More On Legal & Compliancefrom The Advisor's Professional Library
- Using Solicitors to Attract Clients Rule 206(4)-3 under the Investment Advisors Act establishes requirements governing cash payments to solicitors. The rule permits payment of cash referral fees to individuals and companies recommending clients to an RIA, but requires four conditions are first satisfied.
- Suitability and Fiduciary Duty Recommending suitable investments is more than just a regulatory obligation. Many investors bring cases claiming lack of suitability, so RIAs must continuously put the onus on clients to notify the advisor of changes in their financial situation.
The ruling was issued by the 4th Appellate District in an appeal on the case: The Lincoln Life and Annuity Company of New York vs. Jonathan S. Berck, as Trustee, etc, Case No. D056373(May 17, 2011).
The policy at issue in the case was purchased in 2006 by Californian Jack Teren. On the prompting of his son, Jack sought to purchase life insurance for the purpose of selling it to investors.
Jack was approved for a $20 million policy. On the same day he signed the policy application, he also signed documents forming a life insurance trust to hold the policy. Jack was identified in the trust documents as the trust’s settlor, and his son Elliot was named sole beneficiary of the trust. The trust was identified on the policy application as owner of the policy. Jack funded the trust with $1,000. The initial trustee of the trust was Robert Desch, a vice president of TD Banknorth NA.
There were a number of irregularities in the life insurance application. Jack claimed that his net worth was $46.4 million and that his annual income was $3 million. His actual net worth at the time of application was about $50,000 and his monthly pension and social security income was no more than $1,333.23.
Jack’s misrepresentations on the application were supported by a document that was allegedly prepared by a California accounting firm.
When Lincoln’s underwriters questioned whether the policy was being issued as a STOLI policy, both Jack and the trustee signed a document stating that the policy was being purchased for the benefit of Jack’s personal beneficiaries and that Jack was not being paid to apply for the policy.
Prior to Jack signing the policy, a shareholder of Life Products Clearing, LLC (LPC) sought investor contributions to purchase a beneficial interest in a number of policies, including the policy that was to be issued on Jack Teren’s life. Thereafter, Lincoln Life issued two policies on Jack’s life with a total death benefit of $20 million and an annual premium of $909,000.
As required by California law, both policies included an incontestability clause that restricted the carrier from challenging the validity of the policy after it had been in force for more than two years.
After the policy was issued, Elliot Teren transferred his beneficial interest in policy to LPC in exchange for a $600,000 cash payment. Most of that sum was eventually transferred to Jack.
LPC paid premiums on the policy for two years. By the time of trial, the life insurance trust had paid more than $2
million in premiums to Lincoln (using funds provided by LPC).
In May 2008, Lincoln sought judicial declarations that the policy was void for lack of an insurable interest and because of material misrepresentations made on the policy application.
The trial court held that Lincoln’s misrepresentation claim failed under the policy’s incontestability clause because it was brought more than two years after the policy had been issued. But the court ruled in favor of Lincoln on the insurable interest issue, finding that the policies were void because they were issued without an insurable interest. The court ordered Lincoln to refund $430,480 in premiums to LPC.
LPC appealed the trial court’s decision.
Appeals Court Ruling
The Court of Appeals held that, because Jack Teren had an “unlimited insurable interest in his own life,” the policy did not run afoul of the insurable interest requirement. And the trust, which Jack formed and which owned the policies, also had an insurable interest in Jack’s life. Even the beneficiary of the trust, Jack’s son Elliot, had an insurable interest in Jack’s life "engendered by love and affection."
As a result, the Court of Appeals held that issuance of the policy was supported by an insurable interest in Jack’s life and the policy cannot be voided by Lincoln.
The trial court also considered whether a 2009 California law prohibiting exactly the type of arrangement at issue in this case voided the policy. Under the law, a trust does not have an insurable interest in an insured’s life if:
- The trust is used to initiate and apply for a policy of life insurance for the benefit of investors, and
- The trust has a beneficiary that does not have an insurable interest in an insured’s life.
The statute also says that “[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.” [CA Stats. 2009, ch. 343, § 1(d)-(e).]
Lincoln argued that Jack and LPC used the life insurance trust as an artifice to give the appearance that the policy was being issued to a person with an insurable interest in Jack’s life. If the arrangement was held to be a scheme to circumvent insurable interest, the 2009 law would void the policies issued on Jack’s life.
However, the act that introduced the law also included a provision that “this act shall not apply to any life settlement contract entered into on or before July 1, 2010.” As a result, the court was obligated to rule that the 2009 law did not void the life insurance policy, despite its clear application to situations like those in the case.
The investors’ win in this case, while significant, is not indicative of future California rulings on similar arrangements put in force after July 1, 2010.
For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s partner, AdvisorFX, for a free trial.
See also The Law Professor's blog at AdvisorFYI.