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Lincoln National Life Insurance Co. v. Calhoun

January 27, 2009


The opinion of the court was delivered by: Pisano, District Judge



Though framed as a dispute between an individual insurer and an individual insured, the instant case offers a glimpse into a larger debate between the insurance industry and investment speculators that has been brewing for the last several years. This suit requires the Court to contemplate stranger-originated life insurance transactions, in which individuals are able to obtain third party financing to purchase a life insurance policy and to fund the premiums owed under that policy, with some understanding or expectation that the policy will be immediately assigned to an individual lacking an insurable interest, following the expiration of the policy's two-year contestability period. Plaintiff Lincoln National Life Insurance Company ("Lincoln National") seeks rescission of a $3 million life insurance policy owned by Defendant Walter Calhoun's family trust*fn1 that Calhoun purchased using borrowed funds. Lincoln National alleges that at the time he applied for a life insurance policy, Calhoun intended to sell his policy to "stranger investors" in the secondary life insurance market, and that Calhoun's Lincoln National life insurance policy is therefore void for lack of an insurable interest. Further, Lincoln National argues that Calhoun made a material misrepresentation in his application by claiming he had not engaged in discussions about the possible sale or assignment of the policy to a secondary market provider. In lieu of filing an Answer, Defendants move to dismiss the instant Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6), contending that neither a future intent to sell a policy, nor third party financing of the policy's premiums, can serve to invalidate an insurance contract for lack of insurable interest. Further, Defendants advance several arguments that Lincoln National's material misrepresentation claim fails as a matter of law.

For the reasons set forth below, Defendants' motion is denied without prejudice, and the parties are directed to proceed with discovery.

I. Background*fn2

A. The Secondary Life Insurance Market

This case concerns an aspect of a growing cottage industry in the insurance market, known as stranger-owned life insurance policies or "STOLI" plans*fn3 , in which an individual, typically an elderly one, procures life insurance on his own life in order to subsequently assign the policy to a third party following the lapse of the two-year contestability period. STOLI transactions are the product of the burgeoning "life settlements*fn4 " market, in which insureds sell unneeded or unaffordable permanent policies to investors. See Jensen & Leimberg, supra, at 111. STOLI schemes emerged as investor demand for these policies exceeded supply, leading industry speculators to solicit insureds to take out additional policies, even if the insureds had no particular need for supplemental insurance coverage. Often, the insureds are persuaded to engage in these STOLI transactions because their bank accounts have run dry and they are forced to spend increasing amounts of money on medical care. As one court put it, "[o]ften pejoratively termed 'stranger-owned life insurance policies' these policies enable the insured to obtain ready cash by selling his policy to a stranger whose only interest in the insured is his early demise." Life Prod. Clearing LLC v. Angel, 530 F. Supp. 2d 646, 648 (S.D.N.Y. 2008).

A typical STOLI transaction is structured as follows. An agent attempts to sell a life insurance policy to an elderly insurable candidate, and offers the candidate up-front cash in exchange for promising a future sale of the policy. The agent informs the candidate that the candidate will be able to obtain the policy at virtually no cost to himself, because the agent has secured non-recourse financing to purchase the policy. The candidate then acts as a "nominal grantor" of a life insurance trust that is used to apply for the policy. "At that time, the agent will tell the insured that, in all probability, the policy will be sold to investors for a price that will pay the loan and accrued interest, leaving a profit to split between the agent and the insured. ... If the insured survives [the two-year contestability period on the policy], the owner (the life insurance trustee) typically has two options, in addition to the sale of the policies to investors: (1) have the insured pay the outstanding debt with accrued interest and retain the policy; or (2) transfer the policy to the lender in lieu of foreclosure." Jensen & Leimberg, supra, at 111. The insureds are usually able to garner significantly greater sums from the speculators than they would receive by surrendering the policy to the insurance company. See Liam Pleven & Rachel Emma Silverman, Cashing In: An Insurance Man Builds A Lively Business In Death -- As Life Settlements Boom, Banks, Regulators Circle, Wall St. J., Nov. 27, 2007, at A1.

As the New York Times reported several years ago, "[t]rading in life insurance policies held by wealthy seniors has quietly become a big business. Hedge funds, financial institutions ..., and investors ... are spending billions to buy life insurance policies from the elderly. Other investors are paying seniors to apply for life insurance, lending the money to buy the policies, and then reselling them to speculators." Charles Duhigg, Late in Life, Finding a Bonanza in Life Insurance, N.Y. Times, December 17, 2006, at 1. The secondary market has grown from $200 million in transferred death benefits in 1998 to $12 million less than a decade later in 2005. Jensen & Leimberg, supra, at 111. One study suggested that as many as 89% of life insurance policies did not pay out death benefits. Id. at 112.

Though both sides to this controversy agree that consumers should be permitted to sell unnecessary policies on a secondary market, some have suggested that the increasing popularity of STOLI transactions, as well as the controversy engendered by them, frustrates the legitimacy of the secondary life settlements market. See id. at 123 ("The life settlement community is staggering under poor publicity ... and is in great need of distinguishing itself from rogue actors and actions such as [STOLI transactions]."). Life insurance was typically understood as a means of providing for dependents after the insured has passed on. As some insurance industry advocates have stated, "life insurance is a way for individuals to protect their families . . . If someone profits from a stranger's death, it stands the whole purpose of life insurance on its head." Duhigg, supra, at 1. The insurance industry has further argued that such transactions will inevitably raise the cost of life insurance because insurance companies "count on many customers canceling their policies before they die, usually because their children grow up and no longer need the financial protection, their pensions kick in or premiums become too expensive." Id.

B. The Policy

At some time before July 24, 2006, Joshua Weinberger, an individual "in the insurance business" (Pl.'s Br., Ex. 1 at 1), approached 75-year old Calhoun, a New Jersey resident, to solicit Calhoun's participation in a premium finance life insurance transaction, whereby Calhoun would "apply for a life insurance policy and sell it for a profit without any cost whatsoever to [] Calhoun." (Compl. ¶ 17.) Weinberger then introduced Calhoun to Gabriel Giordano,*fn5 a licensed Lincoln National agent in California, in order to prepare an application for a life insurance policy covering Calhoun. Mr. Giordano introduced Calhoun to Defendant Chabner, a California resident, and on July 24, 2006, Calhoun established the Walter Calhoun Family Insurance Trust ("the Trust") with Chabner as the designated trustee. An application seeking a $3 million in life insurance policy for Calhoun's life, with the Trust as the proposed owner and beneficiary, was submitted to Lincoln National two days later, on July 26, 2008 ("the Application"). In response to Question 4a on the Application, which asked whether the applicant had engaged in any discussions regarding possible sale or assignment of the policy to "a life settlement, viatical or other secondary market provider" ("the Question"), Calhoun or Chabner answered "no." (Compl., Ex. A.) Both Defendants Calhoun and Chabner signed the Application and certified that all answers to the Application's questions were "complete and true to the best of [their] knowledge." (Id.) Lincoln National issued a life insurance policy ("the Policy") insuring Calhoun's life, with the Trust as the Policy owner and beneficiary of the $3 million death benefit, on August 11, 2006. (Compl., Ex. B.)

Sometime thereafter, Lincoln National came to believe that Calhoun intended to sell or assign the Policy to stranger investors. Consequently, on June 12, 2008, Lincoln National filed the instant two-count Complaint against Calhoun and Chabner, seeking declaratory judgment that (1) the Policy is void ab initio due to Defendants' material misrepresentations on the Application or, alternatively, the material misrepresentations warrant rescission of the Policy; and (2) the Policy is void due to ...

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