There’s lots that has been and will be written about the changes in the definition of insurable interest in the context of life insurance. Traditionally, an owner of a life insurance policy had to have an insurable interest in the life of the person insured. Typically that meant the policyholder herself, or her spouse or child. The insured life could not be that of a stranger with no connection to the owner. Purchasing a policy on a stranger’s life is considered gambling on someone’s life and generally is not permitted in most jurisdictions.
But a lot has changed: the definition of insurable interest in various states has been amended, and life insurance policies are now frequently sold, either individually or packaged and sold as collateral for securities issued backed by these portfolios of life insurance policies. The traditional notion of an insurable interest on someone else’s life has been altered.
Recently, the Seventh Circuit Court of Appeals succinctly addressed a dispute where a bank sought life insurance proceeds on an individual’s life from a policy it purchased, acting as a securities intermediary, a few years before the person died. Upon acquiring the policy, the bank, in its intermediary capacity, was named as the beneficiary.
In Sun Life Assur. Co. of Am. v. U.S. Bank Nat’l Ass’n, No. 16-1049 (7th Cir. Oct. 12, 2016), the insurance company refused to pay the bank the life insurance proceeds and the bank sued. The district court found for the bank and, in addition to recovering death benefits, the court awarded statutory interest and bad faith damages for delaying payment. On appeal, the insurer argued that the refusal to pay the death benefit was authorized by statute.
The case involved Wisconsin law. According to the court, Wisconsin legislatively altered the common law way of addressing a failure of insurable interest in a policy. Instead of allowing rescission or cancellation of the policy because of the lack of an insurable interest, the statute, Wis. Stat. § 631.07(4), precluded cancellation on this basis, but allowed a court to order the proceeds paid to someone other than the beneficiary who is equitably entitled to the policy proceeds. The court quoted the legislative history indicating that the legislature thought this would discourage insurers from issuing policies to persons without insurable interest by making the insurer pay, but to an equitably entitled person rather than the stranger.
In this case, no other person came forward claiming any equitable right to the policy proceeds. The appeals court rejected the insurer’s statutory arguments that another statute (an anti-gambling statute) precluded payment. The court held that the statute made it clear that the bank as beneficiary was entitled to the proceeds of the policy. The insurer had to pay, and lost its argument on interest and bad faith damages for its delay.
There is a moral hazard associated with investing in stranger-0wned life insurance policies and related efforts to separate elderly policyholders from their life insurance policies. But in many cases there are very legitimate and important reasons to allow an insured to use a life insurance policy to provide immediate cash in exchange for altering the beneficiary or the ownership. This is a very complex area, made even more complex by the securitization of life insurance policy proceeds. But the bottom line on insurable interest seems to be that when the legislature expands the definition of insurable interest, as has been done in Texas, or, as Wisconsin did, decides as a public policy that cancelling the insurance policy where there is no insurable interest, but at the same time allowing the insurer to keep the premium and not pay the death benefit, is a disincentive to issuing policies without a real insurable interest, insurance companies may find themselves paying out more than anticipated.
Thanks to my partners Peter Kramer and Gary Timin for their comments on this post.