Case Note: Insurer’s Loss in Wisconsin “STOLI” Action Affirmed by Seventh Circuit

Following-up on a case note published late last year regarding the courts’ continued analyses of stranger-originated life insurance (“STOLI”) policies, the Seventh Circuit affirmed the district court’s summary judgment order to the policy holder (U.S. Bank) in U.S. Bank, N.A. v. Sun Life Assur. Co. of Canada on October 12, 2016. See Sun Life Assur. Co. of Can. v. U.S. Bank N.A., No. 16-1049, 839 F.3d 654 (7th Cir. 2016).

In the proceedings below, Sun Life contended that a Wisconsin statute prohibiting illegal wagering contracts (Wis. Stat. § 895.055(1)) voided a $6 million life insurance policy procured by an 81 year-old Wisconsin man in 2007. 839 F.3d at 656. In 2011, U.S. Bank, as “securities intermediary” was substituted as both the owner and beneficiary of the policy, and it continued making premium payments until the insured’s death in 2014. A total of almost $2.5 million in premium was paid on the policy from 2007 to 2011. Id. at 656-57. Upon U.S. Bank’s presentment of a claim and the insured’s death certificate to Sun Life, Sun Life “declared that it would refuse to pay U.S. Bank the policy proceeds until it investigated the policy’s validity.” Id. at 656. In response, U.S. Bank sued Sun Life for the policy proceeds. Id. at 657. The district court held that Sun Life was due to pay the policy proceeds plus statutory interest and bad faith damages because of “Sun Life’s foot dragging.” Id. The Seventh Circuit affirmed the district court’s findings that Sun Life breached the subject life insurance policy in failing pay to proceeds to U.S. Bank upon it presenting proof of the insured’s death to Sun Life and that Sun Life acted in bad faith, as a matter of Wisconsin law, despite Sun Life’s concerns about possible misrepresentations made in connection with the policy issuance. Id. at 656-57. Accordingly, Sun Life not only has to pay out the policy proceeds to U.S. Bank, it also has to pay interest (12%) and bad faith damages. Id. at 657.

At the very outset of the opinion, which Circuit Judge Posner drafted, the court expressed the “common law principle” applicable “in every state of the United States” that “forbids a person to own an insurance policy that insures someone else’s life unless the policy owner has an insurable interest in that life.” 839 F.3d at 655-56 (citing Ohio Nat’l Life Assur. Corp. v. Davis, 803 F.3d 904, 907-08 (7th Cir. 2015)). The court also offered several public policy reasons behind this universal principle. First, it noted that “cashing in such [a STOLI] insurance policy would give [the owner] a pure windfall” and “hurt the insurance company by shortening the period in which it would be receiving premiums” (particularly where the insured was already in poor health when the policy was procured). Id. at 656. Second, it would amount to speculation on an insured’s life. Id. (citing Conn. Mut. Life Ins. Co. v. Schaefer, 94 U.S. 457, 460 (1876)). Third, and relatedly, such speculation would give “the policy holder an incentive to shorten [the stranger insured’s] life.” Id. (citing Grigsby v. Russell, 222 U.S. 149, 154-55 (1911)). The court also noted that, under the common law, the “remedy for buying a life insurance policy without having an insurable interest in the life of the insured was to invalidate the policy.” Id.

Despite the public policy concerns against and the common law remedy traditionally available to combat STOLI policies, however, the Seventh Circuit found that it had to defer to the Wisconsin legislature’s enactment of legislation that changed only the remedy available to address such policies. Id. at 656 (“[T]he Wisconsin legislature, while retaining the common law principle forbidding the purchase of life insurance policy by one who lacked an insurable interest, changed the remedy from cancelling the policy to requiring the insurer to honor its promise.”). More specifically, the court noted that the “revised statute provides that ‘no insurance policy is invalid merely because the policyholder lacks insurable interest … but a court with appropriate jurisdiction may order the proceeds to be paid to someone other than the person to whom the policy is designated to be payable, who is equitably entitled thereto.” Id. (quoting Wis. Stat. § 631.07(4)). The court further noted that, in the opinion of the Wisconsin legislature, “‘the best way to discourage insurers from issuing insurance policies to persons without insurable interest is to make them [the life insurance companies] pay if they do, not permit them freely to issue such policies knowing that they have a good public policy defense [the unenforceability of gambling contracts] that lets them off the hook whenever a loss occurs.” Id. (citing Wis. Stat. § 631.07(4), comment).

In light of the Wis. Stat. § 631.07(4), the court rejected Sun Life’s three main arguments. First, it found that the Wisconsin statute voiding gambling contracts did not apply in the insurance context in light of Wis. Stat. § 631.07(4). Id. at 657 (citing Wis. State § 600.12(2), which “provides that if a section of the insurance code conflicts with a section of another code, the section in the insurance code governs”). The court also rejected Sun Life’s argument that there was a distinction between “insurance policies that are wagers and insurance policies in which the policyholder lacks an insurable interest,” stating that such a distinction “does not exist.” Id. (“‘[A] contract of insurance upon a life in which the insured has no interest is a pure wager.”) (quoting Grigsby, 224 U.S. at 154). Second, the court found that the Wisconsin legislature had not authorized gambling contracts, “including life insurance policies that lack an insurable interest,” but instead “changed only the remedy for violation” of the insurable interest requirement in a life insurance policy. Id. (“Gambling contract, including life insurance policies that lack an insurable interest, are still forbidden.”). Moreover, the court found that, because no one was “equitably entitled” to the policy proceeds, as required by the statute, U.S. Bank was entitled to them. Id. (noting that the “statute authorizes the court to order the death benefit paid to someone else, but only to someone who is equitably entitled to it”). Finally, the court rejected Sun Life’s arguments that U.S. Bank was not entitled to statutory interest or bad faith damages under the Wisconsin statute that “requires payment of interest proceeds within 30 days” or interest on delayed payments at the rate of 12 percent a year unless there is “reasonable proof” that the claim is not due to be paid. Id. at 657-58 (finding that Sun Life had no “reasonable proof” that it did not have to pay the claim and that bad faith in delaying payment had been proven).

U.S. Bank, N.A. v. Sun Life Assur. Co. of Canada serves as a warning to insurers facing STOLI policies to carefully consider applicable state insurance laws before failing to pay benefits under such a policy, despite applicable STOLI concerns. This is particularly so in states, like Wisconsin, that believe that the best way to address STOLI concerns is to require insurers to “cough up the proceeds rather than … being allowed to keep all the premiums and pay nothing to the policy holder because the latter had no insurable interest in the policy.” Id. at 657.

Republished with permission. This article first appeared in the DRI Life, Health and Disability Newsletter on April 18, 2017.