Care for a STOLI? Careful! You May Find Yourself in Trouble.

Stranger Originated Life Insurance, also known as a “STOLI,” is a life insurance policy financed or held by a person who has no relationship to the person insured under the policy.  In the typical STOLI transaction, an investor encourages an elderly person to purchase a life insurance policy and name the investor, who pays the premiums, as the policy beneficiary.  Normally, the elderly insured is also paid a sum of money to entice them to enter into the transaction.

In late 2010, the Central District of California issued two rulings, a few weeks apart that help explain the propriety of STOLI transactions in California.  They were:  SEC v. Private Equity Mgmt. Group, LLC, 2010 U.S. Dist. LEXIS 126337 (C.D. Cal. Nov. 18, 2010) and Ohio Nat’l Life Assur. Corp. v. Davis, 2010 U.S. Dist. LEXIS 130510 (C.D. Cal. Dec. 1, 2010).

In Private Equity Management Group, the SEC, after the appointment of a permanent receiver, obtained an August 2009 preliminary injunction preventing any suit against PEM without leave from the court.  In September 2010, Principal Life Insurance Company (“Principal Life”) sought leave to file an action against the receiver of PEM in order to challenge “the validity of an insurance policy issued on the life of Barbara Doricott … which was among PEM’s investment life insurance policies.”  Principal Life sought to void the policy on the grounds of fraud and “a lack of insurable interest.”

In determining whether or not to lift the stay, the court applied a three-factor test from SEC v. Wencke, 622 F.2d 1363 (9th Cir. 1980):  “(1) Whether refusing to lift the stay genuinely preserves the status quo or whether the moving party will suffer substantial injury if not permitted to proceed; (2) the time in the course of the receivership at which the motion for relief from the stay is made; and (3) the merit of the moving party’s underlying claim.”

In applying the last of the Wencke factors, the court found that Principal Life had a “colorable claim” justifying a lifting of the stay.  The court placed credence in Principal Life’s contention that the life insurance policy was void because it lacked an insurable interest:

Likewise, although it is unclear whether the Policy would ultimately be deemed void for lack of an insurable interest, the Court finds that Principal Life has alleged a colorable claim to that effect.  In opposing Principal Life’s motion, the Receiver relies on Lincoln Nat. Life Ins. Co. v. Gordon R.A. Fishman Irrevocable Life Trust, in which the court held that life insurance policies were not void for having been procured by STOLI practices where the trust, its settlor, and its beneficiaries had insurable interests in settlor’s life at time of inception.  638 F. Supp. 2d 1170, 1177 (C. D. Cal., 2009) (“an interest in the life or health of a person insured must exist when the insurance takes effect, but need not exist thereafter or when the loss occurs.”).

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Ms. Dorricott’s daughter allegedly sold 1% of the interest in the policy less than three weeks after the policy was issued.  Thus, while further factual development is necessary to establish whether the Policy is actually void for lack of insurable interest, based on the forgoing, the Court finds that Principal Life’s claim has sufficient potential merit to satisfy the third Wencke factor.

In Davis, supra, the defendant, an attorney, allegedly obtained two life insurance policies (“the Policies”) for two insureds (Smith and Griffin) with each life insurance policy providing a death benefit of $1,000,000.00.  Davis also set up two irrevocable life insurance trusts (collectively, “the Trusts”).  The owners were the Trusts, Davis was the trustee, and the insureds’ wives were the beneficiaries.  Ohio National filed a Motion for Preliminary Injunction, seeking an order to enjoin any policy changes.  The Court, in ruling on the preliminary injunction, had to consider the “likelihood of success on the merits.”

In evaluating whether Ohio National met this test, the court first noted that under California law (specifically California Insurance Code section 280), “no life insurance contract is valid unless the insured has an ‘insurable interest.’”  The court explained that the critical question was whether the Trusts had an insurable interest in the insureds because it was the Trusts that obtained the life insurance policies.  The court determined that the Trusts used to apply for the Policies presumably had insurable interests in the lives of the Insureds because the beneficiaries of the Trusts were the insureds’ wives.  See Cal. Ins. Code § 10110.1(a).  However, the court aptly explained that under California Insurance Code section 10110.1(e) “[a]ny device, scheme, or artifice designed to give the appearance of any insurable interest where there is no legitimate insurable interest violates the insurable interest laws.”  Specifically, any arrangement by which a life insurance policy is initiated for the benefit of a “third party investor” who has no insurable interest in the insured’s life at the time the policy is issued is deemed a STOLI, which is a prohibited “fraudulent life settlement act.”  See Cal. Ins. Code §§ 10113.1(w), 10113.2, 10113.3(s). The Court further explained:

Ohio National presents allegations that strongly support inferences that the Policies were indeed STOLIs.

To begin, Ohio National alleges that Davis solicited and induced Griffin and Smith to apply for life insurance policies promising no premium payment obligations yet receiving payments for their participation.  In the process, Griffin and Smith were convinced to sign irrevocable trusts naming Davis as the trustee and the Trusts as owners of the Policies.  Morady seemingly rubber stamped the life insurance applications without ever seeing the proposed Insureds or examining their financial records.  In addition, Davis, as trustee, was given unfettered discretion to purchase life insurance policies and to borrow money for the same.  Further, Davis was given the power to assign the Policies and the proceeds of the Policies to any lender.  Accordingly, it seems highly likely that Ohio National would succeed in establishing that the procurement of the Policies were STOLI transactions.  Specifically, Ohio National has demonstrated that Davis and Morady did not have insurable interests in the lives of the Insureds yet the Policies were initiated for their benefit.  Therefore, based on the unopposed papers and other submissions, Ohio National has established a likelihood of success on the merits.

The court therefore granted Ohio National’s motion for a preliminary injunction.

The State of California’s requirement that a life insurance policy is invalid without an insurable interest at the time of the policy issuance is a very basic and fundamental requirement that is not to be overlooked or underestimated when dealing with STOLI or STOLI-like transactions.

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