United States: New Jersey Supreme Court Rules On Insurable Interest And Return Of Premiums

On June 4, 2019, in a case captioned Sun Life Assurance Company of Canada v. Wells Fargo Bank, N.A., the Supreme Court of New Jersey answered two questions certified to it by the United States Court of Appeals for the Third Circuit regarding whether a transfer of control over a life insurance policy and its benefit soon after issuance, from an individual or entity who had an insurable interest to an investor who did not, satisfied New Jersey's insurable interest requirement. Specifically, the Third Circuit asked (1) whether such a policy contradicted New Jersey public policy and is therefore void ab initio, and (2) whether the owner of such a voided policy can recover any premiums paid. The New Jersey Supreme Court held that such policies are void, but that in some circumstances a party may be entitled to a refund of premiums paid, depending on the party's knowledge of and participation in the policy's issuance and initial transfer.

The underlying Third Circuit appeal involves a $5 million life insurance policy (the "Policy") issued in 2007 by Sun Life Assurance Company of Canada ("Sun Life") on the life of Nancy Bergman. Mrs. Bergman listed the Nancy Bergman Irrevocable Trust as the sole owner and beneficiary of the Policy. Her grandson, Nachman Bergman, was the initial trustee and beneficiary of the trust. Four investors – all strangers to Mrs. Bergman – funded the Policy, depositing money into the trust account to pay the Policy's premiums. About five weeks after the Policy was issued, Mrs. Bergman's grandson resigned as trustee and appointed the four investors as successor co-trustees. The investors then amended the trust agreement to ensure that most of the Policy's benefits would flow to the investors, and to grant them the power to sell the Policy. Just over two years later – after the contestability period in the Policy expired – the trust sold the Policy to SLG Life Settlements, LLC. The Policy bounced to a company named LTAP, and Wells Fargo Bank, N.A. ("Wells Fargo") later acquired it in bankruptcy in 2011. Wells Fargo claimed to have paid almost $2 million in premiums on the Policy.

After Mrs. Bergman passed away in 2014, Wells Fargo submitted a death benefit claim. Sun Life then sued for a declaration that the Policy was void ab initio as a purported "STOLI" policy. Wells Fargo countersued for the death benefit, and a refund of the premiums if the court voided the Policy. Because no New Jersey court had previously considered whether such a transaction violated the state's insurable interest law, the Third Circuit certified the above questions to the New Jersey Supreme Court.

Chief Justice Rabner answered these questions in a robust opinion. After walking through a comprehensive history of life insurance, the Court addressed whether a policy involved in the type of transaction at issue runs contrary to New Jersey public policy. The Court found that it does. The court relied on New Jersey's insurable interest statute, its Viatical Settlements Act, which prohibits the sale of certain life insurance policies for two years from the date the policy was issued, and the state ban on gambling as "relevant expressions of public policy." Justice Rabner also relied on other states' laws and court decisions that voided policies issued in similar transactions. While the Court completely rejected the validity of a life insurance policy procured and financed by investors, it held that it could not adopt a bright-line rule for policies procured by someone with an insurable interest but later transferred to strangers for full reimbursement of premiums paid and some compensation. Instead, the Court reasoned that several considerations, including timing and the reason for transfer, could determine whether the policy was an illegal "STOLI" policy or part of a legitimate transaction.

The Court further held that policies issued in transactions similar to the one at issue here are void ab initio, following the lead of several other courts in the country. Moreover, the Court ruled that the Policy's two-year incontestability clause – required under New Jersey law – cannot bar challenges to an illegal "STOLI" policy because such policies are void ab initio, meaning the contract never came into effect, so the incontestability clause also never came into effect and is inoperative.

However, the Court also held that the life insurance company may be required to refund the premiums paid under certain circumstances, finding that exceptions exist to the general rule that courts leave the parties to a void contract as they are. To determine whether a party is entitled to a return of premiums, a court must engage in a fact-sensitive inquiry of the particular case and balance relevant factors, including a party's level of culpability, its participation in or knowledge of the "STOLI" transaction, and its failure to notice "red flags" that normally indicate "STOLI" policies. If these circumstances weigh in favor of the policyholder, then the holder may be entitled to a refund of its premiums paid towards a voided policy. The court also noted that a "later purchaser" who was not involved in the illicit conduct would normally be entitled to a refund of premiums paid.

The New Jersey Supreme Court's decision aligns New Jersey law with that of several other states, including Delaware and Illinois, in holding that a policy whose beneficial interest is transferred soon after issuance may run contrary to public policy and be void ab initio. However, the Court's holding that a policyholder may be entitled to the return of its premiums if it was not complicit in the alleged "STOLI" transaction means that tertiary market purchasers should be able to recoup some or all of their investments even when a court finds a policy is void. Unfortunately, the Court did not go so far as to hold that the insurance company must always return the premiums when a policy is voided.

Ultimately, the New Jersey Supreme Court's decision adds to the uncertainty surrounding the validity of policies that were transferred soon after issuance. It also likely adds to uncertainty surrounding policies funded through certain forms of non-recourse premium financing. Rather than drawing a bright-line rule, the Court's analysis signifies that every challenge to insurable interest under New Jersey law will require a fact-based determination about the issuance of the policy and the reasons for its initial purchase and subsequent transfer. Even the return of premiums is not guaranteed and will require a fact-intensive inquiry involving the balancing of various factors. As a consequence, investors will continue to face litigation risk on life settlement policies governed by New Jersey law.

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