California’s anti-STOLI law does not apply retroactively

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by Jim Orr

Like many states, California has passed legislation over the last several years to regulate so-called “stranger originated life insurance” or “STOLI” policies. Typically STOLI refers to a triangle transaction involving the purchase of life insurance. First, an individual, usually elderly, may be encouraged to purchase an insurance policy by a broker or agent. Soon after the policy is acquired, the policy is sold for a lump sum to an investor or group of investors who are the “strangers.” The investors pay the premium on the policy for the life of the insured. When the insured dies, the investors collect the policy benefits.

In 2009, California enacted a new law targeting stranger originated life insurance (STOLI) transactions. The law was primarily based on the NCOIL Model Life Settlement Act. For example, the 2009 Act imposes a two-year ban on life settlements, establishes a statutory definition of STOLI and classifies such transactions as fraudulent acts. However, a California Court of Appeals panel has ruled that the new law does not apply to policies written before the law took effect. See Lincoln Life & Annuity Co. of N.Y. v. Berck, No. D056373, 2011 WL 1878855 (Cal.App. May 17, 2011) review denied Aug. 31, 2011.

In the Lincoln Life case, Jack Teren decided in early 2006 to buy a life insurance policy so that he could sell the beneficial interests. A New York company that acquires and manages life insurance policies for investors helped Teren set up a trust and provide financing that he could use to pay for life insurance. On the relevant applications, Teren falsely represented his net worth was more than $40 million when it was no more than $50,000. When underwriters flagged the application for review, Teren executed documents representing he was buying the coverage for the benefit of his personal beneficiaries and that an outside party was not helping him pay for the coverage. After the policies were issued, Teren’s son, the beneficiary of the trust that held the policies, transferred his interest in the trust to the New York company in exchange for $600,000.

More than two years after the policies were issued, Lincoln Life filed suit seeking a judicial declaration stating that the policies were void ab initio, or that Lincoln was entitled to rescind the policies, because Lincoln issued them in reliance on material misrepresentations. The trial court found that any misrepresentation claim was too late and barred by the policies’ 2-year incontestability clauses. However, the trial court also found that the policies were void ab initio because they were issued without an insurable interest. The court of appeals reversed.

The court of appeals held that 2009 changes to the law did not apply. “”There is no clear and unavoidable implication here that the Legislature intended [the STOLI act] to apply retroactively, and retroactive application of the act would impose liability for actions not subject to liability when taken,” the court noted. “We conclude the act does not retroactively apply to the insurance transaction in this case because it effects a change in the law regarding insurable interest and the validity of certain life settlement contracts.” Id.

Applying the prior law, the court of appeals noted that an insurable interest must exist when an insurance policy takes effect but need not exist when the loss occurs. Furthermore, applicable California law allows a life insurance policy to be transferred by assignment to a person having no insurable interest in the life of the insured. The court of appeals explained:

The trial court ruled that the policies “lack an insurable interest because, in fact, the Teren Trust took out and procured the insurance policies on the life of Jack Teren for the benefit of [LPC] and its investors.” Although the evidence shows the trust intended that LPC ultimately would acquire the beneficial interest in Jack’s policies, that intent does not negate the fact that when the trust acquired the policies, they were supported by an insurable interest.

Id.

Because the policies in question here were supported by an insurable interest when they took effect and California law allowed the beneficial interest in the policies to be transferred to a transferee without an insurable interest, the trial court erred by ruling the policies are void ab initio because of the absence of an insurable interest.

Id.

The result in Lincoln Life would clearly have been different under the new law. The court of appeals specifically noted that “[i]n 2009, the Legislature passed an act that made insurance transactions like those in … the present case unlawful and invalid.” Id. Among other things, the act amended section 11010.1 to add the following two subdivisions:

(d) Trusts and special purpose entities that are used to apply for and initiate the issuance of policies of insurance for investors, where one or more beneficiaries of those trusts or special purpose entities do not have an insurable interest in the life of the insured, violate the insurable interest laws and the prohibition against wagering on life.

(e) Any device, scheme, or artifice designed to give the appearance of an insurable interest where there is no legitimate insurable interest violates the insurable interest laws.

Stats.2009, ch. 343, § 1. Section 8 of the act states any transaction that qualifies as a “life settlement contract” is not subject to the requirements and prohibitions of the act unless the contract was entered into after July 1, 2010.

The federal Ninth Circuit has since reached essentially the same result as the Lincoln Life court in Wells Fargo Bank, N.A. v. American Nat. Ins. Co., 493 Fed.Appx. 838 (9th Cir. August 10, 2012). The Ninth Circuit held that the earlier version of the California Insurance Code applied because the beneficial interest at issue in the case was transferred in January 2008 and the 2009 changes to the statute did not apply retroactively. In that case, Benjamin Cabal formed an insurance trust to apply for and own the policy insuring his own life and named Thelma Cabal, his wife, the trust beneficiary. The irrevocable trust therefore had an insurable interest when the policy took effect.

Moreover, under applicable California law, after a policy takes effect, no insurable interest is required and the policy may therefore be transferred to any other person. An intent to transfer “does not negate the fact that when the trust acquired the policies, they were supported by an insurable interest,” and therefore, under the prior and applicable version of the law, it made no difference that the parties always intended to transfer the insured’s interest to another.

The court noted that the insurer’s argument focusing on the fact that strangers had “caused [the policy] to be procured” was misplaced. The court held that the “caused to be procured” language under the applicable version of the law comes into play only if the person applying for the insurance does not have an insurable interest in the individual insured.

Heygood, Orr & Pearson has filed lawsuits on behalf of life settlement companies who did not receive the death benefits on policies when life insurers wrongfully claimed that they were STOLI policies or carried no insurable interest. We have also filed lawsuits on behalf of  investors in life settlements who were allegedly misled about the value of life settlements investments that they purchased from Life Partners.

Throughout the country, the legal landscape for STOLI transactions and life settlement investments is complex and evolving. Heygood, Orr & Pearson has experience with life settlement litigation from a variety of perspectives. For more information and a case evaluation that will help determine your legal rights, please contact us by calling toll-free at 1-877-446-9001, or by filling out the free case evaluation form located on this page.