On March 13, 2015 the United States Court of Appeals for the Eighth Circuit handed down a game-changing ruling with major implications for the life settlements industry. The Eighth Circuit’s decision in PHL Variable Insurance Company v. Bank of Utah, No. 14-1210, endorses the validity and importance of the secondary market and significantly strengthens the hand of life settlement policy investors. The Court of Appeals held that under Minnesota law, the insurable interest requirement is met when a person purchases insurance on his own life, regardless of any intent to later transfer the policy, and an insurer may not challenge that policy outside the two-year contestability period on any grounds. Reversing a district court decision finding the policy void for lack of insurable interest, the Eighth Circuit remanded the case with instructions for the district court to dismiss PHL’s claim seeking a declaration of invalidity.
The leading decisions applying Minnesota law on the topic before Bank of Utah were two related Federal District Court decisions in Sun Life Assurance Co. of Canada v. Paulson. In Paulson I, the court outlined the basic rule: “If a life insurance policy was procured under a scheme, purpose, or agreement to transfer or assign the policy to a person without an insurable interest in order to evade the law against wagering contracts, it violates public policy and is void ab initio.” No. 07-3877, 2008 WL 451054, * (D. Minn. Feb. 15, 2008). The court later elaborated on this in Paulson II, holding that the insurer must prove that there was a prearranged agreement at the time the policy issued between the insured and the “relevant” third party—i.e., the party that later purchases or obtains the policy. No. 07-3877, 2008 WL 5120953, at *4 (D. Minn. Dec. 3, 2008). The district court in Bank of Utah identified Paulson as supplying the governing insurable interest standard.
The Eighth Circuit rejected the district court’s approach, concluding that the Minnesota Supreme Court would not adopt Paulson’s “agreement” standard because it overrides the principle that a court’s power to declare a contract void ab initio “is a very delicate and undefined power, and . . . should be exercised only in cases free from doubt.” (Slip Op. 10.) Instead, the court laid down a broad and clear-cut rule: “[W]hen a person other than the insured purchases life insurance on a stranger, naming himself as beneficiary, the insurance policy is ‘against public policy and void.’ But when a person purchases insurance on his own life and later assigns it to a stranger, the contract between the insured and insurer is valid unless voidable for fraud or other defenses that are subject to the incontestability bar.” (Slip Op. 9 (second emphasis added).) In other words, an insurer cannot use the insurable interest defense to declare a policy void if that policy was purchased by the insured on his own life.
The Eighth Circuit’s opinion included another important holding, equally valuable for policyholders. It rejected the district court’s assumption that Minnesota’s two-year contestability period does not apply to claims under the insurable interest doctrine. Instead, if an insurer wishes to contest a policy under the insurable interest doctrine (a difficult task now under the court’s first holding), it must bring such a challenge within the two-year contestability period.
While the holding addressed Minnesota law, the opinion will have broad implications. The relative lack of precedent on insurable interest means that courts often look to other courts to determine the bounds of the insurable interest requirement. For instance, in Paulson II, Judge Doty cited cases from New York, Ohio, Maryland, Pennsylvania, Kentucky, and Mississippi. 2008 WL 5120953, at *5. A federal circuit court opinion like Bank of Utah will likely have significant impact around the country.
An important note to policy owners: Under the Minnesota Insurable Interest Act, a policy owner “who believes in good faith that the insurer may challenge the policy for lack of insurable interest,” is able to bring a declaratory judgment action for a court order declaring the policy valid. Minn. Stat. § 60A.0789 subd. 3(b). This key provision allows policy owners to gain confidence that they will see a return on their ongoing premium payments instead of being held hostage by an insurer who could otherwise wait until the insured dies, and only then bring an insurable interest challenge to the policy. The Bank of Utah decision significantly strengthens the hand of the policy owner and may provide the owner good cause to exercise its right to obtain a declaratory ruling validating the policy under § 60A.0789 subd. 3(b). The decision whether to bring such an action, however, must be made soon because the right to bring such declaratory actions sunsets on December 31, 2016.
