident or accidental means, shall be incontestable, except for nonpayment of premiums, after it has been in force during the lifetime of the insured for a period of two years from its date of issue.” A.R.S. § 20-1204.
[viii] Columbus Life Ins. (Order)
[ix] Id.; Arizona Supreme Court Oral Argument Case Summary, Columbus Life Ins.Co. v. Wilmington Tr. NA, CV-22-0202-CQ, https://www.azcourts.gov/LinkClick.aspx?fileticket=JxDDSMy0XXo%3d&portalid=45
[xi] A.R.S. § 20-1104(A); see also Columbus Life Ins. (Order).
[xii] Id.; Arizona Supreme Court Oral Argument Case Summary, Columbus Life Ins.Co. v. Wilmington Tr. NA, CV-22-0202-CQ, https://www.azcourts.gov/LinkClick.aspx?fileticket=JxDDSMy0XXo%3d&portalid=45.
[xiii] PHL Variable Ins. Co. v. Price Dawe 2006 Ins. Tr., ex rel. Christiana Bank & Tr. Co., 28 A.3d 1059, 1069 (Del. 2011) (Price Dawe).
Over the last two decades [prior to 2011], . . . an active secondary market for life insurance, sometimes referred to as the life settlement industry, has emerged. This secondary market allows policy holders who no longer need life insurance to receive necessary cash during their lifetimes. The market provides a favorable alternative to allowing a policy to lapse, or receiving only the cash surrender value. The secondary market for life insurance is perfectly legal. Indeed, today it is highly regulated. In fact, most states have enacted statutes governing secondary market transactions, and all jurisdictions permit the transfer or sale of legitimately procured life insurance policies. Virtually all jurisdictions, nevertheless, still prohibit third parties from creating life insurance policies for the benefit of those who have no relationship to the insured. These policies, commonly known as “stranger originated life insurance,” or STOLI, lack an insurable interest and are thus an illegal wager on human life.
In approximately 2004, securitization emerged in the life settlement industry. Under this investment method, policies are pooled into an entity whose shares are then securitized and sold to investors. Securitization substantially increased the demand for life settlements, but did not affect the supply side, which remained constrained by a limited number of seniors who had unwanted policies of sufficiently high value. As a result, STOLI promoters sought to solve the supply problem by generating new, high value policies.
Price Dawe, 28 A.3d at 1069-70; see also California Department of Insurance, “Senior Advisory on STOLI Life Insurance Schemes”, https://www.insurance.ca.gov/0150-seniors/0100alerts/upload/SA2011-02A.pdf.
[xvi] E.g., California law prohibits “[a]ny device, scheme, or artifice designed to give the appearance of an insurable interest where there is no legitimate insurable interest violates the insurable interest laws.” See Cal. Ins. Code § 10110.1(e) (2010) (emphasis added), which is not retroactive to any policy entered before 2010; New Jersey enacted lengthy legislation in late 2020 (“the STOLI-Act) that among other things authorizes insurers to contest the validity of STOLI policies, with an express exemption from New Jersey’s two-year contestable statute and permits civil actions by any “person damaged” by any violation of the Act. N.J.S.A. 17B-30B-1, et seq.; see also Minnesota Statutes, section 60A.0786.