The judges on a California Court of Appeal panel have ruled 2-1 that a 2009 state law that is supposed to stop stranger-originated life insurance (STOLI) transactions does not apply to policies written before the law took effect.
The judges, in California’s 4th Appellate District, were ruling on an appeal filed in connection with The Lincoln Life and Annuity Company of New York vs. Jonathan S. Berck, as Trustee, etc. (Court of Appeal Case Number D056373).
The Teren Life Insurance Policies
Jack Teren, a California resident, decided in early 2006 to buy a life insurance policy so that he could sell the beneficial interests, Justice Alex McDonald writes in an opinion for the 4th District majority.
A New York company that acquires and manages life insurance policies for investors helped Teren set up a trust and provide financing that he could use to pay for life insurance, McDonald says.
Teren then applied for two life insurance policies with $20 million in combined death benefits, and he falsely represented on the application that he had a net worth of $46.4 million and $3 million in annual income, McDonald says.
Teren’s actual net worth was less than $50,000, and his monthly income was about $1,333, McDonald says.
Underwriters at Lincoln Life, a unit of Lincoln Nation Corp., Radnor, Pa. (NYSE:LNC), received the application and flagged it for a STOLI review. Lincoln Life then had Teren and the trust’s initial trustee sign a form in May 2006 stating that Teren was buying the coverage for the benefit of his personal beneficiaries and that an outside party was not helping him pay for the coverage, McDonald says.
Teren’s son, the beneficiary of the trust that held the policies, transferred his interest in the trust to the New York company in exchange for $600,000, McDonald says.
The Trial Court Case
In May 2008, Lincoln filed a declaratory relief action against Teren and the trust in a state court in San Diego. Lincoln stated four causes of action, including a declaration that the policies were void ab initio, or that Lincoln was entitled to rescind the policies, because the policies were issued without “any legally cognizable insurable interest,” McDonald says.
Lincoln also sought a judicial declaration stating that the policies were void ab initio, or that Lincoln was entitled to rescind the policies, because Lincoln issued them in reliance on material misrepresentations, McDonald says.
A trial court judge granted judgment in favor of the trust and Teren on the cause of action involving misrepresentation, but the court found that the policies lacked insurable interest under California law and were avoid ab initio, McDonald says.
The court did not address the misrepresentation claim, because the court found that the policies were void, but it also found that the misrepresentation claim would be barred by the policies’ 2-year incontestability clauses, McDonald says.
The Appellate Court Analysis
The 4th District majority says that, in California, an insurable interest must exist when an insurance policy takes effect but need not exist when the loss occurs.
California law also states that a life insurance policy may be transferred by assignment to a person having no insurable interest in the life of the insured, the majority says.
“Because the policies in question here were supported by an insurable interest when they took effect and California law allowed the beneficial interest in the policies to be transferred to a transferee without an insurable interest, the trial court erred by ruling the policies are void ab initio because of the absence of an insurable interest,” the majority says.
In 2009, the California Legislature passed a bill changing the laws governing life settlement contracts and insurable interest, and the governor signed the bill into law.
The 2009 law would not apply to the Teren policies, because a California statute may be applied retroactively only if there is clear evidence that the Legislature meant for the statute to be retroactive, the majority says.
“There is no clear and unavoidable implication here that the Legislature intended [STOLI act] to apply retroactively, and retroactive application of the act would impose liability for actions not subject to liability when taken,” the majority says. “We conclude the act does not retroactively apply to the insurance transaction in this case because it effects a change in the law regarding insurable interest and the validity of certain life settlement contracts.”
Lincoln declined to comment on the case.
Steven Sklaver and Ryan Kirkpatrick, lawyers in the Los Angeles office of Susman Godfrey L.L.P. who represent the trust that now holds the Teren life insurance policies, say in a statement that Lincoln had tried to pierce the corporate formalities of a transaction that complied with the letter of the insurable interest law.
“The court of appeal’s detailed and well-reasoned decision is a clear rejection of the carrier’s attempt to void the policies,” Sklaver says.