The New York Department of Insurance's Office of General Counsel held on Feb. 25 that insurance carriers cannot refuse to convert a term policy to a permanent policy on the ground that the policy will be sold on the secondary market. The primary issue in the case was whether the converted policy is a “new” policy that must satisfy anew the insurable interest requirement.

The Department held that a converted policy is not equivalent to a “new policy” and that John Hancock could not deny the consumer’s request to convert her policy for the following reasons:

  1. A conversion is merely a new policy form; it provides the consumer with the same level of coverage originally sold to the insured individual, provided she does not receive an increase in any death benefits;
  2. The conversion of the policy is not prohibited by law; and
  3. The Legislature’s intent was not for insurance laws to restrict legal conversions.

John Hancock argued that the consumer was taking part in a stranger-originated life insurance (“STOLI”) transaction, whereby an individual applies for a life insurance policy on behalf of a third party which holds no insurable interest in the applicant’s life. Because the Department disagreed and held that the conversion was

not considered a “new policy,” John Hancock could not enforce renewed insurable interest requirements at the time of conversion.

This ruling will not affect all term policies, since many term life insurance policies are not convertible. A policy that includes a conversion provision generally allows the consumer to convert his or her term life insurance policy to a permanent life insurance policy—such as a whole life or universal life insurance policy—without running through the application process a second time. But the New York ruling is a foot in the door for life settlement companies and may signal a greater willingness on the part of state insurance regulators to recognize a consumer’s right to sell a life insurance policy on the secondary market.

Proponents of the secondary markets believe that they ensure that policyholders receive maximum value when selling life insurance policies that are no longer of any use to them. Darwin Bayston, executive director of the Life Insurance Settlement Association (“LISA”), stated in response to the ruling that, “rather than receive no value when a term policy lapses, a policyowner may qualify for a cash payment through a life settlement.” He added that “[t]he significance of this ruling for consumers and the secondary market for life insurance is vital to the fundamental property and contract rights of all policyowners.”

While the ruling will assist consumers who want to sell their policies, it may also inadvertently harm consumers by offering STOLI promoters a new avenue to circumvent carrier procedures and policy application questions designed to ferret out applications for policies that will be used in STOLI schemes. Rather than starting the STOLI scheme with a form of permanent life insurance—and take the risk that the scheme will be detected—STOLI promoters could use the insured to purchase term policies and then have the insured convert the policies to a form of insurance that’s amenable to STOLI.

 

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