Update on Key Issues From 2010

The beginning of the new year seems an appropriate time to update some of the insurance fraud issues discussed in this column over the past year.

As noted here last January, the Court of Appeals decision in State Farm Mutual Auto. Ins. Co. v. Mallela established that a violation of a licensing requirement by a medical provider renders the provider ineligible to be reimbursed by an insurance company for no-fault claims that have been assigned to the provider by an individual allegedly involved in an automobile accident. The January and March Insurance Fraud columns discussed numerous issues left open by Mallela that continue to be litigated by both medical providers and insurance companies.

State and federal courts are still facing Mallela issues. Consider, for example, the November 30 decision by the Appellate Division, First Department, in Allstate Ins. Co. v. Belt Parkway Imaging, P.C. The issue was whether Insurance Law § 5109, which was enacted after Mallella and which authorizes the Superintendent of Insurance to promulgate standards for investigating and suspending or removing the authorization for providers of health services to request the payment of no-fault benefits, actually overruled Mallella because it provided the superintendent with the exclusive right to take action against fraudulently incorporated health care providers.

The First Department found that § 5109 did not overrule Mallela. It observed that the Superintendent had not yet issued regulations pursuant to § 5109 and said that if the defendants were correct that only the superintendent could take action against fraudulently incorporated health care providers, then no one could take such action. In light of the fact that the licensing requirement was contained in regulations that were intended “to combat fraud,” the First Department concluded that “this would be an absurd result.”

Another recent Mallela-related decision was issued on December 20 by the Appellate Term, Second Department. In Belt Parkway Imaging, P.C. v. State Wide Ins. Co., the plaintiffs sought to recover assigned first-party no-fault benefits for medical services rendered. After a nonjury trial, the civil court found, among other things, that the insurance carrier had failed to establish, by clear and convincing evidence, its defense that the plaintiffs were ineligible for reimbursement of no-fault benefits on the ground that they were operated in violation of state licensing requirements. The carrier appealed, contending that the civil court had erred in finding that it had to establish its defense – that the plaintiffs were operated in violation of state licensing requirements thereby making them ineligible for reimbursement of no-fault benefits – by clear and convincing evidence rather than merely by a preponderance of the evidence.

The appellate court concluded that it did not have to decide that issue because the evidence at trial “was insufficient to establish, even by a preponderance of the evidence, that plaintiffs were operated in violation of state licensing requirements.” The required level of proof is certainly going to arise in future Mallela-related litigation.

Yet another recently-decided Mallela¬-related issue was whether insurance companies could assert claims under the federal Racketeer Influenced and Corrupt Organizations Act (RICO), including a RICO conspiracy claim, against allegedly fraudulently incorporated health care providers. In Allstate Ins. Co. v. Etienne, in which the author’s firm represented the insurance carrier, the defendants moved to dismiss the RICO claims that had been filed against them, arguing that the plaintiff insurance carrier had failed to sufficiently plead an association in fact enterprise, insufficiently alleged the existence of an enterprise separate and apart from the alleged racketeering activity, and insufficiently pleaded a RICO conspiracy.
The U.S. District Court for the Eastern District of New York rejected the defendants’ motion to dismiss. Among other things, the court applied the U.S. Supreme Court’s recent RICO decision, Boyle v. United States, and found that the complaint sufficiently pled a RICO enterprise.

STOLI

There have been a number of recent developments in connection with so-called stranger-originated life insurance (STOLI) plicies, discussed here in November.

As noted in November’s Insurance Fraud column, Settlement Funding, LLC v. AXA Equitable Life Ins. Co. arose several years ago when AXA Equitable Life Insurance Company issued a $5 million life insurance policy to the “Esther Adler Trust,” which policy insured the life of Mrs. Adler. Eli A. Rubenstein, the trustee of the trust, had applied for the policy; the trust beneficiaries included Mrs. Adler’s two daughters, Judith Abrams and Zeva Citronenbaum, as well as Chaim Citronenbaum, Mrs. Adler’s son-in-law. AXA later contended, however, that the policy had been obtained through fraud.
The U.S. District Court for the Southern District of New York rejected Settlement Funding’s motion for summary judgment and a jury trial was held from October 18-25. The jury found that AXA was barred from contesting the validity of the policy because Mrs. Adler died beyond the contestability period; that AXA was liable for $5 million in damages for negligent misrepresentations on which the company that had acquired title to the policy, Life Settlement Corporation, had relied. The jury also found that the trustee had made false statements in the application for the policy. The jury, however, determined that AXA had not reasonably relied on those representations and decided that it was entitled to only $1 in damages.
Thereafter, AXA requested judgment as a matter of law on its declaratory judgment claim that the trust had never existed and thus lacked legal capacity to obtain the policy. The court denied the motion but AXA moved for judgment under Fed.R.Civ.P. 52(a)(1) and 50(b). It filed its memorandum of law in support of its motion on November 18, and Life Settlement filed its memorandum in opposition on December 6.
The court’s decision on that motion very well may be impacted by one of the most significant recent STOLI events: the decision by the N.Y. Court of Appeals in Kramer v. Phoenix Life Ins. Co.
As noted in this column in November 5, the Kramer case involved the following question certified to the N.Y. Court of Appeals by the U.S. Court of Appeals for the Second Circuit: “Does New York Insurance Law §§3205(b)(1) or (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 litigation involved several insurance policies obtained by Arthur Kramer, a New York attorney, on his own life, allegedly with the intent of immediately assigning the beneficial interests to investors who lacked an insurable interest in his life. His widow, Alice Kramer, as personal representative of her husband’s estate, asked the U.S. District Court for the Southern District of New York to order the death benefits from these insurance policies paid to her. She alleged that these policies, which collectively provided about $56 million in coverage, violated New York’s insurable interest rule because her husband had obtained them without the intent of providing insurance for himself or anyone with an insurable interest in his life. Under New York Insurance Law, an insurable interest is, “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.”
The defendants included the insurance companies that had issued the policies, various insurance brokers, and an investor that sought to have the proceeds of one of the policies paid to it. An intervenor claimed that it had purchased another policy, and it asked the court to order the insurance company to pay it the proceeds.
In late November, a divided Court of Appeals answered the certified question in the negative and held that New York law, as it existed at the time of the circumstances underlying this dispute, 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.
According to the Court, Insurance Law § 3205(b)(1) codified the common law rule that an insured has total discretion in naming a policy beneficiary. Moreover, under that same section of the Insurance Law, an insurance policy “so procured or effectuated” may be “immediate[ly] transfer[ed] or assign[ed]” – and, the Court added, § 3205(b)(1) “does not require the assignee to have an insurable interest and, given the insured’s power to name any beneficiary, such restriction on assignment would serve no purpose.” This freedom of assignment, the Court decided, was not limited by § 3205(b)(2), which addresses procurement of an insurance policy on another’s life, “either directly or by assignment.” That was because § 3205(b)(2) requires an insurable interest only “at the time when such contract is made” and therefore incorporates the common law rule that a policy valid at the time of procurement may be assigned to one without an insurable interest in the insured’s life and, relatedly, that no insurable interest is required when one holds a policy on another’s life, so long as the policy was “valid in its inception.”
In esssence, the Court ruled that there was “simply no support in the statute” for the argument “that a policy obtained by the insured with the intent of immediate assignment to a stranger is invalid.”
The impact of the Court’s decision may be tempered by the provisions added by the Legislature to the Insurance Law in late 2009, regulating permissible “life settlement contracts,” i.e. agreements by which compensation is paid for “the assignment, transfer, sale, release, devise or bequest of any portion of: (A) the death benefit; (B) the ownership of the policy; or (C) any beneficial interest in the policy, or in a trust . . . that owns the policy.” The law prohibits anyone from entering a valid life settlement contract for two years following the issuance of a policy, with some exceptions.
In addition, the new law prohibits STOLI transactions, defined as “any act, practice or arrangement, at or prior to policy issuance, to initiate or facilitate the issuance of a policy for the intended benefit of a person who, at the time of policy origination, has no insurable interest in the life of the insured under the laws of this state.”
Although the impact of Kramer on STOLI transactions remains to be seen, given the new statute, the decision already has had practical implications. For example, in early December, a federal magistrate judge in the Southern District of New York, decided Bernstein v. Principal Life Ins. Co., an action to collect on a life insurance policy on the life of the late Fletcher Johnson in the amount of $5 million that was issued in 2007 when Dr. Johnson was 76 years old. Shortly after the policy was issued, the policy was transferred to a trust. Dr. Johnson died approximately 16 months after the policy was issued.
The insurance company that had issued the policy refused to pay the proceeds, claiming that the purchase of the policy and its transfer to the trust were the product of a STOLI scheme. The insurance company moved to compel the non-party insurance agent who had procured the policy to produce documents concerning 12 other putative STOLI policies in which he allegedly had participated. The insurance carrier claimed that documents concerning these other policies were relevant to show the insurance agent’s alleged intent to defraud.

In its decision, the court explained that, in light of Kramer, even if it construed the insurance company’s counterclaims to allege a scheme or conspiracy among Dr. Johnson, the insurance agent, and others to conceal the purpose for which the policy was procured, i.e., a STOLI transaction, and that the insurance agent’s intent was attributable to Dr. Johnson, “such a scheme would not affect the validity of the policy.” Accordingly, the court ruled that the documents concerning other policies were immaterial, and it denied the insurance company’s application to compel their production.

Conclusion

The growing recognition among policy makers, prosecutors, and the public that insurance fraud needs to be controlled, whether in connection with no-fault insurance, life insurance, health insurance, or otherwise, is certain to lead to significant insurance fraud developments during this year, and in the future. Civil and criminal law questions are likely to be addressed by the courts, while new statutory and regulatory provisions are likely to be debated by Congress, the state legislature, and the state Department of Insurance. Their resolution will have great practical significance for many.

This article is reprinted with permission from the January 7, 2011 issue of the New York Law Journal. Copyright ALM Properties, Inc. Further duplication without permission is prohibited. All rights reserved.