A federal court in New York has just issued a ruling in one of the most important cases concerning the value of secondary market life insurance investments¹. The ruling affects all participants in the secondary market, and this alert summarizes the key lessons. The court:
1. enforced the New York two-year incontestability rule for insurable interest despite assertions by the insurance companies that a massive fraud and conspiracy was involved;
2. determined that alleged misrepresentations about eventual third party ownership could not be the cause of damage to an insurer upon the death of a person whose life was underwritten on valid medical information;
3. criticized the insurers for complaining about the transfer of a beneficial interest in insurance trusts despite not inquiring at the inception of the policy about the identity of the original trust beneficiaries; and
4. tossed out a myriad of fraud and conspiracy claims against the broker, the initial investors who acquired the beneficiary interests in the trusts, and the estate of Kramer, finding those claims barred by the incontestability statute and the lack of damages.
The court left for another day the determination of whether the proceeds of the insurance payments should go to the investors who contracted with the insured and members of his estate, or to the estate (despite the fact that its members had previously sold their interests). The court asked for guidance on this latter point from the Second Circuit Court of Appeals and the New York Court of Appeals, and various petitions have been filed seeking review by those courts.
In 2005, Arthur Kramer, the former leader of the Kramer Levin law firm, purchased $56 million in life insurance through his broker with various insurance companies, including Lincoln Financial and Phoenix, which remain as parties to the case. The policies named his children as the beneficiaries of the trusts he created to own the policies. Shortly after the policies were issued, his children elected to sell the beneficial interests in those trusts to various investors. Mr. Kramer died beyond the contestability period of the policies, and the Kramer Estate thereafter sued the insurance companies which had issued the policies and the investors who had purchased the beneficial interests in the trusts, claiming that the Kramer Estate was entitled to the death benefits because the policies were issued in violation of New York's insurable interest law.
Lessons For the Secondary Market
There are three:
1. The court's most important decision was its enforcement of the strict two-year contestability law in New York, with respect to claims based on lack of insurable interest. The court refused to consider any modification to this rule, embodied in the well-known Caruso decision, despite Lincoln's and Phoenix's assertions that the court should make an exception to it based on alleged "fraudulent conduct" involving the Kramer policies. Note that Lincoln tried to avoid the Caruso issue entirely by arguing that Connecticut law applied, based on its underwriting and administering the policies in its Connecticut office, and the insured was a Connecticut resident. But the court had no difficulty determining that New York law, and therefore the Caruso rule, applied to policies issued to New York trusts through a New York broker and it was not the place of a federal court to modify a Court of Appeals decision on New York law.
2. The court ruled that Phoenix can't claim fraud for failure to disclose information it never sought. Phoenix did not inquire as to the identity of the original trust beneficiaries in its application (who became third party investors after Kramer's children sold the beneficial interest to investors). "If Phoenix needed to know the beneficiaries of the Arthur Kramer Insurance Trust prior to determining whether to issue the policy it could have asked for that documentation or conducted an investigation. They cannot claim now that failure to disclose the beneficiaries of the Trust is fraud."
3. The court concluded that an insurer does not suffer damages when it issues a policy that is, in the insurer's view, a STOLI policy, where there were no misrepresentations as to underwriting risk. As in most of the well-known and heavily litigated STOLI cases around the country, here the alleged misrepresentations related to the identity of persons paying the premium, acquiring the death benefit, or ultimately having an interest in the policy and the trust. Regardless of the entity that ultimately will receive the death benefit, the risk the insurance company has undertaken remains one of mortality/morbidity—will the insured live or die and has the insurance company properly rated the risk? Where there is no allegation of misrepresentation going to the risk, the fact that Phoenix and Lincoln would now be forced to pay death benefits due to the untimely death of an insured could not be the fault of any party from whom recompense could be sought. The court said, "[t]he damage as alleged by Phoenix here, potentially having to pay the large death benefits, was not caused by Kramer's alleged misrepresentation, but was always part of the bargain Phoenix entered."
The court also dismissed a variety of claims against the insurance broker who acted for both Lincoln and Phoenix. While allowing both of those insurers to pursue the broker for breach of contract, the court dismissed claims based on tort and fiduciary duty, concluding that the sole relationship between the insurer and its broker is one of contract.
Following the order, two key issues remain before the court for resolution. One is the insurers' breach of contract actions against their broker. The second issue, and one of great importance to the secondary market industry, is the determination of who gets the death benefits on the policies: the investors who negotiated with and bought from various members of the Kramer family their beneficial interest in the trusts, and thus the death benefits; or the estate, if it can prove that the sale of the beneficial interests violates insurable interest law in New York, despite the fact that three members of the estate, who were the trust beneficiaries, willingly entered into arm's-length contracts to sell the beneficial interests to the third party investors.
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Copyright © 2009 Herrick, Feinstein LLP. Court Clarifies New York Law on Investor-Owned Life Insurance is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
¹In Re Arthur Kramer Insurance Trust Litigation, No. 08 Civ. 2429 (DAB).