Insurer on the Hook for Policy Obtained in Fraud

ST. LOUIS (CN) - A bank that inherited the $5 million life insurance policy fraudulently obtained and later sold by a retiree is entitled to collect, the 8th Circuit ruled.

William Close obtained the policy at issue in 2007 with the intent of selling it for a fraction of its value, but still twice what he paid PHL Variable Insurance Co. for it, according to the ruling.

Working on the application with a financial professional, 74-year-old Close fraudulently inflated his income and net worth, and he excluded mention of a prior criminal conviction for receiving kickbacks.

Close used the proceeds of a loan to pay the premiums for the first two years of the policy, after which time the policy became incontestable under Minnesota law.

Though he expected to sell the policy in 2009 for 10 percent of its value, a buyer remained elusive because the secondary market for such policies had just crashed.

Close instead surrendered the policy to the hedge fund that funded his loan, and Bank of Utah holds the policy today as securities intermediary for the entity that bought it.

When Close died in 2011, Bank of Utah tried to collect the benefit from PHL.

Since its failure to detect the original fraud foreclosed it from rescinding the policy on that basis, PHL asked a federal judge in Minneapolis to void the policy as contrary to public policy based on the bank's lack of an insurable interest.

Though the trial court did just that, holding the policy invalid ab initio, a three-judge panel of the 8th Circuit reversed last week.

The March 13 opinion traces the booming industry of stranger-owned-life-insurance policies, or STOLIs, to the AIDS epidemic when insured individuals living with AIDS sold their policies to investors so that would have cash to cover their high medical bills.

Since AIDS treatment has progressed, however, the policies are now being marketed to senior citizens as investments.

Writing for the three-person appellate panel, Judge James Loken noted that the "aggressive secondary market for life insurance policies raises serious public policy issues."

"While passive investors of securitized policies are unlikely to murder the insureds, the life settlement market functions in part on the truism that a policy is worth more to an investor if the insured is elderly or in poor health," the ruling continues. "Thus, it is entirely reasonable for legislators and insurance regulators to conclude that many STOLI premium financing programs and marketing practices should be curtailed or banned because these practices induce elderly insureds to purchase high-value life insurance policies that are not needed for insurance purposes under terms ensuring that life settlement promoters and premium financing companies will ultimately collect the substantial death benefits. But these are issues that go far beyond Minnesota common law decisions, none of which even suggest that an existing life insurance policy will be declared void ab initio for lack of an insurable interest at the behest of an insurer that wishes to avoid paying the death benefit."

PHL had hoped to show the policy was void ab initio, meaning it never came "into force," but Loken said that "to declare that a facially valid policy on which PHL collected substantial premiums for over four years was never 'in force' is simply a fiction."

Judges Bobby Shepherd and Judge Steven Colloton concurred.

Colloton wrote separately to emphasize that case law protects the sale by Close, who had an insurable interest in that he wanted to continue living, to a third party that had no such interest.

"To establish that an insurance contract is void ab initio as a cover for a wagering contract, the Minnesota court likely would require an insurer to show that the scheming parties agreed that the insured would resell the policy to an identified person without an insurable interest," Colloton wrote (italics in original).

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