Stranger-Originated Life Insurance and Life Settlements After ‘Kramer’

When the New York Court of Appeals issued its decision late last year in Kramer v. Phoenix Life Ins. Co.,[1] holding that New York law permitted a person to procure an insurance policy on his or her own life and immediately transfer it to one without an insurable interest in that life, even where the policy was obtained for just such a purpose, some might have expected that the Court was opening the door to a Wild West-type unregulated life settlement market in this state.[2] That has not been the result, however, and one likely reason is the state’s new law prohibiting stranger-originated life insurance (“STOLI”) and otherwise regulating the life settlement industry.[3] The law, which took effect last May 18, did not apply to Kramer, but now governs the life settlement business.

This article first briefly summarizes the Kramer ruling. It then reviews the key provisions of the state’s law and Insurance Department actions in support thereof, and concludes by suggesting that the life settlement market in New York is, indeed, likely to grow, although in a restrained manner and with the interests of policyholders better protected.[4]

Background

According to the complaint in Kramer, Steven Lockwood, the principal of Lockwood Pension Services, Inc., approached New York attorney Arthur Kramer about participating in a STOLI arrangement as early as 2003. In June 2005, Mr. Kramer established the first of two insurance trusts (“the June trust”) and named two of his adult children, Andrew and Rebecca Kramer, as beneficiaries. A Lockwood Pension employee was named as trustee, ultimately succeeded by Jonathan Berck. In June and July 2005, Transamerica Occidental Life Insurance Co. funded the trust with one or more insurance policies with a total death benefit of approximately $18.2 million. Andrew and Rebecca Kramer then assigned their beneficial interests in the trust to a stranger investor, Tall Tree Advisors, Inc. In 2007, Jonathan Berck, as trustee, sold the ownership interests in the policies to a non-party purchaser.

Mr. Kramer established a second trust in August 2005 (“the August trust”) and named a third adult child, Liza Kramer, as beneficiary. Hudson United Bank was named trustee, and also was succeeded by Mr. Berck. In July 2005, Phoenix Life Insurance Company issued three insurance policies to fund the August trust, with a total death benefit of $28 million, and Liza Kramer assigned her interest to Tall Tree.

In November 2005, Lincoln Life & Annuity Co. of New York issued a policy to the August trust with a death benefit of $10 million, and Liza Kramer assigned her interest to another stranger investor, Life Products Clearing, LLC. Lifemark S.A. allegedly purchased the Phoenix policy from the August trust in August 2007.

Allegedly both the June trust and August trust agreements were prepared by counsel for Lockwood Pension, neither Arthur Kramer nor his children ever paid premiums on the policies, and the Kramer children were never “true beneficiaries” of the trusts after the policies were issued.

Mr. Kramer died in January 2008, and his widow, Alice Kramer, as personal representative of her husband’s estate, refused to turn over copies of the death certificate to the investors holding beneficial interests in the policies. She brought suit alleging that these policies violated New York’s insurable interest rule, arguing that the proceeds should be paid to her, as the representative of the decedent’s estate.

The defendants were the insurance companies that issued the policies, trustees, and various insurance brokers and investors. Among other things, Mr. Berck, as trustee, and Life Products filed nearly identical answers seeking to have the proceeds of the Lincoln policy awarded to them. Lifemark, claiming to be a good faith purchaser for value, sought to have the Phoenix policy proceeds paid to it. Phoenix and Lincoln brought claims against Mr. Lockwood for breach of contract and also sought a declaratory judgment declaring that the policies were void and that they were not required to pay policy proceeds to anyone.

The U.S. District Court for the Southern District of New York granted motions to dismiss many of the parties’ claims, but denied Mr. Lockwood’s motion to dismiss the insurers’ claims against him. The district court found that Mr. Lockwood had breached provisions of New York Insurance Law in that he caused to be procured directly or through assignment or other means a contract of insurance upon the life of Mr. Kramer for the benefit of strangers who did not have an insurable interest in his life at the time the policy was obtained. The district court also determined that the insurers could not attempt to void the policies, as they had been issued over two years earlier and therefore were incontestable.[5]

The district court certified its order to allow for an interlocutory appeal to the U.S. Court of Appeals for the Second Circuit, noting that there was “substantial ground for difference of opinion” on the application of the New York Insurance Law to STOLI arrangements of this type. The Second Circuit granted Lifemark’s petition for leave to appeal the interlocutory order, and certified the following question to the New York Court of Appeals:

Does New York Insurance Law §§ 3205(b)(1) and (b)(2) prohibit an insured from procuring a policy on his own life and immediately transferring the policy to a person without an insurable interest in the insured’s life, if the insured did not ever intend to provide insurance protection for a person with an insurable interest in the insured’s life?

The Court’s Decision

The Court, in an opinion by Judge Carmen Beauchamp Ciparick, began by discussing New York’s insurable interest requirement. It explained that, at common law, the insurable interest requirement was designed to distinguish an insurance contract from a wager on someone’s life. The Insurance Law now defines an insurable interest as, “in the case of persons closely related by blood or by law, a substantial interest engendered by love and affection” or, for others, a “lawful and substantial economic interest in the continued life, health or bodily safety of the person insured.”[6]

The Court added that Insurance Law § 3205(b)(1) addresses individuals obtaining life insurance on their own lives, stating that “[a]ny person of lawful age may on his own initiative procure or effect a contract of insurance upon his own person for the benefit of any person, firm, association or corporation. Nothing herein shall be deemed to prohibit the immediate transfer or assignment of a contract so procured or effectuated.” Insurance Law § 3205(b)(2) addresses a person’s ability to obtain insurance on another’s life and requires, in that circumstance, that the policy beneficiary be either the insured or someone with an insurable interest in that person’s life.

Relying on these statutory provisions, the Court answered the certified question in the negative. It found that Section 3205(b)(1) codified the common law rule that an insured had total discretion in naming a policy beneficiary. Moreover, the Court ruled, it was “equally plain” that such a policy could be “immediate[ly] transfer[ed] or assign[ed],” and that Section 3205(b)(1) did not require the assignee to have an insurable interest.

Simply put, the Court found “no support” in the statute for the argument that a policy obtained by an insured with the intent of immediate assignment to a stranger was invalid.

Then, the Court found that the mandate that a policy must be obtained on an insured’s “own initiative” required that the insured’s decision be free from “nefarious influence or coercion.” The initiative requirement did not prohibit an insured from obtaining a policy pursuant to a non-coercive arrangement with an investor, the Court decided.

The Court concluded by noting that the insurable interest requirement of Section 3205(b)(2) did not alter its interpretation of Section 3205(b)(1) because it did not apply when an insured freely obtained insurance on his or her own life.

The New Law

Judge Robert S. Smith dissented in Kramer, in an opinion in which Judge Eugene F. Pigott, Jr., joined. Judge Smith stated that his view of New York law was that where an insured purchased a policy “on his own life for no other purpose than to facilitate a wager by someone with no insurable interest, the transaction is unlawful.”

Nevertheless, Judge Smith pointed out, the majority’s decision “may be of limited importance” because of the recently enacted statutory prohibition on STOLI transactions. The law, S66009-2009, created a new framework to regulate the life settlement business. Among other things, “life settlement brokers” are now required to obtain a license from the Insurance Department – and the Department may revoke, suspend, or refuse to renew those licenses. Life settlement brokers may receive compensation only pursuant to a written contract, and are prohibited from charging excess fees. The continuing education requirements of Insurance Law §2132 now also apply to licensed life settlement brokers. In fact, a new Insurance Law § 2137 specifies the licensing requirements (both initial and renewal) applicable to life settlement brokers.

The law amends Insurance Law § 2401 to include life settlements within the category of insurance subject to the prohibitions of unfair methods of competition or unfair or deceptive acts or practices. In addition, a new Article 78 of the Insurance Law:

• requires life settlement providers to obtain approval by the Superintendent of Insurance of life settlement contract forms prior to use;
• requires each licensee to file an annual statement with the Superintendent, and authorizes the Superintendent to examine or investigate the affairs of any licensee, registrant, or applicant;
• prohibits licensees and registrants from disclosing the identity of the insured or owner in connection with a proposed or actual life settlement unless the disclosure is necessary for specifically identified purposes;
• prohibits any person who obtains or may obtain a settled policy from disclosing the identity of the insured under or owner of the policy;
• requires specific disclosure to be provided by the life settlement provider and the life settlement broker including the amount of compensation to be paid to the broker; and
• permits a life settlement provider to transfer ownership of a settled policy only to another licensed life settlement provider, accredited investor, qualified institutional buyer, financing entity, special purpose entity, or related provider trust, but provides an exception to that requirement by allowing a transfer of ownership of a settled policy to persons other than the listed persons if no personally identifying information of the policy owner or insured is provided to such persons.

There also is a provision in the new law, referenced in Judge Smith’s dissent in Kramer, that prohibits STOLI transactions. In particular, it prohibits life settlement providers and life settlement brokers or their representatives from engaging in any act, practice, or arrangement at or prior to issuance of a policy to facilitate issuance of the policy for the intended benefit of a person who has no insurable interest in the life of the insured.

The legislative history makes it clear that, in the case of a sale of a life insurance policy, if it can be shown that there was a prior plan or arrangement for the individual to purchase the policy for the purpose of selling it to the third party, “it may be determined that there was no insurable interest at the inception of the policy.”[7]

In addition, Insurance Law § 7813(j)(1) now prohibits anyone from entering a valid life settlement contract for two years following the issuance of a policy, with some exceptions. The law also sets forth penalties and civil remedies for violation of that provision. Insurance Law § 403 was amended to make the commission of a fraudulent life settlement act a violation of the Insurance Law; to define a fraudulent life settlement act by reference to Penal Law § 176.40; and to add “fraudulent life settlement act” as one of the actions for which the Superintendent now is empowered to impose a civil penalty.

Developments Since Kramer

There have been few developments in New York state or federal courts in STOLI cases since Kramer.[8] The Insurance Department, however, has been active. For example, it adopted a rule establishing license and registration fees and financial accountability requirements for life settlement providers.[9] In December, the Department announced that it had granted licenses to two life settlement providers.[10] In January, it notified all life settlement providers that they are required to file a fraud prevention plan.[11]

Life settlements are on the radar of New York insurance regulators, and the Legislature. The market is going to grow, but as a result of the recently enacted law, it should grow in a fairly and appropriately regulated manner.

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[1] 15 N.Y.3d 539 (2010).

[2] The life settlement market involves the sale of life insurance policies by owners to third parties. The insured owners may no longer want or need their policies and are able to obtain a monetary benefit greater than the cash surrender value but less than the death benefit of the policy by selling their policy to a life settlement provider.

[3] The shortage of capital affected the growth of the life settlement market since its peak in 2008, but the market now appears to be showing some new life. See Leslie Scism, “Fallout From Life Policies: Insured Suits,” Wall Street J., at C1 (Feb. 2, 2011).

[4] Insurers, investors and policyholders are all involved in growing numbers of lawsuits, as the rules take time to get established. See Leslie Scism, “Insurers Sued Over Death Bets — Scrutiny on Secondary-Market Policies That Paid Investors When Others Died,” Wall Street J., at C1 (Jan. 3, 2011).

[5] See Insurance Law § 3203(a)(3).

[6] Insurance Law § 3205(a)(1)(A), (B).

[7] See http://open.nysenate.gov/legislation/bill/S66009-2009.

[8] See, e.g., Bernstein v. Principal Life Ins. Co., 2010 U.S. Dist. LEXIS 127733 (S.D.N.Y. Dec. 12, 2010).

[9] See http://www.ins.state.ny.us/r_emergy/html/re198s.htm; see, also, http://www.ins.state.ny.us/r_emergy/pdf/re198t.pdf.

[10] See http://www.ins.state.ny.us/press/2010/p1012101.htm.

[11] See http://www.ins.state.ny.us/frauds/fdlifeltr.pdf.