The life settlement market enjoyed a ‘win’ on July 27; the Supreme Court of Arizona answered “No” to the question: “Does Arizona law permit an insurer to challenge the validity of a life insurance policy based on a lack of insurable interest after the expiration of the two-year contestability period required by A.R.S. § 20-1204?”
The case is the latest of many legal contests between life insurance companies and life settlements investors on the topic of insurable interest; the former, in this case, Columbus Life Insurance Company filed suit in Arizona, claiming that a life insurance policy on Howard Peterson, who died in January 2018, and Eunice Peterson, who died in May 2020, was issued without the required insurable interest. Columbus Life claimed the policy was void because it lacked an insurable interest, and therefore the contract and the two-year contestability period (the period in which a life insurance policy in the US cannot be sold or transferred) never existed, thus it was not obligated to pay the death benefit to the securities intermediary, which represented the interest of the investor.
“The result is an important victory for the life settlement industry. Incontestability statutes have been ubiquitous in the US for a hundred years but remain a frequent subject of litigation – particularly in recent years, as insurers have argued for an “insurable interest exception” that would permit them to challenge even policies that have been in force for decades,” said Jule Rousseau, a Partner at law firm ArentFox Schiff, which advised the securities intermediary Wilmington Trust in the case.
“The Arizona Supreme Court has definitively rejected these arguments and made clear that Arizona’s incontestability statute prohibits insurers from challenging policies for lack of insurable interest after the contestability period has passed,” Rousseau added.
A spokesperson for Western & Southern Financial Group, owner of Columbus Life Insurance Company, wrote in an emailed statement to Life Risk News, “While we are disappointed in the court’s ruling, we do not otherwise comment on pending litigation.”
Institutional investors that have allocations to the life settlement asset class benefit as their asset managers’ exposure to policies issued in Arizona now face lower legal risk. Indeed, the Arizona Supreme Court ruling brings the state in line with other states, such as New York, Florida, and Michigan, which have already ruled in similar cases. But that’s not always the case.
“Courts have routinely enforced incontestability in all cases except insurable interest and some odd imposter cases for years. Thus, the concept is widely recognised, yet the insurer argument that a policy that was issued without requisite insurable interest was void and thus not subject to a contractual obligation of incontestability has been accepted in some states,” said Rousseau.
But New Jersey and Delaware are two states that have heard similar cases and ruled against the life settlement investor and/or securities intermediary. The lack of uniformity at the state level brings into focus the risk management function of a life settlements asset manager, namely that the regulatory environment in the life settlement market is a risk that needs to be managed by a life settlements portfolio manager, just like other risks they are exposed to, such as valuation risk, longevity risk and Cost of Insurance risk (another risk where lawsuits have occurred). Buying policies of insureds in states which have ruled in favour of the life settlement market, like New York, Florida, Michigan, and now Arizona, whilst reducing exposure to policies of insureds in New Jersey and Delaware, for example, on the face of it is a risk mitigation exercise that would seem to make sense. Other states have ruled in favour, making this risk less of a concern.
“Most states in the US have already heard similar cases, in particular, the larger, more populous states,” said Rousseau. “The legal risk from the perspective of the contestability of insurers when it comes to insurable interest is there in some states, but low overall.”
The ruling isn’t just a win for the life settlement market, however. The individual insureds also benefit, because if carriers are precluded from later challenges, the reduction of risk to life settlement investors should lead to a better market for sellers/viators. The life settlement industry generally touts itself as being a ‘consumer good’, because the insured receives more from a life settlement transaction that it would from the cash surrender value from the carrier – and so the ruling means that the Arizona resident can rest assured that their policies will be more tenable in the market.
“This is undoubtedly a win for the consumer as well,” said Rousseau. “Insurers in many states have argued for an “insurable interest exception” that would permit them to challenge even policies that have been in force for decades. States that permit challenges years after a policy was issued cause life settlement investors to tread more cautiously in those states, reducing the likelihood of a transaction occurring. Arizona residents should have more confidence that investors find the state an attractive place to do business.”