In the original case, Kramer’s widow alleged facts indicating an arrangement to procure seven life insurance policies from defendants Transamerica Occidental Life Insurance Co. (Transamerica), Lincoln Life & Annuity Co. of NY (Lincoln) and Phoenix with the purpose of immediately transferring the beneficial interests in those policies to stranger investors, in contravention of the insurable interest rule as codified in the New York Insurance Law.  (See the December 2005 opinion of the Office of the General Counsel of the State of New York Insurance Department, discussed in our Bulletin No. 06-07.) 

During 2005, defendant Lockwood, an insurance broker and former pension attorney, reportedly instructed Mr. Kramer to establish trusts, naming himself as grantor and his children as beneficiaries and defendant Lockwood Pension Services, or its affiliates, as trustee.  In 2007, two years after the trusts acquired an interest in the Transamerica, Lincoln and Phoenix policies (and after the expiration of the “contestability period” on those policies), Mr. Kramer, acting at the direction of the defendants, allegedly directed his children to execute an assignment of their beneficial interests in the trusts to stranger third-party investors arranged by Mr. Lockwood.  The investors named in the lawsuit included defendants Tall Tree Advisors, Inc. and Life Products Clearing, LLC.  Credit-Suisse also appears to have participated as a third party investor.

Mr. Kramer died unexpectedly on January 26, 2008, and his widow sued to prevent the payment of death benefits of approximately $18,200,000, $28,000,000 and $10,000,000 by Transamerica, Phoenix and Lincoln, respectively, to the defendant investors, claiming that they lacked an insurable interest in Mr. Kramer’s life and thus that the transaction was illegal from its inception.  The estate claimed: “where the procurement of life insurance violates the insurable interest rule, the remedy is either that the death benefits be paid to the personal representative of the decedent’s estate . . . or, if already paid to a stranger investor, that they be disgorged and paid to the personal representative.” 

Although nearly 200 pleadings had been filed in the case as of last year, according to the WSJ, “[r]esolution of the sprawling litigation [was]s on hold, pending the New York Court of Appeals ruling on the underlying question of whether the policies were illegal from the start [as violative of the NY insurable interest law].”

New York’s insurable interest requirement is codified in Insurance Law §§ 3205(b)(1) and (2). Section 3205(b)(1) states:

“Any 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.”

Section 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 himself or someone with an insurable interest in his life, as follows:

“No person shall procure or cause to be procured, directly or by assignment or otherwise any contract of insurance upon the person of another unless the benefits under such contract are payable to the person insured or his personal representatives, or to a person having, at the time when such contract is made, an insurable interest in the person insured.”

The Court of Appeals distinguished the two sections in its decision by noting that the first section [3205(b)(1)] applies to the insured, while the second section [3205(b)(2)], which is based on the common law prohibition on “wagering contracts,” applies to persons other than the insured. 

The Court rejected the plaintiff’s arguments that that, under common law, “an insured could only assign a policy to one without an insurable interest if the policy was obtained ‘in good faith’ compliance with the insurable interest rule, not as a means of circumventing it.”  The plaintiff also argued - to no avail - that one who procured a policy of insurance on his or her own life at the instigation of another (in this case the brokers and investors involved in the STOLI arrangement) could not be acting “on his own initiative,” as required by § 3205(b)(1).

In rejecting the plaintiff’s arguments, the Court relied on the plain language of the statute, as follows:

“Here, § 3205(b)(1) clearly provides that, so long as the insured is ‘of lawful age’ and acts ‘on his own initiative,’ he can ‘procure or effect a contract of insurance upon his own person for the benefit of any person, firm, association or corporation’ . . . This language is unambiguous and not limited by the statutory text.  It thus codifies the common law rule that an insured has total discretion in naming a policy beneficiary . . .. Our lower courts have long held that, under § 3205 (b), ‘[w]here the deceased effects the insurance upon her own life, it is well-established law that she can designate any beneficiary she desires without regard to relationship or consanguinity’ . . . It is equally plain that a contract ‘so procured or effectuated’ may be ‘immediate[ly] transfer[ed] or assign[ed] . . .” [Citations omitted.]

The Court observed that § 3205(b)(1) was amended in 1991 to allow the immediate assignment of a policy procured by the insured to a third party in response to an IRS private letter ruling (PLR 9110016), which denied an income tax charitable deduction to the donor/insured of a life insurance policy to a charity on the grounds that the charity lacked an insurable interest in the donor/insured. (See our Bulletin No. 91-32.)  The language of the amendment to § 3205(b)(1) was not, however, limited to transfers to charities.

The dissent felt that the statute should have been interpreted as incorporating the common law prohibition against “wagering contracts.”  The majority rejected this interpretation, noting that “if our legislature intended to impose such a limitation, it could easily have done so.”

The New York Court of Appeals decision should only apply to contracts entered into prior to May 18, 2010, when a new NY prohibition on STOLI arrangements went into effect.  As noted by the dissenting opinion, in 2009 the NY State legislature added several new provisions to the Insurance Law 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” Insurance Law § 7802(k). The new law prohibits “stranger-originated life insurance,” 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.”  Insurance Law § 7815. It also prohibits anyone from entering a valid life settlement contract for two years following the issuance of a policy, with some exceptions.  Insurance Law § 7813(j)(1).

An  article in the November 18, 2010 issue of the WSJ opined that:  “[t]he ruling is a blow to insurers and a victory for hedge funds that have bought billions of dollars of such policies in recent years, part of a controversial practice in which thousands of people have taken out life policies and quickly sold them to investors, who pay the premiums and collect when the insured dies.”  (See “Court Gives Life to Death-Bet Insurance,” Wall Street Journal, Nov. 18, 2010).

            Over the past two or three years, we have reported on a number of STOLI cases (pending and concluded), most of which were decided against the position taken by the STOLI promoters and investors and many of which encompassed circumstances not present in Kramer (e.g.,…(i) questionably accurate completion of policy applications, (ii) clearly false factual assertions by insureds or policy applicants and (iii) inappropriate actions by promoters or life insurance agents). 

            In the last case so covered in the Washington Report (see our Bulletin No. 10-92), we described the  factors which are negative toward past and future STOLI, including: (i) the recent reduced economic "allure" of the STOLI approach, (ii) the fact that there has been negative legislation respecting that approach in many state legislatures and (iii) the seeming anti-STOLI trend of the subjects' judicial treatment.    

AALU will assess, monitor and discuss with industry partners the potential impact of theNew York Court of Appeals decision in Kramer on STOLI. It is doubtful that the case at this point presents much of an encouragement for the instigation of future STOLI transactions.  For past STOLI transactions, as noted above, there were factual situations which in Kramer which are not similar to many other pending STOLI cases—in Kramer there were not allegations of questionably accurate or clearly false statements in policy applications or inappropriate actions by promoters or life insurance agents.

We will continue to report on the effect of this decision.  Any AALU member who wishes to obtain a copy of Kramer v. Phoenix Life Insurance Co., et. al. may do so through the following means: (1) use hyperlink above next to “Major References,” (2) log onto the AALU website at http://www.aalu.org/ and enter the Member Portal with your last name and birth date and select Current Washington Report for linkage to source material or (3) email Anthony Raglani at raglani@aalu.org and include a reference to this Washington Report.