Please note that the below article, prepared by Gregg Bateman of Seward & Kissel LLP, appeared in the November 29 online edition of Law360. The article discussed the impact of the recent New York Court of Appeals case of Kramer v. Lockwood Pension Services Inc. on future STOLI cases.
While the term stranger-originated life insurance has been used quite frequently in the insurance industry, particularly in the life settlement industry, defining its parameters has been met with some difficulty. Many experts define STOLI transactions as “a practice or a plan to initiate a life insurance policy for the benefit of a third party investor who, at the time the life insurance policy is originated, has no insurable interest in the insured.”1
Federal and state views on STOLI arrangements have varied widely over the years, and many states have only recently begun the process of passing state-specific legislation to address STOLI transactions. Views on STOLI transactions also vary widely between life settlement market participants and the insurance companies issuing such life insurance policies. Generally, life settlement market participants encourage the development of STOLI transactions in order to increase liquidity in the marketplace, while insurance companies generally discourage the use of STOLI transactions, as they deem such transactions as violative of public policy.
The issue of the legality of STOLI transactions recently came to the forefront in the state of New York in Kramer v. Lockwood Pension Services Inc., et al.2 In Kramer, Arthur Kramer purchased life insurance policies from various insurers and concurrently created a trust wherein Kramer was the depositor and his children were the beneficiaries. After purchasing the life insurance policies, Kramer deposited the policies into the trust for the benefit of his children, and then immediately directed his children to assign their beneficial interests in the trust to a third-party investor. After his death, Arthur Kramer’s wife, Alice, asserted that the assignments to the third party investors were void under New York insurance law, and accordingly, the death benefits from Arthur Kramer’s life insurance policies should be paid to Alice Kramer.
In Kramer, the U.S. District Court for the Southern District of New York issued an interlocutory appeal to the U.S. Court of Appeals for the Second Circuit citing “substantial ground for difference of opinion on the application of New York insurance law to STOLI arrangements.” 3 After review of the interlocutory appeal, the U.S. Court of Appeals for the Second Circuit, by order entered Jan. 20, certified the following question to the New York Court of Appeals:4
“Does New York Insurance Law 3205(b)(1) and (b)(2)5 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?”
On Nov. 17, the New York Court of Appeals held, in a 5-2 decision, that New York law permits 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. The court reasoned that New York insurance law codifies the common law rules that:
1) an insured has total discretion in naming a policy beneficiary and
2) a policy valid at the time of procurement may be assigned to one without an insurable interest in the insured’s life, and, relatedly, no insurable interest is required when one holds a policy on another’s life, so long as the policy was valid in its inception.
The court also explained that the statutory mandate that a policy be obtained on an insured’s “own initiative” merely requires that the decision to obtain a life insurance policy be knowing, voluntary and actually initiated by the insured, and that such decision be free from nefarious influence or coercion. In so holding, the court also rejected, based on “overwhelming textual and historical evidence,” the insurance company’s argument that New York insurance law requires good faith on the part of the insured when purchasing a life insurance policy, and that an insured’s intent to transfer its policy at the time of such purchase would violate New York insurance law.
The Kramer decision will affect those policies and transactions governed by New York law. The decision supported the secondary market’s position that such STOLI transactions are lawful, and ultimately should result in increased liquidity and stability in the secondary market. The decision also created some certainty for existing secondary market transactions in that investors and sellers will not be able to challenge whether the policies serving as collateral for such transactions, which were purchased pursuant to a valid STOLI structure, are voidable.
It is important, however, to note that the Kramer decision is qualified by the newly effected life settlement law in New York, which requires that an insured retain its policy for two years after purchase of the policy before being able to sell such policy to a third party.6 Reading the newly effected life settlement law together with the Kramer decision, it seems as though a challenge to the legality of valid STOLI arrangements should not prevail in a New York court; however, insureds will no longer be able to immediately sell their policy to a purchaser, rather they will have to wait for the two-year holding period to expire.
It is still unclear which jurisdictions will ultimately adopt the holding in Kramer. However, with a multitude of STOLI cases currently pending in various jurisdictions, one would assume that the Kramer decision will certainly affect future court decisions in other jurisdictions.
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1 NCOIL Model Act, Section 2.Y.
2 653 F. Supp. 2d 354 (S.D.N.Y. 2009).
3 Id.
4 The New York Court of Appeals accepted the certification of question April 29, 2010.
5 New York Insurance Law §§3205(b)(1) and (b)(2) states that:
“(b)(1) 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.
“(b)(2) 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.”
6 New York Insurance Law §7813(j)(1).
