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In 2009, the Penn Mutual Life Insurance Company sued a trust and its trustee in a Delaware federal court, alleging the life insurance policy issued to them was part of an impermissible “stranger oriented life insurance” or “STOLI” scheme. Penn Mutual sought to rescind the policy because of “material misrepresentations” it relied upon when it placed the coverage.

The trust filed a counterclaim against Penn Mutual, essentially arguing that any misrepresentations in the policy application were made by Penn Mutual’s agents and should therefore be imputed to Penn Mutual itself. Penn Mutual asked the Delaware court to dismiss the counterclaim. But the court refused.  On July 30, 2010 it held the trust’s allegations “implicate legal and factual issues related to agency” and allowed the counterclaim to proceed further. The case is styled civil action number 09-677, Penn Mutual Life Insurance Company v. Barbara Glasser 2007 Insurance Trust, in the United States District Court for the District of Delaware.

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Penn Mutual Life Insurance Company sued two insurance agents, Kevin Bechtel and Steven Brasner, alleging they unlawfully initiated a “stranger originated life insurance” or “STOLI” policy. Penn Mutual claimed Bechtel and Brasner contacted a seventy-one-year-old woman, encouraged her to participate in a STOLI scheme, and then submitted an “Agent's Underwriting Report” which falsely stated the policy was not intended for sale in the secondary market and the premiums would not be paid with borrowed funds. Brasner was to receive 60% of the policy’s sales commission. Bechtel was to receive 40% of the commission

Bechtel moved to dismiss the case, arguing that the Illinois federal court did not have jurisdiction over him because he did not: (1) do business in Illinois, (2) speak with the woman insured by the policy while he was in Illinois, or (3) sign the underwriting report. The Court was not persuaded. It denied Bechtel’s motion and noted he carefully crafted his statements to leave the misleading impression that he did not engage in any conduct with regard to the policy, but did not actually deny any of the essential claims against him. The Court concluded it had jurisdiction because Bechtel had an Illinois insurance agent’s license and was therefore subject to suit in Illinois. Bechtel also asked the Court to dismiss the case because Penn Mutual had not “stated a claim” against him. The Court refused, stating Bechtel’s arguments “merit little discussion.” It denied the motion on a procedural matter and also restated the obvious sufficiency of Penn Mutual’s allegations.  

Notably, Bechtel’s co-defendant Brasner has been accused in other civil actions alleging the same type of STOLI scheme, including suits filed by Axa Equitable Life Insurance Company and West Coast Life Insurance Company. He was also indicted in Florida on charges of grand theft, insurance fraud, creating an organized scheme to defraud, and aggravated white-collar crime for allegedly inflating the income and net worth of several senior citizens on life insurance applications to foster STOLI transactions.

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       Liberte Capital Group advertised itself as a “viatical investment company.” Its stated business was to buy existing life insurance policies from terminally-ill or elderly persons with a lump-sum payment and then receive the policy benefits when they died. But in reality, Liberte was a fraud. Its chief executive was convicted of two counts of conspiracy and 155 counts of money laundering for buying life insurance policies from others who, with his assistance and through false statements, acquired the policies after receiving diagnoses of terminal illnesses. The owner of Liberte’s escrow agent was also convicted of multiple counts of fraud and tax violations relating to the transactions and sued for embezzling the company’s assets. 

       On May 28, 2009, the United States Court of Appeals for the Sixth Circuit made the most recent examination of Liberte’s affairs after Liberte’s receiver sued for rescission of three policies and return of the premiums. The Court’s opinion contains the unexpected and remarkable statement that:

The viators’ purchases of the insurance policies with the intent to re-sell them to Liberte immediately constituted insurance fraud, because the viators never intended to insure their own lives.

       It would not have been remarkable for the Sixth Circuit to label the policies fraudulently-procured. The false statements in policy applications were legion and well-litigated. The Court’s statement was remarkable because it focused on the insured person’s intent to immediately sell the policy to an investor. 

       STOLI is an acronym for “stranger-owned life insurance” or “speculator-owned life insurance.” It is a shorthand reference for transactions in which someone buys insurance on his own life only to sell it to a third party, often an unrelated investor, once the policy’s contestability period expires. For those who participate in STOLI transactions, the Court’s opinion is noteworthy. Perhaps inadvertently, perhaps not, the Sixth Circuit’s opinion classifies the basic STOLI transaction as “insurance fraud.” 

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     Litigation involving “stranger-owned life insurance” or “STOLI” is on the rise as insurance companies take aggressive legal action to rescind policies that they perceive to be involved in STOLI transactions.  These cases may be the beginning of a cottage industry of litigation concerning alleged STOLI arrangements.

     In January, a New Jersey federal court ruled that Lincoln National Life Insurance Company could seek rescission of a $3 million policy allegedly used for a STOLI transaction. In February, Hartford Life and Annuity Company announced that it was nearing a settlement of a case in a Texas federal court involving its rescission of a $5,900,000 policy. And on March 31, 2009, a Florida federal court ruled that Axa Equitable Life’s claim to rescind five policies—valued at approximately $73,000,000—would be decided partially in arbitration.

     The cases have two characteristics in common. First, the insurers base their claim for policy rescission on alleged misrepresentations in the policy application—usually that the insured person falsely stated that he or she did not intend to sell the policy in a secondary market transaction. Second, the policies involved carry a multi-million dollar death benefit. Based on the vast market for STOLI policy transactions, future cases involving these characteristics appear imminent. 

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STOLI is an acronym for “stranger-owned life insurance” or “speculator-owned life insurance.” It is a shorthand reference for transactions in which someone buys insurance on his own life for the purpose of selling it to a third party, often an unrelated investor, once the policy’s contestability period has expired. A recent ruling by a federal court in New Jersey, however, may undermine the security of such investments.

In a STOLI transaction, the insured person typically gets cash for the policy and the investor receives the right to the policy benefits when the insured person dies. Life insurers loathe the transactions because investors are unlikely to let STOLI policies lapse, meaning that insurers will have to pay death benefits on a greater percentage of insurance contracts than they have become accustomed. 

On January 27, 2009, the United States District Court for New Jersey became one of the first courts to weigh-in on what may become a recurring topic of litigation—an insurer’s effort to rescind one of its life insurance policies because of the possibility that it would be sold in a secondary market in a STOLI transaction. 

In Lincoln National Life Insurance Company v. Calhoun, Lincoln National sued to rescind a $3 million policy on the life of Walter Calhoun. First, the insurer argued that the policy is void because Calhoun intended—at the time he applied for the policy—to sell it to “stranger investors” in the secondary life insurance market, thereby removing the necessary insurable interest.  Second, Lincoln National argued that Calhoun made a material misrepresentation in his application by falsely stating that he had not discussed the possible sale or assignment of the policy in a secondary market.  

The court held that Lincoln National properly stated a case, noting that a material misrepresentation on the policy application may be reason to void the policy. But more importantly, the court added that Lincoln National’s allegation of no insurable interest could also serve to void the policy. The court held, “Insureds begin to run afoul of the insurable interest requirement, however, when they intend at the time of the policy's issuance, to profit by transferring the policy to a stranger with no insurable interest at the expiration of the contestability period.” 

The impact of the court’s insurable interest holding could be enormous. The market for STOLI policies is now estimated to be in the tens of billions of dollars. The court’s ruling that a policy may be void if the insured person intended, at the time of purchase, to transfer the policy to one without an insurable interest may undermine the security of those STOLI investments.     

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I have previously used this forum to describe instances of life insurance abuse and stress the role that human nature plays in those abusive acts. With the regulation of life insurance practices remaining a noteworthy topic, especially in the context of stranger-owned, bank-owned, and corporate-owned life insurance, these abusive acts should be a constant reminder of the potential harm that may result when a person has an incentive to profit from another’s early death. 

One especially horrific example of such abuse involves a scheme devised by Francis Marion Black, Jr., who was convicted of murdering twelve-year-old Marvin Noblitt to claim life insurance benefits. Black was sentenced to death. The appeals court that affirmed Black’s conviction held that there was no doubt that he formed, planned, and committed the crime. His acts were inhuman and the evidence from his trial supported the conviction.

Black and his wife Guinevere were married in 1934 and promptly lost their savings through poor stock investments.  Black schemed to recapture the losses by adopting a boy, purchasing an insurance policy on the child’s life, and then killing him in a way that appeared accidental. He contacted two insurance companies about policies on the life of a boy he “intended to adopt.”  He requested $50,000 in coverage, but was told that he could insure a child for only $5,000. 

Black and his wife then moved to San Benito, Texas and began asking about a twelve or thirteen year old boy they could adopt. Black met Marvin Noblitt’s mother, told her that he intended to open an ice cream parlor in San Antonio, and wanted to adopt a boy who would work at the store before and after school. Marvin’s mother refused the adoption. But she allowed Black to take him for six months and said she would reconsider the adoption if Marvin liked the arrangement. 

A few days after arriving in San Antonio, Black applied for a $5,000 policy on Marvin from the Acacia Insurance Company, which refused the application. Undeterred, he applied to the Great American Insurance Company for a $5,000 policy. Black lied in the application and stated that he had cared for Marvin since taking him from an orphanage in Oklahoma. Great American issued the policy on May 29, 1938 and named Black as the policy beneficiary. 

Within a week, Black and Guinevere packed all of their possessions and began driving to San Antonio with Marvin. They stopped in Alpine, Texas on June 8th. Black went to a local drug store the next morning and asked about post cards of the Grand Canyon, the local mountain scenery and places of interest within a hundred miles of Alpine.  The pharmacist did not have the post cards, but suggested that Black visit Alpine’s Chamber of Commerce.  He did so and asked about the Limpia, Grand, and Santa Helena Canyons.  The Chamber of Commerce gave him information about the scenic beauty of the country and Agua Frio Springs, located at the foot of a 400 foot cliff.  Later that day, Black went to Agua Frio Springs.

The Agua Frio Springs were on a private ranch and the ranch’s owner appeared at Black’s trial. He testified that the springs were located at the foot of a cliff, approximately 400 feet high.  He also testified that Black, accompanied by his wife and a child, arrived at the ranch on June 9th at about 5 p.m. and asked for permission to look at the springs, the bluff, and the scenery.  He granted Black’s request and, in a very short time, saw two people on top of the cliff rolling stones into the canyon.  About thirty minutes later, Black went to the ranch house and reported that his little boy had fallen off the cliff and was injured.  The rancher drove his truck to the foot of the cliff and brought Marvin’s mangled body back to the ranch house. Marvin’s body was then taken to an undertaker in Alpine. 

Black told the undertaker that he had adopted the boy but had not yet gone through all of the legal formalities. He added that he had taken the boy from Oklahoma about a year earlier and that there was no reason to delay the burial because he did not think he could ever find the boy’s mother.  Black also said that he did not have much money and asked if the undertaker would help him collect a $5,000 insurance policy on the boy’s life.

After the funeral, Black and Guinevere were arrested and charged with homicide. Black made a written confession in which he admitted the killing. The confession stated that Black went to the top of the cliff with the boy, threw a few rocks, and then shoved the boy off the cliff.

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     Near this time every year, I am reminded of this story.  And it demonstrates why insurance regulators and policy makers who are currently analyzing regulations on life settlements and “stranger owned life insurance” should consider the impact of human nature on those insurance transactions.  Insurance products are frequently abused by profiteers and life insurance policies pose a significant risk in the hands of the unscrupulous. There is no better example of this abuse than Ronald Clark O’Bryan.

     Ronald Clark O’Bryan had serious personal financial problems. He earned $150 per week, was eight months behind on his car payments and had total debts up to $100,000. In January of 1974, over his wife’s objection, he took out $10,000 life insurance policies on both of his two children. Later that year, over the objection of his life insurance agent, he bought additional $20,000 life insurance policies on his son and daughter.  By mid-October, both of his children were covered by several life insurance policies but O’Bryan had virtually no coverage on himself. It was also at this time that O’Bryan told a creditor that he expected to receive a large sum of money before the end of the year and extended his debt obligations into 1975.

     In August of 1974, O’Bryan, who worked as an optometrist, asked his manager for cyanide to clean gold glass frames—an unusual request considering that cyanide had not been used in the industry for over twenty years.  He also talked about the commercial uses of cyanide with his co-workers, as well as what dosages of the chemical would be deadly. After his request for the cyanide was denied, O’Bryan asked a friend (and employee of Arco Chemical Company) where he could buy cyanide and, “out of curiosity,” what doses would be fatal to humans. He finally asked how one could detect the presence of chemicals in a dead body. 

     Two weeks before Halloween, O’Bryan bought costumes for his children and appeared excited about taking them “trick or treating” even though he had never been excited about it before. A week later, he invited a friend’s family to dinner on Halloween night and suggested that the children from both families “trick or treat” together. 

     On Halloween, the families met for dinner as planned and then went “trick or treating.”  The group approached a house, only to find no one home. The children ran to the next home, but O’Bryan remained behind in the darkness for about thirty seconds.  He quickly caught up with the group holding “giant pixy styx” and exclaimed that the "rich neighbors" were handing out expensive candy. 

     When they returned home, O’Bryan’s son Timothy asked for one of the pixy styx. He took two gulps of the powder, complained that it tasted bad and began vomiting. He went into convulsions and was taken to the hospital where he died within an hour. Fluids taken from his stomach contained 16 milligrams of cyanide.  The level of cyanide in his blood was .4 milligrams.  A fatal human dose of cyanide is a blood level between .2 and .3 milligrams.

     On November 1st, O’Bryan met with the funeral director and learned that a separate death certificate was required to make a claim under each policy on Timothy’s life. He ordered six death certificates. He also described how he intended to use the insurance policy benefits and said the didn't see how the police could “pin” the death on anyone.

     O’Bryan was mistaken. The police did, in fact, pin Timothy’s death on him. O’Bryan was tried, convicted, and sentenced to death. He was executed by lethal injection on March 31, 1984.

     The story of Ronald Clark O’Bryan is horrific. It is almost impossible to comprehend how a person could murder his or her own child for life insurance proceeds. But examples of life insurance abuse, often equally horrific, are legion. And such examples speak volumes about how basic human nature, when presented with profiteering opportunities through life insurance, can produce unimaginable results. 

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     Virtually every jurisdiction in the United States recognizes a person’s right to insure his or her own life and name another as the policy beneficiary, either through an assignment or express designation. The designated beneficiary or assignee is thereafter deemed to have an insurable interest in the insured person’s life by virtue of that designation or assignment. 

     In the context of life or viatical settlements, the requirement of an insurable interest is typically satisfied when the insured person assigns the policy to the purchaser. The insured person in a “stranger owned life insurance” or “STOLI” transaction may likewise satisfy the insurable interest requirement through designation or assignment. Thus, it is arguable that the beneficiary in both life settlement and STOLI transactions have an insurable interest in the insured person’s life because of the assignment—an act taken by the insured person himself.

     One matter absent from the current debate over life settlement and STOLI transactions, however, involves the maintenance of an insurable interest after a secondary transfer of the policy. Most contracts may be transferred time and time again. But life insurance policies are not like most contracts because the requirement of an insurable interest is a fundamental. It is therefore likely that the second (or third, or fourth) assignee of the life insurance contract will not have an insurable interest in the insured person’s life—the insured person did not assign the policy to the subsequent owner or name it as the policy beneficiary. And in many jurisdictions, the absence of an insurable interest renders the policy void as a wagering contract that violates public policy.

     To learn more about this topic, please contact any of the firm's partners at mmellp.com.

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     The appropriate use, or misuse, of certain life insurance products remains a hot topic of conversation. Earlier this year, Florida passed legislation about who may benefit from life insurance policies. The State of Washington recently banned “dead peasant” insurance. And more than twenty-five states are now analyzing regulations concerning life settlements and “stranger owned” life insurance.

     Policy makers addressing these issues should, first and foremost, consider the impact of human nature on transactions in which one may profit from the death of another. Human nature is a dangerous thing, writes George Will. There are few statements so consistently true. 

     Insurance products have been abused by speculators since the beginning of insurance itself. Life insurance is no different. And that vehicle, fueled by human nature, will always present a profit opportunity for the unscrupulous.

     One fascinating example of such unscrupulous speculation is a policy purchased by National Convenience Stores, Inc., the former operator of the Stop-N-Go chain of convenience stores. During the summer of 1991, NCS bought insurance on the lives of all its Texas employees. It also designated itself as the policy beneficiary and was entitled to $250,000 every time an employee died on the job. 
 

     At the time it bought the policy, NCS’ business was failing. It filed for bankruptcy protection just a few months later. In December of 1991, the company, according to one executive, “had no money in the bank.” 

     But while its core business was failing, NCS experienced a remarkable number of employee deaths. Six employees died during the policy term, mostly from robbery-related murders. NCS was paid $1.5 million in policy benefits. And because the policy premium was approximately $620,000, the bankrupt company profited by almost $900,000 because of employee deaths. The insurance broker who placed the policy and had to process the claims, suggested prayer a way to control the mounting losses.

     Notably, NCS decided not to invest in many safety devices because it stated that it could not afford them. It decided against bullet-proof glass and drop safes for stores in high-crime areas. It also decided against having multiple employees on duty during late-night hours when crime was highest. Once it emerged from bankruptcy, and after the policy term expired, NCS was acquired by a competitor that installed new safety devices. On-the-job deaths then decreased dramatically.
 

     The NCS example is worthy of consideration. Defenders of practices such as broad-based, leveraged, corporate owned life insurance often argue that the coverage poses no moral hazard because the corporate beneficiary would never murder its insured employees. But as the NCS policy demonstrates, murder is not the relevant inquiry. The relevant inquiry, the moral hazard, is whether one wagers on the early death of another. NCS made a substantial profit, not from murder, but by depriving its employees of a safe work environment. 

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     Last October, television personality Larry King filed suit against insurance brokers Alan Meltzer and the Meltzer Group, Inc.  The suit concerned policies that are sometimes called “Stranger Owned Life Insurance,” "STOLI," or “Speculator Owned Life Insurance.”  (see the complaint).  The essence of a “STOLI” transaction is that the insured person buys the policy on his life while intending to immediately sell the policy to a third party.

    King alleged that, on the advice of the brokers, he bought a $10 million policy on himself and promptly sold it for $550,000. He also sold an existing $5 million policy for $850,000 in cash. King’s suit alleged that the brokers were liable to him because he did not receive enough money for the policies, the brokers did not adequately advise him about his continuing life insurance needs, he had unexpected tax consequences from the transactions, and the brokers improperly benefitted themselves at his expense.

     King’s suit also alleged that the brokers sold the policies on his life to an entity named Coventry First, LLC, a member of The Coventry Group. As I have previously written, The Coventry Group is the brokerage firm that drafted memos concerning Winn-Dixie’s policies of “Corporate Owned Life Insurance” that spawned the name “dead peasant” insurance for COLI products.  (see the entry). 

     King agreed to a settlement during July 2008.  The presiding court entered an order dismissing the case on August 4, 2008 because of the settlement.  The parties did not disclose the settlement terms. 

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