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The war between life insurance carriers and STOLI promoters is in full force, and the tide may be turning in the carriers’ favor. In the latest battle, the Delaware Supreme Court reached a ruling on Sept. 20 in the case of Lincoln National Life Insurance Co. v. Schlanger that could dramatically affect stranger-originated life insurance (STOLI) schemes across the country.
In the Lincoln case, the policy at issue was a $6 million face-value policy issued by Lincoln on Joseph Schlanger’s life and owned by the Joseph Schlanger 2006 Insurance Trust.
Schlanger died just over two years after the policy was issued. The life insurance trust sought to collect the death benefit from Lincoln shortly thereafter. Lincoln sued in Delaware state court asking the court to find that the policy was void for lack of an insurable interest.
Lincoln claimed that the policy was never intended for legitimate insurance needs and that it was intended by the insured to be transferred to GIII, a private investing firm, using a multi-layer trust scheme to hide the true nature of the transaction from the carrier.
The Court’s Decision
The Delaware Supreme Court answered the following question in its ruling: “Can a life insurer contest the validity of a life insurance policy based on a lack of insurable interest after expiration of the two year contestability period set out in the policy?”
The policy at issue has an incontestability clause that, as required by Delaware law, limited the insurance company’s right to contest the validity of the policy to the two years immediately after the policy was issued.
The carriers argued that a policy issued without an insurable interest is void when it is issued because it amounts to a “wager on human life.” Because the contestability period is specified in the policy’s incontestability clause, it is a part of the policy. If the policy is void from issuance, no policy exists and thus the incontestability clause is never operative.
The defendant investors argued that the plain meaning of the state insurance statute and the clause in the contract was that the carrier was prohibited from contesting of the policy’s validity after the period expires.
The court agreed with the carriers’ argument, noting that the Delaware legislature had chosen to implement the contestability period as a mandatory contractual provision instead of a direct statutory prohibition on carrier challenges after the period is over. The court held that carriers are not limited by the contestability period when they challenge a policy for lack of an insurable interest.
The result in the Schlanger case isn’t necessarily groundbreaking—courts have consistently ruled both ways on the question. What’s interesting about the case is the court’s reasoning, which is compelling and could be influential in future STOLI cases.
Despite Delaware’s small geographic size, the state is often on the forefront of business and financial legal issues, so it would be unsurprising Schlanger marked a shift toward more courts ignoring the contestability period when considering whether a policy was issued with an insurable interest.
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See also The Law Professor's blog at AdvisorFYI.