New York Trusts & Estates Law Blog » Life Insurance

Life insurance basics

Saul Elnadav — Sun, 03 May 2009 05:13:00 +0000

The New York Times published a basic article on life and disability insurance last week. See Life and Disability Insurance: What You Need to Know, Paul Sullivan, New York Times, April 28, 2009.

From the article:

Life insurance comes in a variety of forms meant to accomplish a range of objectives, from providing for survivors to moving assets out of your estate. The prices for it depend not only upon how much coverage you want but also upon what type of policy you get, either for a finite period of time or indefinitely.

Sullivan explains the basic differences between term life and whole life insurance, encourages consumers to check on the financial soundness of insurance companies, and provides links to other resources on purchasing insurance and selecting a broker.

Read the full article here.

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Risks of stranger-originated life insurance policies (SOLI or STOLI)

Saul Elnadav — Thu, 19 Mar 2009 15:03:00 +0000

Besides the potential for committing fraud by misrepresenting the state of one’s health or finances, a life insurance customer can be hurt by a stranger-originated life insurance policy (SOLI or STOLI), a subject I blogged about earlier this week.

The STOLI agent or broker’s sales pitch does not inform the customer of the risks. I heard a spiel last summer from someone in the STOLI business. I’m not sure this particular person saw any downside to a STOLI arrangement.

As he put it, the investor pays the premiums for two years (the period in which an insurance company may contest a policy), so there’s no out of pocket cost. After two years, the insured person gets a lump sum payment he or she wouldn’t otherwise get. The insurance companies issuing the policies are often players on the secondary market themselves, so it isn’t as though they don’t know the policy might be sold. Nobody is hurt, no one’s out any money, and the purchaser walks away with a lump sum risk-free. I’d have to be crazy to talk my grandmother out of purchasing a STOLI.

So where is the harm? Consider these points:

There may be hidden income tax ramifications for the insured person resulting from of the lump sum payment and from the payment of premiums on his/her behalf (if you’ve purchased a STOLI policy, speak to your tax professional).

Turning life insurance policies into easily traded commodities may induce Congress to strip life insurance policies of the tax benefits they now enjoy, which hurts everyone.

Pricing for policy premiums takes into account that a percentage of policies will eventually lapse because the policy owners stop paying premiums; in order to make up for STOLIs, which are investor backed and won’t lapse, premiums for all policies would have to increase.

If an insurance company succeeds in rescinding a policy, the insurance company is not back to where it was before. It’s out the huge commission it paid to the broker. If it can’t find the broker or the broker is judgment proof, the insurance company might try to recover the commission from the estate of the original policy purchaser.

There’s a public policy behind the statute. Remember how short sellers were being blamed for causing the financial crisis by betting against the market and driving down stock prices? When someone buys your life insurance policy, they’re betting against your longevity. How well will you sleep at night knowing that some stranger somewhere has no idea what a wonderful, caring person you are but has a very profitable, multi-million dollar incentive in seeing you dead? (Cue up the horror soundtrack.) You might want to join a self-defense class or get a licensed weapon.

Litigation over stranger-originated life insurance policies (SOLI or STOLI)

Saul Elnadav — Mon, 16 Mar 2009 16:23:00 +0000

The New York Law Journal recently reported on a case involving a life insurance company’s refusal to pay a death benefit on a policy it considered a “stranger-originated life insurance” policy (known as SOLI or STOLI policies).

In ruling on a motion to dismiss claims in Phoenix Life Ins. Co. v. Irwin Levinson Ins. Trust II, Justice Carol Edmead wrote by way of background that in a SOLI arrangement:

a policy is purchased, not with a view of the insured paying premiums for the benefit of the insured’s family, but with a view toward reselling the policy to an “outside investor” in a secondary market for life insurance. The outside investor pays the insured in order to make a “wager” on the duration of the insured’s life. [Blogger's note: i.e., the investor pays the premiums for two years and then buys the policy for a lump sum.]

The entire secondary market for life insurance policies (sometimes called the “life settlement” market) is a multibillion dollar financial industry that provides life insurance policyholders who do not wish to continue maintaining their policies alternatives besides either allowing their policy to lapse or selling it back to the insurer for its cash surrender value, but also involves parties who seek to invest in an “insured’s imminent demise.”

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In 2006 alone, more than $12 billion in life insurance policies (measured by face value) were sold to purchasers in the secondary market such as Goldman Sachs & Co., Credit Suisse, and UBS AG. Phoenix itself created its own separate division, Phoenix Life Solutions, to participate in the life settlement market.

The problem with STOLI policies is that, under New York law, it is illegal to procure a life insurance contract if the benefits are payable to a person who at the time the contract was made did not have an insurable interest in the person insured.

What is an insurable interest? “In the case of persons closely related by blood or by law,” an insurable interest is defined as “a substantial interest engendered by love and affection.” Among other persons, an insurable interest is defined as “a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.” (New York Insurance Law § 3205)

The investors behind a SOLI have no interest in the insured person’s continued life. On the contrary, they’re betting that the insured person will die sooner rather than later, so that fewer premiums are paid before they receive the large death benefits.

How do they get around the law? Justice Edmead wrote:

To conceal the real policyholder’s lack of insurable interest from the insurer, as well as to induce the insured’s application, investors establish an irrevocable trust solely to hold the target insurance policy. The trust is established around the time that the insured submits his application, and is named as the owner and beneficiary of the policy, with the beneficiary being entitled to the death benefits payable under the policy. The beneficiary of the trust is typically disclosed to the insurer and designated as the insured or a family member. Once the policy is issued, the insured transfers the beneficial interest in the policy to an outside investor in exchange for a significant lump sum payment.

Investors selling STOLIs usually target elderly people because they benefit from shorter life expectancies. Often, to get the purchaser eligible for the large policy, the application involves medical or financial misrepresentations.

Whether the policy owned by the Irwin Levinson Insurance Trust was in fact illegal is subject to dispute between the parties. Phoenix Life Insurance said the policy was stranger-originated. They also claimed that application for the policy contained medical misrepresentations. The Trust countered that the Phoenix’s refusal to pay the death benefits was part of a deceptive business practice.

Justice Edmead ultimately decided not to dismiss the deceptive business practice claim. However, she also noted that individuals instrumental in procuring the policy include life insurance experts who are also involved in a number of large life insurance transactions currently being litigated. Referring to the Trust, she further noted that:

it appears that defendants are relying on a consumer protection statute to defend a practice that the very same statute was intended to guard against.

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