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Stranger-Owned Life Insurance: Is the Contestability Period a Shield or a Sword?

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Should insurance applicants and third party investors be allowed to make material representations when applying for life insurance, if they can manage to conceal misdeeds for at least two years? The United States District Court for the Southern District of New York thinks so.

In the latest STOLI case coming out of the federal courts, judge and jury considered whether outright fraud on a life insurance policy application is sufficient to invalidate a policy after the contestability period has passed. The jury and court held for the investor in the $5 million case. [Settlement Funding, LLC v. AXA Equitable Life Ins. Co., No. 09 CV 8685 (HB) (S.D.N.Y.) Mar. 21, 2011]

The Facts

AXA Equitable Life Insurance Company issued a life insurance policy with a face value of $5 million on the life of Esther Adler. Although not at issue in the case, two other $5 million policies purchased from two other life insurance companies were also taken out on Mrs. Adler’s life.

The policy application claimed that Mrs. Adler had a net worth of $12 million. Originally, the policy was payable to the Esther Adler Family Trust (the “Trust”).

Sometime after the policy was issued it was sold to Settlement Funding for about $1 million.

After Mrs. Adler died, AXA refused to pay the $5 million death benefit to Settlement Funding. Settlement Funding then sued AXA in the United States District Court for the Southern District of New York.

The Evidence

AXA submitted evidence that Mrs. Adler did not in fact have a net worth of $12 million, but had less than $100,000 in assets and lived in an apartment at the time of the application. Evidence also showed that someone, unidentified in the case, posed as

Mrs. Adler’s accountant and verified the facts included on the policy application. In addition to this solid evidence of fraud, AXA also presented evidence that Mrs. Adler’s signature was forged on the trust agreement.

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The Law

Most states have a “contestability period,” running from the date a policy is issued, after which a life insurance carrier will be barred from asserting that the policy is void because the insured made a misrepresentation on the policy application. In most jurisdictions, the contestability period is two years.

At issue in this case was whether outright, intentional fraud on the part of the policy applicant was enough to override the contestability period and allow the carrier to void the policy after the two-year period had passed.

The Verdict

In October 2010, the jury returned a verdict in favor of Settlement Funding. The jury found that AXA was barred from contesting the validity of the policy based on the fact that Mrs. Adler died after the two-year contestability period had run on the policy. Because AXA was barred from contesting the validity of the policy, the judge entered judgment in favor of Settlement Funding for $5 million. 

Although the jury found that Rubenstein made misrepresentations on the policy application, they also found that AXA would not have issued the policy if it had known the true facts; the jury nevertheless found that AXA didn’t “reasonably rely” on the misrepresentations. As a result, AXA’s claim of misrepresentation against Rubenstein failed.

The jury did find for AXA and against Trustee Alan Rubenstein for conspiracy to commit fraud, although it only found that nominal damages of $1.00 were appropriate.

Both AXA and Rubenstein asked the court to overturn its judgment. The court denied both side’s motions, upholding the jury’s verdict.

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.