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Judge Posner on stranger-oriented life insurance

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The U.S. Court of Appeals for the Seventh Circuit, in a decision written by Judge Richard A. Posner, has affirmed a $726,000 award in favor of an insurance company – that included its attorneys’ fees – in a case involving the insurer’s challenge to so-called “stranger-originated life insurance” (“STOLI”).

The Case

As Judge Posner explained:

Mavash Morady, an insurance agent, contracted with Ohio National to sell life insurance policies issued by it. Douglas Davis, a lawyer formerly licensed in California, approached elderly persons and persuaded them to become the nominal buyers of the policies, with Ms. Morady as the insurance agent. Mr. Davis promised to pay these persons small amounts of money for obtaining policies, and in exchange for the promises they filled out applications for life insurance.

A typical buyer was Charles M. Bonaparte, Sr. His application was accepted, the policy was issued to him, and the defendants [Ms. Morady and Mr. Davis] had him place the policy in the Charles M. Bonaparte Sr. Irrevocable Life Insurance Trust (which they created), designating the trust as the policy’s owner and beneficiary. This was an irrevocable trust, with Mr. Davis as trustee. The defendants paid (in the name of the trust) the premiums on the insurance policy; Mr. Bonaparte paid nothing.

The defendants created trusts in the names of the insured to conceal from Ohio National the fact that they rather than the insured controlled the policy and that they planned to sell it as an investment.

A few weeks or months after the creation of each trust, Mr. Davis would have the nominal buyer of the policy (such as Mr. Bonaparte) assign the beneficial interest in the trust (and, therefore, in the policy) to a company owned by another defendant, Paul Morady, Ms. Morady’s husband. Mr. Morady would make the initial premium payments to Ohio National but then resell the beneficial interest in the trust to an investor who hoped that the insured would die soon, for on the insured’s death the investor would obtain the proceeds of the policy because the investor was its beneficiary. Having acquired the beneficial interest in the policy, the investor would pay the remaining premiums as they came due.

Ohio National would not have sold the policies to the persons so recruited had it known that the premiums would be paid or financed by an unrelated third party (an investor) in the expectation that the policy would be transferred to the investor. The company’s contracts with its agents, such as Ms. Morady, required them to conform to its business-practice advisories, which contained an “absolute prohibition against participation in any type of premium financing scheme involving an unrelated third party” – an exact description of this STOLI scheme.

Ohio National filed a lawsuit and the U.S. District Court for the Northern District of Illinois awarded it damages of $726,000 – amounting to the premiums that it had received plus its litigation costs – against all the defendants but Stephen Egbert, an investor to whom the district court awarded $91,000, which was the amount that he had paid Ohio National in premiums on a particular insurance policy.

The district court found that Ms. Morady’s conduct constituted fraud and a breach of her contract with Ohio National and awarded the insurance company as damages the $120,000 that she had received as commissions as an insurance agent for the company. She had admitted knowing that the premiums on the disputed policies would be paid by her husband, who had no interest in the continued life of the insureds and who had planned to sell the policies to investors. Such premium-financing arrangements were forbidden by her contract with Ohio National. 

Damages awarded to Ohio National were not limited to Ms. Morady’s fraudulent conduct, but were based more broadly on the tort of civil conspiracy: The district court found that the defendants conspired to violate Illinois’ common law prohibition against insurance contracts procured by persons who did not have an insurable interest.

The defendants (other than Mr. Egbert) appealed to the Seventh Circuit, and Ohio National appealed the award to Mr. Egbert.

The Seventh Circuit’s Decision

The circuit court affirmed in a decision written by Judge Posner.

Judge Posner explained that the common law of Illinois has for at least a century and a half prohibited the purchase of an insurance policy by a person who had no interest in the survival of the insured, adding that arrangements such as the defendants’ STOLI scheme were “now prohibited by statute” as well, see 215 ILCS 159/50(a), 159/5, although it conceded that these provisions, enacted in 2009, were not yet in effect when the policies challenged by Ohio National in this case were issued.

Judge Posner pointed out that Ohio National had been the target of the conspiracy and that the defendants had concealed the fact that they, rather than the insureds, controlled the insurance policies from the outset by listing the irrevocable trusts as the owners, and that they would use their control to transfer income from the insurance company to themselves and their investors by accelerating the receipt of insurance proceeds by their choice of the insureds and by false representations of the insureds’ life expectancy.

Judge Posner noted that the net loss that the scheme ended up causing Ohio National (beyond the commissions paid to Ms. Morady) consisted of the more than $605,000 that the company had incurred in litigation expenses to void the policies. By voiding the policies, Judge Posner noted, the insurance company accelerated its defense against the claims that the investors were bound to make when the insureds died.

Judge Posner acknowledged that, generally, the victorious party to a lawsuit is unable to charge its litigation expenses to the loser but he wrote that that was “not what Ohio National” was doing. Rather, he said, it was “seeking reimbursement of the expenses it has incurred in this litigation in order to avoid future litigation over the death benefits in the policies that it was fraudulently induced to issue.” According to Judge Posner:

The defendants’ misconduct placed Ohio National in the position of potentially having to litigate with the purchasers of the insurance policies upon the death of the insureds, and the expenses it incurred in the present suit to avoid such litigation by voiding the policies were in lieu of the future litigation that it would otherwise have had to engage in at considerable expense. It paid in advance, as it were.

Therefore, Ohio National could receive its attorneys’ fees and the premiums paid by the defendants on the voided policies; as a result, it ended up with more money than if these contracts had never existed.

The circuit court also ruled that Mr. Egbert was entitled to have the premiums he paid for one policy returned to him by Ohio National because he was not a conspirator and there was no evidence that he knew the policy was void and “the assignment of an insurance policy to an investor” was “not itself unlawful.”

The case is Ohio National Life Assur. Corp. v. Davis, Nos. 14–3664, 14–3725 (7th Cir. Oct. 20, 2015).