A Fraudulently Obtained Life Policy Void Even After Expiration of Incontestability Period
Sometimes, much to the surprise of the litigants, bad facts make good law. In New Jersey the Supreme Court was asked whether the owner of a fraudulently obtained Stranger Originated Life Insurance (STOLI) policy could be declared void from its inception after the expiration of the two-year uncontestability period.
In Sun Life Assurance Company of Canada v. Wells Fargo Bank, N.A., as Securities Intermediary, A-49 080669, Supreme Court of New Jersey (June 4, 2019) Chief Justice Rabner, writing for the New Jersey Supreme Court concluded, in a case of first impression in New Jersey, answered in the affirmative. Chief Justice Rabner noted that betting on a human life with the hope that the person will die soon not only raises moral concerns but also invites foul play.
In April 2007, Sun Life Assurance Company of Canada received an application for a $5 million insurance policy on the life of Nancy Bergman. The application listed a trust as the sole owner and beneficiary of the policy. Ms. Bergman’s grandson signed as trustee. The other members of the trust were all investors, and all strangers to Ms. Bergman. The investors paid most if not all of the policy’s premiums.
Sun Life received an inspection report that listed Ms. Bergman’s annual income as more than $600,000 and her overall net worth at $9.235 million. In reality, her income was about $3000 a month, and her estate was later valued at between $100,000 and $250,000. Although Ms. Bergman represented that she had no other life insurance policies, five policies were taken out on her life in 2007, for a total of $37 million.
Sun Life issued the policy on July 13, 2007. At the time, the trust was the sole owner and beneficiary. The policy had an incontestability clause that barred Sun Life from challenging the policy – other than for non-payment of premiums – after it had been “in force during the lifetime of the Insured” for two years.
More than two years later, the trust sold the policy. Wells Fargo Bank, N.A. eventually obtained the policy in a bankruptcy settlement and continued to pay the premiums.
After Nancy Bergman passed away in 2014, Wells Fargo sought to collect the policy’s death benefit. Sun Life investigated the claim, uncovered the discrepancies noted above, and declined to pay. Instead, Sun Life sought a declaratory judgment that the policy was void from the beginning.
The United States Court of Appeals for the Third Circuit certified two questions of law to this Court:
- Does a life insurance policy that is procured with the intent to benefit persons without an insurable interest in the life of the insured violate the public policy of New Jersey, and if so, is that policy void ab initio?
- If such a policy is void ab initio, is a later purchaser of the policy, who was not involved in the illegal conduct, entitled to a refund of any premium payments that they made on the policy?
The policy in question is a “STOLI”. Because such policies can be predatory and may involve fraud, other states have adopted legislation that bars them.
The Chief Justice and the rest of the Supreme Court found that STOLI policies run afoul of New Jersey’s insurable interest requirement and are against public policy. It would elevate form over substance to conclude that feigned compliance with the insurable interest statute – as technically exists at the outset of a STOLI transaction – satisfies the law. Such an approach would upend the very protections the statute was designed to confer and would effectively allow strangers to wager on human lives.
Life insurance is an agreement between an insurance company and the policyholder to pay a specified amount to a designated beneficiary on the insured’s death. Life insurance has been around for more than 500 years. From its earliest days, there have been concerns about who can purchase a policy on the life of another. In 1419, for example, the Venetian Senate outlawed wagers on the Pope’s life and nullified many speculative bets about how long the reigning pope would live.
The insurable interest requirement was adopted in the United States by the nineteenth century, even in states where insurable interest statutes had not yet been enacted, in most cases the older common law was followed. It is axiomatic that a man cannot take out insurance on the life of a total stranger, nor on that of one who is not so connected with him as to make the continuance of the life a matter of some real interest to him.
Like statutes of limitations, incontestability clauses create incentives for insurers to challenge questionable policies in a timely manner, rather than continue to collect premiums and complain only when called upon to pay. Incontestability clauses, however, are not a bar to all defenses. The majority of jurisdictions, however, follow the view that an incontestable clause does not prohibit insurers from resisting payment on the ground that the policy was issued to one having no insurable interest – such a defense may be raised despite the fact that the period of contestability has expired.
A STOLI arrangement is different from a traditional life settlement because the investors purchase existing life insurance policies from insureds who no longer need the insurance to protect their families in the event of their deaths. In a STOLI arrangement, by contrast, a life settlement broker persuades a senior citizen to take out a life insurance policy – not to protect the person’s family but for a cash payment or some other current benefit arranged with a life settlement company.
Since STOLI investors have no insurable interest in the life of the insured the transactions pose questions in light of New Jersey’s policy against wagering.
In a classic STOLI situation, a stranger who hopes the insured will die soon causes the policy to be procured and collects the death benefit. Insurance contracts that are contrary to public policy, like STOLI policies cannot be enforced despite an incontestability clause.
Although the Supreme Court rejected STOLI policies it did not suggest that life settlements in general are contrary to public policy. Valid life insurance policies are assets that can be sold. An established secondary market exists for the sale of valid policies – at least two years after they are issued or earlier in certain cases – to investors who lack an insurable interest.
In New Jersey, when an insurance policy violates public policy, it is as though the policy never came into existence. No contract can be sustained if it is inconsistent with the public interest or detrimental to the common good. Courts will decline to enforce an insurance policy, like any other contract, if its enforcement would be contrary to public policy.
The vast majority of courts today that have interpreted STOLI contracts have held that such contracts are void from their inception.
Rescission of an illegal transaction can result in recovery of consideration where the parties are said not to be in pari delicto. Now, generally, one who has been induced by fraud, coercion, or undue influence to convey property in fraud of creditors can rescind and recover it or its proceeds despite the illegality. In some other types of cases, the guilt of the parties is differentiated for other reasons, such as one party’s lack of knowledge of the other party’s illegal activities.
The Supreme Court, therefore, concluded that in New Jersey a life insurance policy procured with the intent to benefit persons without an insurable interest in the life of the insured violates the public policy of New Jersey, and such a policy is void at the outset. In response to the second question, a party may be entitled to a refund of premium payments it made on the policy, depending on the circumstances.
The policy involved here was obviously one procured by fraud. The insurer could have caught the fraud before the expiration of the incontestability period but was deceived by an inspection report. A fraudulently obtained policy should never be honored. In this case the policy was obtained fraudulently by people who had no insurable interest in the life of the elderly school teacher and was a gambling contract that put her life at risk. The court correctly declared the policy void and allowed the trial court to consider the innocence of Wells Fargo to determine if it is entitled to a return of the premium it paid.
© 2019 – Barry Zalma
This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States. The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and firstname.lastname@example.org.
Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.
Over the last 51 years Barry Zalma has dedicated his life to insurance, insurance claims and the need to defeat insurance fraud. He has created the following library of books and other materials to make it possible for insurers and their claims staff to become insurance claims professionals.
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