Regulation Not Prohibition: The Comparative Case Against the Insurable Interest Doctrine
The Comparative Case Against the Insurable Interest Doctrine
Regulation Not Prohibition: The C omparative Case Against the Insurable Interest Doctrine
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1 Sharo Michael Atmhe, Regulation Not Prohibition: Th e Comparative Case Against the Insurable Interest Doctrine , 32 Nw. J. Int'l L. & Bus. 93, 2011
Regulation Not Prohibition: The
Comparative Case Against the
Insurable Interest Doctrine
Sharo Michael Atmeh
TABLE OF CONTENTS
Introduction ...................................................................................... 94
Precedent & Comparative Background on the Insurable Interest
A. What is the Insurable Interest Doctrine?................................... 97
Law Clerk to the Hon. Chief Judge Alvin W. Thompson, U.S. District of Connecticut. J.D.,
Harvard Law School, 2011; M.P.P., Harvard Kennedy School, 2011; B.A., Rutgers College,
2007. I would like to thank Amal Charro and Michael Atmeh for always reminding me that
the rule of law is precious and that it ought to be paramount. For his patience in developing
a young writer, I would like to deeply thank Professor Robert H. Sitkoff. Finally, I thank
Professors Sarah Wald and Chris Stone for their unending willingness to help improve an
idea and ask, “Why does this matter?”
For hundreds of years, people have been trying to invest in the lives of
other persons through insurance policies; meanwhile, the insurable interest
doctrine has attempted to stop them and failed. In the United States, widely
divergent insurable interest laws in the several states nominally prohibit
taking out a life insurance policy on an individual without having a stake in
the person’s well-being.1 The logic behind this rule is obvious: to prevent
the creation of a futures market on a pool of individuals’ lives. However,
this paper argues that the rule does more harm than good. There are
plausible policy reasons for such a rule, but those policies can be achieved with
other more finely tuned, specific, and coherent rules. Laws preventing
individuals from collecting improperly on life insurance or by fraudulently
drawn wills already alleviate much of the problem of any potential futures
market in individual well-being. The structure of the insurable interest rule
is not only completely duplicative of laws preventing fraud in the field, but
it also creates massive amounts of evasion by market actors and engenders
substantial transaction costs.
While the insurable interest doctrine sounds like an age-old component
of the common law, it is not. Prior to 1745, a pecuniary or emotional
interest in the subject of an insurance policy was not a requirement for the
receipt of a payout from that policy. Thus, insurance contracts were held
valid, notwithstanding that the absence of an insurable interest gave the
transaction the characteristics of a wager.2 The insurable interest doctrine
developed in response to the common law’s validation of such contracts in
an effort to both prevent wagers on the lives of individuals and to quell
attempts to destroy the subject of an insurance policy. Lacking more finely
tuned regulatory tools, the insurable interest doctrine was developed by an
English parliament trying to rein in such “wagers” in the mid-eighteenth
The doctrine is now effectively avoided by persons who structure their
deals to escape its reach. Even before these evasion techniques were
developed, as discussed below, the doctrine was expanded via statute to the point
where the purported barrier became meaningless to sophisticated parties.
Well-informed parties can simply thwart the doctrine through the creation
of a “cloak” that tricks insurance firms into thinking an insurable interest
does exist in an insurance policy. A common cloak works by making it
nominally appear that the person taking out the insurance policy has an
interest in the subject of the insurance, because the cloak makes it look like it
is the insured herself taking out the policy. Further, a statutory loosening of
the insurable interest doctrine expanded the definition of who may take out
an insurance policy far enough that even the mildest pecuniary connection
can qualify for an insurable interest alongside individuals with an affective
or consanguine interest. Even before these modern evasions, however, at
least one scholar in history claimed that the insurable interest doctrine was
merely technical and should be eliminated because criminal, trust, and
estate law otherwise protect an insured from being murdered by
contemporaries holding an insurance policy on the insured’s life.3
Reform in this area is particularly difficult, largely because companies
promoting life insurance transferability resist regulation, as do the insurance
firms that underwrite the policies. For example, because insurers benefit
from an option to later invalidate insurance policies, they have an interest in
maintaining the insurable interest doctrine, as it allows them to retain a
lastditch defense against the assignment of a policy. Furthermore, the firms
that operate in the realm of transferring insurance policies by creating
cloaks seek to retain the profits gained from fees charged to structure these
transactions. Indeed, because of the complex structuring involved, much of
the financial benefit from the industry in secondary life insurance does not
accrue to either the insured or the person to whom the policy is transferred.
Often times, the insured is forced to pay out insurance premiums on a
2 LEE R. RUSS & THOMAS F. SEGALLA, COUCH ON INSURANCE § 41:1 (3d ed. 2011).
3 Cf. Edwin W. Patterson, Insurable Interest in Life, 18 COLUM. L. REV. 381, 390 (1918)
(citing FREDERICK H. COOKE, THE LAW OF LIFE INSURANCE §§ 58, 59 (1st ed. 1891) for the
propositions that criminal law protects against murder; while “unjust enrichment” law
protects beneficiaries from collecting on insurance policies which are triggered by their
murdering the subject of the insurance—today these laws would be known as “slayer” laws).
cy that the insured has been told will be resold by an arranger—only to later
find out that the policy is not salable. At other times, insurance companies
will turn a blind eye to potential problems in insurable interest at the
formation of a policy—only to later rely on the insurable interest doctrine as
an affirmative defense when the policy is redeemable. Yet other times,
individuals seeking to invest in the insurance market by purchasing other
insurance policies are told that a policy will reap double-digit returns—only
to realize that the arranger of a policy, like Life Partners Holdings Inc., has
substantially understated the risk involved in such an investment.4 All of
these market failures come about as a result of the insurable interest
This paper will argue that the insurable interest doctrine no longer
achieves the regulatory goals that it intends to achieve. I advocate for an
elimination of the doctrine. As an affirmative defense, allowing insurance
companies to invalidate an insurance policy many years after its inception it
is too blunt a regulatory instrument. Developments in the modern market
and other financial regulations, including the development of a modern
regulatory environment for securities, obviate the need for an insurable interest
doctrine. The idea that individuals should be free to alienate their own
insurance policies is not new, and neither is the idea that the doctrine should
be eliminated entirely. This paper takes the view that the American legal
system should follow the lead of Australia to eliminate the insurable interest
doctrine entirely for both property and life insurance, while creating a
comprehensive national regulatory scheme that will streamline a market bloated
with unnecessary actors and a thicket of burdensome and conflicting
Arguing for the elimination of the insurable interest doctrine in
America through a comparative lens is unique to this paper. Part II will explore
the parallels between development of the insurable interest doctrine in
England and the United States. It will then explain the plethora of American
laws and model codes that attempt to elucidate the doctrine, but which
continue to fall short and lead to highly inefficient case-by-case determinations.
Part III will explain how a highly complex market has developed with the
sole purpose of getting around the insurable interest doctrine in the life
settlement market. The section will then explain the policy reasons for the
elimination of the doctrine, focusing on the elimination of transaction costs.
Part III will highlight how the insurable interest doctrine harms the actors it
was meant to protect: individual persons who are the subject of insurance
policies and persons who seek to invest in such policies. Finally, Part IV
will show that the natural experiment in Australia proves that the insurable
4 See Scism, supra note 1. 5 See infra Part III.E.2.
interest doctrine can be eliminated without any significant effect on the size
or financial sustainability of the insurance industry, but with greater
freedom for both consumers and investors to enter a regulated market. Indeed,
the Australia example will show that the insurance market continues to
grow, even in the absence of the insurable interest doctrine.
II. PRECEDENT & COMPARATIVE BACKGROUND ON THE
INSURABLE INTEREST DOCTRINE
The insurable interest doctrine is, or was, a creature of statute in the
United States,6 England,7 and Australia.8 Under very similar historical
conditions in their respective insurance markets, these three nations developed
an insurable interest doctrine that substantially emulated an original English
doctrine. However, two of those three nations have either completely
eliminated (in the case of Australia) or substantially abrogated (in the case of
England) the insurable interest doctrine. In the field of insurable interest,
America is the laggard in insurance law. This part of the paper will
establish the historical similarity of the doctrine between England and the United
States to provide the necessary background for understanding why the
United States should follow the lead of England and Australia in
eliminating the insurable interest doctrine.
A. What is the Insurable Interest Doctrine?
The insurable interest doctrine requires that someone taking out
insurance either benefit from the preservation of the subject matter of the
insurance or suffer a disadvantage from loss of the insured subject.9 The history
behind this definition of the insurable interest in the three nations’ doctrines
can be traced back to two strands of English doctrine established by statute
in 1745 for property and in 1774 for life insurance. The first strand, dealing
with actual pecuniary losses for property, is the “indemnity” insurance
strand.10 The second strand, dealing with life insurance and loss of life, is
dubbed the “non-indemnity” insurance strand. Essentially, the insurable
6 See infra Part II.C.
7 See Life Assurance Act, 1774, 14 Geo. 3, c. 48, § I (Eng.).
8 See Life Insurance Act 1995 (Cth) s 200 (Austl.).
9 RUSS & SEGALLA, supra note 2, § 41:17.
As a general rule, it can be stated that a person has an insurable interest in the life
of another if he or she can reasonably expect to receive pecuniary gain from the
continued life of the other person and conversely, if he or she would suffer
financial loss from the latter’s death . . . .
Id. See also LAW COMM’N & SCOTTISH LAW COMM’N, INSURABLE INTEREST: ISSUES PAPER 4,
4 (2008) (U.K.), available at http://www.scotlawcom.gov.uk/download_file/view/203/107/.
10 Patterson, supra note 3, at 386 (defining “insurable interest” as a person’s “maximum
possible pecuniary loss from the happening of the event.”).
terest doctrine operates as a defense used by the insurer to estop insured
individuals who lack an interest in the person or object insured from
collecting on insurance policies after an insured event happens.
At common law—before the English legislature intervened with two
statutes—a gambling contract was not illegal.11 Thus, contracts “which
were cloaked in the guise of policies of insurance were valid . . . .”12 At the
time, parties simply declared whether they had an interest by using terms
like “interest or no interest” or “without proof of interest,” and, thus,
delineated whether they were making an indemnity contract or a wager.13
Without the “interest” clause, courts would construe the contract as one of
indemnity and give no remuneration to the insured unless she could prove an
actual loss.14 However, after the enactments of the Marine Insurance Act of
174515 and the Life Assurance Act of 1774,16 having an “interest”—whether
pecuniary or consanguine—became a non-elective, mandatory term for the
enforcement of any insurance contract.
B. History of the Insurable Interest Doctrine
In a sharp break with the common law, the Marine Insurance Act of
1745 invalidated insurance policies taken out on marine cargo if the person
taking out the insurance had no pecuniary interest in the goods.17 The
English Parliament came to require an insurable interest because it was found
“by Experience, that the making Assurances, . . . without further Proof of
Interest than the Policy, hath been productive of many pernicious Practices,
whereby great Numbers of Ships with their Cargoes, have . . . been
fraudulently lost and destroyed.”18 Indeed, going further, it was common in
England at the time to “wager on another’s life, in the form of insurance, by
persons in no way connected nor in any manner interested in the insured’s
life.”19 In transactions that have parallels to today’s insurance industry:20
Popular accounts of the period describe the practice of purchasing
11 KENNETH SUTTON, INSURANCE LAW IN AUSTRALIA 504 (3d ed. 1999).
15 Marine Insurance Act, 1745, 19 Geo. 2, c. 37 (Eng.).
16 Life Assurance Act, 1774, 14 Geo. 3, c. 48 (Eng.).
17 Marine Insurance Act, 1745, 19 Geo. 2, c. 37, § I (Eng.).
19 Gary Salzman, Murder, Wagering, and Insurable Interest in Life Insurance, 30 THE J.
OF INS. 555, 562 (1963).
20 See infra Part III.A.
insurance on the lives of those being tried for capital crimes. These
policies constituted naked wagers on whether the accused would
ultimately be convicted and executed for the alleged offense. A related
practice was the purchase of insurance on the lives of famous,
elderly persons; the premium would be a function of what was known
about the person’s health, including any recent illnesses.21
Given these practices, the English Parliament developed a major
concern over wagering not only on property but also on individual lives. Thus,
less than 30 years after the establishment of the insurable interest doctrine
for property, the doctrine was extended to life insurance contracts with the
Life Assurance Act of 1774.22 The locus of the 1774 enactment was not
necessarily a concern about hastening the death of these individuals, but
rather about gambling on a morally prohibited subject. In a similar preamble
to the 1745 enactment, Parliament states, “[i]t hath been found by
experience that the making insurances on the lives or other events wherein the
assured shall have no interest hath introduced a mischievous king of
gaming . . . .”23 Interestingly, Parliament seemed to have placed another
limitation on the writing of insurance policies at the time by stating that “no
greater sum shall be recovered or received from the insurer . . . than the
amount of value of the interest of the insured in such life or lives, or other
event or events.”24 Thus, it would seem that the same principles underlying
property insurance law—primarily in indemnity contracts—were applied to
individual lives by simply applying the property policy to life insurance.
Unfortunately, the English Parliament did not provide any guidance on
what exactly constituted an insurable interest, and it was left to the courts to
decide on a case-by-case basis through highly fact-dependent
As attitudes against gambling hardened, English law indirectly created
an insurable interest obligation for various property indemnity contracts
with the Gaming Act of 1845.25 Section 18 of the 1845 Gaming Act created
the requirement that a policyholder must be able to demonstrate an
insurable interest in the subject matter of the insurance; otherwise, the contract is
invalid as a “wager.”26 Marine insurable interest laws were also
strengthened with the passing27 of the Marine Insurance Acts of 190628 and 1909.29
21 ROBERT H. JERRY, II, UNDERSTANDING INSURANCE LAW 292 (3d ed. 2002); see also
Peter Nash Swisher, The Insurable Interest Requirement for Life Insurance: A Critical
Reassessment, 53 DRAKE L. REV. 477, 481 (2005).
22 Life Assurance Act, 1774, 14 Geo. 3, c. 48 (Eng.).
23 Id. pmbl.
24 Id. § III.
25 Gaming Act, 1845, 8 & 9 Vict., c. 109 (Eng.).
26 Id. § 18; see also LAW COMM’N & SCOTTISH LAW COMM’N, supra note 9, at 7–8.
27 LAW COMM’N & SCOTTISH LAW COMM’N, supra note 9, at 8.
The 1906 Act defined someone as having an interest in a marine adventure
[H]e stands in any legal or equitable relation . . . to any insurable
property at risk therein, in consequence of which he may benefit by
the safety or due arrival of insurable property, or may be prejudiced
by its loss, or . . . damage . . . or may incur liability in respect
While this definition provides some clarity about what an insurable interest
is, it does not provide for when facts and circumstances affecting such an
interest occur. The 1906 Act extended the penalties for taking out a marine
insurance policy without an insurable interest and made such action a
criminal offense, punishable by a fine or prison for up to six months.31
Evidently, though, no prosecutions ever occurred under this act.32 Even at this
point, the English parliament again did not provide guidance on the
insurable interest concept, and most of the heavy lifting with respect to defining
and regulating an insurable interest was left to the courts.
Two major cases interpreted insurable interest legislation prior to
2005. First, in 1806, Lucena v. Craufurd33 laid out the definition of
insurable interest for England and all of its territories. Establishing what later
became known as the beginnings of an economic “relationship” test, the
House of Lords stated, “[t]o be interested in the preservation of a thing, is to
be circumstanced with respect to it as to have benefit from its existence,
prejudice from its destruction.”34 Thus, if one’s position in life were either
benefitted or damaged by an interest in a life or object, then an interest can
be claimed in that subject. This logic seems mildly circular, as the
existence of one legal right depends on the existence of other legal or equitable
Over 100 years later, in 1925, Macaura v. Northern Assurance,35
helped sharpen the definition of an insurable interest only somewhat. In
Macaura, Lord Buckmaster indicated that no shareholder had any right to
any company property because she (or, more likely at the time, he) had no
legal or equitable interest.36 According to Macaura, a shareholder’s
relationship was to the company, not to the company’s goods, and thus any
28 Marine Insurance Act, 1906, 6 Edw. 7, c. 41 (Eng.).
29 Marine Insurance (Gambling Policies) Act, 1909, 9 Edw. 7, c. 12 (Eng.).
30 Marine Insurance Act, 1906, 6 Edw. 7, c. 41, § 5 (Eng.).
31 Marine Insurance (Gambling Policies) Act, 1909, 9 Edw. 7, c.12, § 1 (Eng.).
32 See SUTTON, supra note 11, at 8 n.17.
33 (1806) 127 Eng. Rep. 630 (H.L.) (appeal taken from Eng.).
34 Id. at 643.
35  A.C. 619 (H.L.) (appeal taken from N. Ir.) (Eng.).
36 Id. at 626.
damage to the goods was not to the shareholder, but merely to a company’s
assets.37 To at least one Lord adjudging the Macaura case, this difference
in interests mirrored the separation of ownership and control in a
corporation.38 The Macaura court also indicated that a creditor does not have an
insurable interest in a debtor’s property, but an interest did exist in the life
of that debtor.39
More recently, in 1987, the Supreme Court of Canada called into
question the legal interest test developed in Lucena through its decision in
Kosmopoulos v. Constitution Insurance Co.40 In Kosmopoulos, the court found
no basis in public policy for a restrictive formalistic definition.41 Thus,
overall, some economic relationship or concern in the subject of the
insurance would be sufficient for an insurable interest.42 This economic interest
test was said to fall in line with the majority of U.S. jurisdictions on the
topic.43 Uncertainty in both the definition and status of an insurable interest
remained paramount in England until 2005.
The area of insurable interest law remained unchanged in England, at
least legislatively, until the Gambling Act of 2005.44 The Gambling Act
intended to regulate new gambling ventures on the Internet and through
technologies that helped such transactions occur outside British Law. “[The
English] [g]overnment wanted to provide rigorous and effective protection
for the public by creating a regulatory regime for gambling.”45 The
Gambling Act repealed Section 18 of the 1845 Gaming Act, and replaced it with
the following language: “The fact that a contract relates to gambling does
not prevent its enforcement.”46 Thus, by making gambling legal in an effort
to regulate it in the United Kingdom, the insurable interest doctrine was
dealt a death knell—at least when it came to insurance relating to property.
Meanwhile, for life insurance, the 1774 Life Assurance Act still controls.
Thus, in England, the insurable interest doctrine was eliminated by
2. The United States
While the insurable interest doctrine developed formally in England
through statute, it appears to have developed with a public policy bent in
the United States.47 Mirroring the twin roots of the insurable interest
doctrine in England, the United States seems to have developed insurable
interest ideas separately for both property insurance (“indemnity contracts”) and
life insurance (“non-indemnity contracts”). The earliest reference to these
policies occurred in the property context in 1803 in Pritchet v. Insurance
Co. of North America.48 Treating insurable interest in property as a public
policy dictate, the Pritchet court stated:
We have adopted the policy and principles which gave rise to . . .
[The Marine Insurance Act of 1746] both in courts of justice and by
commercial usage; but we are not prepared to say, that every
particular provision or resolution under it, has been engrafted into our
system of law. An insurance amongst us, is a contract of indemnity. Its
object is, not to make a positive gain, but to avert a possible loss. A
man can never be said to be indemnified against a loss which can
never happen to him.49
This very early passage is interesting in many respects. First, it
directly cites to an earlier act of British Parliament, and says that it is adopting
those policies as a matter of public policy (through the common law) in at
least one of the states. Second, the court goes on to carve out precisely
which of the policies from the English statute that it is adopting into
American law. Judge Yeates chooses to peg the idea of an insurable interest to an
actual loss being wrought to a person claiming proceeds under an insurance
contract. Thus, the actual loss motive in this particular American judge’s
mind seems to differ slightly from the anti-gambling motives envisaged by
the British Parliament’s version of an insurable interest. These motives are
clear for the property or “indemnity” contract version of insurance policies.
More than ten years after the insurable interest doctrine was elucidated
for indemnity contracts, the insurable interest policy was applied to life
insurance.50 In Lord v. Dall, the Massachusetts Supreme Judicial Court stated
that the law of insurable interest applied to a life insurance policy taken out
by a sister to insure the life of her brother while he sailed on a cargo ship
from December 1809 to July 1810.51 The court in Dall did not base its
ruling—that insurable interest doctrine applied to life insurance—on the
English statute. Rather, the court said that a life insurance policy without an
insurable interest would be “contrary to the general policy of our laws. . . .”52
As to determining what an insurable interest truly is, the court found
satisfactory nothing more than the “common understanding no one would
hesitate to say, that in the life of such a brother the sister had an interest. . . .”53
In an unusual admonition, the court in Dall stated that it cannot easily be
discerned why the underwriters of such an insurance policy should question
its validity “after a loss has taken place, when it does not appear that any
doubts existed when the contract was made; although the same subject was
then in their contemplation.”54
Thus, as early on as the first cases that formulated the insurable
interest doctrine in the U.S., some interesting quirks in the doctrine are apparent.
First, American judges seem to base their decisions not on any statute, but
on some sense that insurable interest is integral to the public policy
structure of the states. It is important to note the deep similarities between
England’s basis in statute and the United States’ basis in public policy, as they
establish the insurable interest doctrine with the same principles, but with
two different methods of reasoning. Second, the determination of what
qualifies for an affective stake triggering an insurable interest is unclear,
and this lack of clarity existed even at the time of the doctrine’s inception.
Third, insurance companies have consistently asserted the insurable interest
defense well after the formation of an insurance policy, even though they
are entitled to examine issues concerning the insurable interest at the outset
of the policy—while the consumer is not allowed to create an insurable
interest after-the-fact to save the policy.
Over the ensuing decades, the insurable interest doctrine developed on
highly fact-based grounds, and the issue wound itself into the Supreme
Court. The seminal quote upon which most scholars attribute modern
insurable interest doctrines in the several states is found in Warnock v.
Davis.55 In Warnock, the Supreme Court based the validity of an insurance
policy on the following: “[I]n all [life insurance] cases there must be a
reasonable ground, founded upon the relations of the parties to each other,
either pecuniary or of blood or affinity, to expect some benefit or advantage
from the continuance of the life of the assured.”56 The Court went on to
resuscitate the wagering concerns from the British system as the reason
51 Id. at 118.
54 Id. at 119.
55 104 U.S. 775 (1881).
56 Id. at 779.
derpinning insurable interest law in America by stating that without an
insurable interest, “[a] contract is a mere wager, by which the party taking the
policy is directly interested in the early death of the assured.”57 Finally, the
court extended insurable interest doctrine one step further by stating that,
“[t]he assignment of a policy to a party not having an insurable interest is as
objectionable as the taking out of a policy in his name . . . [That person]
stands in the position of one holding a[n invalid] wager policy.”58
Implicitly, then, the court in Warnock placed the cost of an insurable interest wager
on the consumer of the insurance policy—the insurance companies have the
right, but not the obligation, to assert the insurable interest defense and
invalidate a policy.
Around the time of the Warnock decision, there appears to have been
some indecision in the American courts about whether a life insurance
contract was one of indemnity or non-indemnity.59 The Supreme Court seems
to settle this question in Phoenix Mutual Life Insurance Co. v. Bailey by
Life insurances have sometimes been construed in the same way [as
indemnity insurance policies], but the better opinion is that the
decided cases which proceed upon the ground that the insured must
necessarily have some pecuniary interest in the life of the cestui qui
vie60 . . . [indicate] that the contract of life insurance is not
necessarily one merely of indemnity for a pecuniary loss . . . .61
For the historical purposes of this paper, it is important to note that while
the insurable interest doctrine originated in a muddy fashion, there exists a
clear difference between indemnity and non-indemnity contract types.62
Bailey, combined with the decision in Grigsby v. Russell,63 brings both
the American and the English systems in line with each other on the
motives for insurable interest.64 In Grigsby, the Supreme Court sanctioned the
transfer of a life insurance policy to someone without an insurable interest
59 See Patterson, supra note 3, at 381.
60 This term refers to the life that is the subject of the life insurance policy.
61 80 U.S. 616, 619 (1871).
62 See RUSS & SEGALLA, supra note 2, § 103:4 (stating, for example, that: “The major
substantive distinction between a liability policy and an indemnity contract is that payment
of a claim by the insured is a condition precedent to the insured’s right to recover under the
indemnity contract, but not under the liability contract. This distinction also means that
liability insurance covers injuries sustained by third parties, while indemnity contracts cover
first party losses.”).
63 222 U.S. 149 (1911).
64 Id. at 155.
in the insured.65 In that case, Justice Holmes stated, “the ground of the
objection to life insurance without interest in the earlier English cases was not
the temptation to murder, but the fact that such wagers came to be regarded
as a mischievous kind of gaming.”66 Thus, at the turn of the century, the
Supreme Court painted the full picture of what it believed to be insurable
interest policy: (1) an insurable interest—either pecuniary or blood—must
exist prior to the execution of a life insurance policy; (2) if not, then the
insurance policy is void and does not need to pay out; and (3) this must be the
case, otherwise people will engage in “wagering” on each other’s lives that
can be tied to the risk of murdering (in the case of humans) or destroying
(in the case of property) the subject of the insurance. American law as it
currently stands is elucidated in the next section.
C. Current U.S. Law Governing the Insurable Interest
While the insurable interest doctrine began as judge-made law, with no
legislative basis in the United States, it was later codified by many of the
states.67 Such codification, across fifty jurisdictions, leaves the legal
landscape uncertain for both insurance companies and consumers with respect
to the insurable interest doctrine, as considerable variation among the fifty
states’ laws exists. Essentially, states seek to regulate what is called the
“secondary life insurance” market through the lens of the insurable interest
doctrine. In its simplest form, the secondary market for life insurance
policies originates because the surrender price of a life insurance policy is much
less than the price the same policy would fetch if it were sold to investors
on the open market.68 An individual can sell his or her life insurance policy
for a value below the face value of the policy, but above its cash-surrender
65 Id. at 156.
67 See, e.g., IOWA CODE § 502.102(31A) (2009); ME. REV. STAT. tit. 32, § 16102(32)
(2009); NEB. REV. STAT. § 8-1101(17) (2010); N.J. STAT. ANN. § 49:3-49(w) (2010); N.C.
GEN. STAT. § 78A-2(13) (2009); N.D. CENT. CODE § 10-04-02(21) (2009); OHIO REV. CODE
ANN. § 1707.0
1 (LexisNexis 2010
); UTAH CODE ANN. § 61-1-13(1)(v) (LexisNexis 2009);
WIS. STAT. § 551.102(32) (2009).
68 See Jared Heady, Regulating the Secondary Market for Life Insurance: Promoting
Consistency to Maximize Utility, 62 RUTGERS L. REV. 849, 85
Since life insurance companies had universally decided to refuse buying back
issued policies, policyholders who could not afford to continue paying premiums
were left with the option to either default, and subsequently let their policy lapse,
or seek liquidation at an auction. Seeing injustice in these limited options, Elizur
Wright, known to many as ‘the father of life insurance,’ endeavored to attach a
cash-surrender value to life insurance policies, an amount reflective of the market
value for the policy that the issuing life insurance company would be required to
pay if policyholders default or seek to liquidate their policy.
value, to an investor or a group of investors on the open market. Thus,
instead of settling for the cash-surrender value, individuals seek to maximize
the value of their life insurance policies by going to the open market.69
From the paltry sum arising out of the cash-surrender practice, the
secondary life insurance industry exists because investors make an arbitrage
bet between a cash-surrender value and a policy’s face value. Indeed, the
bet is a gruesome one that the individual will die either as actuarially
scheduled or before, and that the payment from the face value of the policy
will exceed premiums paid in by a certain percentage.70 The insured gains
because she gets much-needed immediate cash flow from an insurance
policy. Meanwhile, investors enter the market as an investment for an
opportunity to reap double-digit returns on their capital in an alternative product.
The policy ramifications of this market and the effect of insurable interest
regulation on it will be discussed below.71 However, this section will seek
to lay out the current legal landscape in the United States for the insurable
interest doctrine as is expressed in laws governing the secondary market for
life insurance settlements in three fields: (1) viatical settlements;72 (2) life
settlements;73 and (3) stranger-originated life insurance (STOLI) policies.74
To date, states fall into a few distinct categories of insurable interest
legislation. Very few locales attempt to prohibit the “secondary market” in
insurance by creating strict insurable interest regimes that invalidate
insurance policies if the beneficiary at the time that the death benefit pays out
does not have an insurable interest. The more common tact in states like
Virginia and North Carolina is to structure insurable interest laws around
the Viatical Settlements Model Act (the NAIC Model Act)75 developed by
the National Association of Insurance Commissioners (the NAIC) and the
Life Settlements Model Act (the NCOIL Model Act) 76 adopted by the
National Conference of Insurance Legislators (the NCOIL). These states alter
the insurable interest doctrine by creating extended contestability periods77
for policies, or preserving insurable interest as a contestable point
notwithstanding the running of a contestability period, or utilizing other alterations
to the doctrine.78 The most liberal state regime allows for the immediate
transfer of insurance policies to a beneficiary without an insurable interest.79
1. Federal Regimes on Insurable Interest
Before the particulars of state regulation are elucidated, it is of some
note that there is already federal legislation on insurable interest in the
Internal Revenue Code (the Tax Code).80 The Tax Code explicitly deals with
income from viatical settlements, and what qualifies as an “amount paid,”
but does not seem to deal with standard life settlements.81 In some sense,
the Tax Code does away with the insurable interest requirement itself when
If any portion of the death benefit under a life insurance contract on
the life of an insured . . . is sold or assigned to a viatical settlement
provider, the amount paid for the sale or assignment of such portion
shall be treated as an amount paid under the life insurance contract
by reason of the death of such insured.82
Thus, in a few words, the Tax Code—for purposes of deciding payment—
places the assignee of a life insurance policy in the shoes of the insured.
For any amounts received under an insurance policy, the assignee is taxed
as though they were the insured—whether or not they exhibit an insurable
interest—for federal purposes. Furthermore, the law sets out explicit
definitions for what persons qualify as “terminally ill”83 or “chronically ill,”84
76 LIFE SETTLEMENTS MODEL ACT (Nat’l Conf. of Ins. Leg
77 Contestability periods are discussed in more detail infra Part II.C.3.
78 See, e.g., PHL Variable Ins. Co. v. Price Dawe 2006 Ins. Trust, 28 A.3d 1059, 1066
(Del. Sept. 20, 2011)
79 See Kramer v. Phoenix Life Ins. Co., 940 N.E.2d 535, 542 (N.Y. 2010).
80 I.R.C. §
81 See id. § 101(g) (This section is explicitly titled “Treatment of certain accelerated
82 See id. § 101(g)(2)(A).
83 See id. § 101(g)(4)(A) (“The term ‘terminally ill individual’ means an individual who
has been certified by a physician as having an illness or physical condition which can
reasonably expected to result in death in 24 months or less after the date of the certification.”).
84 See id. (“The term ‘chronically ill individual’ has the meaning given such term by
section 7702B(c)(2); except that such term shall not include a terminally ill individual.” A
“chronically ill individual” is defined in I.R.C. § 7702B(c)(2) as a person who is “unable to
perform (without substantial assistance from another individual) at least 2 activities of daily
and carves out special circumstances for the individual brokering the sale of
a viatical settlement and for a person receiving proceeds from such a
2. The Model Codes and the States
Despite the efforts of insurance law reformers to create a model code,
a vast array of disparate state legislation exists in the insurable interest area.
Due to the need to protect sick individuals and to create a transparent and
fair viatical settlements market, the National Association of Insurance
Commissioners developed the NAIC Model Act86 and the Viatical
Settlements Regulations87 to guide states in their regulation of the viatical
settlements industry. On the life settlements front, the National Conference of
Insurance Legislators adopted the NCOIL Model Act. The model acts have
grown over time to contain licensing requirements, contract statement
requirements, reporting requirements and privacy, examinations and
investigations, disclosure, general rules, prohibited practices, advertising
requirements, fraud prevention and control, penalties for failure to comply, and
unfair trade practices.88 Various portions of these model acts have been
adopted by the adherent states. One important difference between the
model acts is the level to which they prohibit stranger-originated life insurance
transactions—speaking most directly to the most vexing area of insurable
interest jurisprudence. The NAIC Model Act imposes a five-year waiting
period between the time of issuance of a life insurance policy and the time
of entering into a life settlement contract.89 That is, the NAIC Model Act
would increase what is called a state’s “contestability period” beyond the
currently standard two-year period.90 These contestability periods act as the
primary enforcement time when an insurable interest can be controverted by
an insurance company. Thus, if a policy is taken out, and an insurable
interest is found not to exist or some other defect is found in a policy during
the contestability period, the policy can be retracted. After a contestability
period runs, however, retracting the policy becomes much more difficult,
and transferability by the consumer becomes much easier. For example,
after the contestability period runs, any transaction—even if that transaction
is to or from a stranger—is not able to be controverted by an insurance firm.
The NCOIL Model Act, on the other hand, provides a definition of STOLI,
living for a period of at least 90 days due to a loss of functional capacity . . . .”).
85 See id. § 101(g)(2)–(3).
86 VIATICAL SETTLEMENTS MODEL ACT (Nat’l Ass’n of Ins. Comm’rs 2009), available at
87 VIATICAL SETTLEMENTS MODEL REGULATION ACT (Nat’l Ass’n of Ins. Comm’rs 2009),
88 See, e.g., LIFE SETTLEMENTS MODEL ACT (Nat’l Conf. of Ins. Leg
89 VIATICAL SETTLEMENTS MODEL ACT § 11(A) ) (Nat’l Ass’n of Ins. Comm’rs 2009).
90 Heady, supra note 68, at 865 n.115.
which indicates that it is prohibited as a “fraudulent life settlement,” and
subjects a provider, broker, or other person involved in a STOLI transaction
to criminal penalties or sanctions.91 However, the NCOIL Model Act
imposes only a two-year waiting period—subject to certain exceptions for
terminally ill or chronically ill policy owners—prior to entering into a life
settlement contract.92 That is, the NCOIL Model Act leaves room for
individuals to quickly transfer their life policies and does not extend the waiting
period beyond a customary two-year period.
Of particular import, the Tax Code adopts Sections 8 and 9 of the
NAIC Model Act,93 which outline disclosure requirements to both the
vitiator and insurance company by the successor in interest to a policy,
respectively.94 Thus, in order to get the proper tax-free treatment for a death
benefit paid out from an assigned viatical policy, one is pointed to the model law
requirement—a rarity in the law—but also a clear indication of a public
policy favoring disclosure in financial transactions, even ones dealing in
personal life insurance. On the life settlements front, the Internal Revenue
Service (the IRS) released Revenue Ruling 2009-13, to attempt to clarify
the issue of what is taxable at the regular income rate and what is taxable as
capital gains.95 However, the guidance is unclear and the Life Insurance
Settlement Association has asked for a clarification of the issues from the
Jared Heady conducted a very helpful survey of insurable interest
regulations in early 2010;97 however, given the relative rapidity of change
in this market, even that survey is slightly out of date. The most recent
surveys by the NAIC come to the following findings:
Five states have adopted the NAIC Model Act in a uniform and
substantially similar manner . . . . Thirteen states [have] adopted [at
least] some portions of the NAIC Model Act. [Other] states have
undertaken “related state activity” in the area of life settlements. In
all, 44 states are identified as having adopted legislation relating to
life settlements under state insurance law. Among states that have
recently enacted life-settlement related legislation, the majority have
followed the NCOIL model act or have combined elements of the
NAIC and NCOIL model acts. The NAIC identifies approximately
30 states where life settlement legislation, including anti-STOLI
legislation, has been enacted since spring of 2008. Of these, [fourteen]
tracked the NCOIL model act provisions, and 12 states enacted
hybrid legislation, combining elements of the NAIC and NCOIL model
What is somewhat odd about these new restrictions enacted by the
Model Act makers is that they appear to be similar to those enacted by the
Marine Insurance (Gambling Policies) Act of 190999—in that they are
piecemeal legislation that does not address the whole market, with heavy,
possibly criminal, sanctions attached—yet none seem to cite to the 1909
Act. It should also be noted that the criminal provisions in the 1909 Act
went relatively unused; it is yet to be seen whether the NCOIL Model Act’s
criminal provisions will suffer the same fate.100
3. New York vs. Delaware and the Quagmire of Disagreement
The most recent developments in the U.S. insurable interest arena
come not from statute, but rather from divergent state supreme court rulings
in New York101 and Delaware,102 decided roughly one year apart. The New
York court dealt a fatal blow to the insurable interest doctrine in that
jurisdiction.103 In contrast, the insurable interest doctrine not only endures in
Delaware,104 but also is firmly declared to be a valid defense even after the
98 SECS. & EXCH. COMM’N, LIFE SETTLEMENTS TASKFORCE REPORT 35 (July 22, 2010)
[hereinafter SEC REPORT] (citation omitted), available at
/lifesettlements-report.pdf (citing two documents prepared by the NAIC: (i) an
April 2010 NAIC Model Act state adoption table
and (ii) a June 2010
settlements/STOLI legislation survey). The five states that had adopted the NAIC Model Act in a
uniform and substantially similar manner were Nebraska, North Dakota, Oregon, Vermont,
and West Virginia. Id. at 35 n.163. The thirteen states that had adopted at least some
portions of the NAIC Model Act were Hawaii, Idaho, Illinois, Iowa, Kansas, Kentucky,
Minnesota, Nevada, Ohio, Oklahoma, Rhode Island, Tennessee, and Washington. Id. at 35 n.164.
The states that had undertaken “related state activity” had adopted an older version of the
NAIC Model Act, legislation or regulation derived from other sources, bulletins, and
administrative rulings. Id. at 35 n.165. The SEC noted that of the 44 states identified by the NAIC
as having adopted legislation relating to life settlements under state insurance law, a few
“regulate only viaticals (sale of a life insurance policy by a person who is terminally or
chronically ill) and not all life settlements.” Id. at 35 n.166. Additionally, as of July 22,
2010, the date of the SEC’s report, 45 states had adopted legislation relating to life
settlements, as New Hampshire had just recently enacted life settlement legislation. Id.
99 1909, 9 Edw. 7, c. 12 (Eng.).
100 See SUTTON, supra note 11, at 531.
101 See Kramer, 940 N.E.2d 535.
104 See Dawe, 28 A.3d at 1073–74 (“Although the statute has been periodically updated,
expiration of a two-year contestability period for an insurance policy,105 as
the Delaware Supreme Court describes in twin cases decided on the same
day. This rift among arguably the two most important states for the
investment and creation of life and casualty insurance will likely create dramatic
uncertainty in the market for insurance products, and offer insurers and
insureds an opportunity to structure even more complex insurance products to
subvert the rulings.
a. New York & The Case of Arthur Kramer
Notwithstanding many states’ adoptions according to the Model Acts,
one important state stands apart from the rest: New York. In the case of
Kramer v. Phoenix Life Insurance Co., the New York Court of Appeals de
termined that New York law permits a person to procure an insurance
policy on her own life and immediately transfer it to one without an insurable
interest in that life, even where the policy was obtained for the purpose of
such an immediate transfer.106 In Kramer, Arthur Kramer—a prominent
New York lawyer and founder of Kramer, Levin, Naftalis & Frankel LLP—
was approached by an insurance broker offering to turn life insurance
policies into cash without any obligation on Kramer’s part.107 Kramer assented
to the creation of two trusts that would later be funded with insurance
policies issued on his life upon death.108 Two trusts were formed, with the
interest in those trusts initially issued in the names of Kramer’s children, for
the purposes of procuring the life insurance that would fund the trust.109
Immediately following the insurance purchases, the interests in those trusts
were assigned, so as to reduce Kramer’s potential premium liability.110
Policy arguments in that court were three-fold, and similar to those we have
seen throughout the history of the insurable interest requirement, as
discussed above: (i) a policy obtained with the intent to assign to a party
lacking insurable interest violates statutory language; (ii) in accordance with the
common law rule, an insured can only assign a policy if obtained in “good
the substance of Delaware law on insurable interest has remained the same. An insured is
permitted to take out an insurance policy on his own life, but the law prohibits persons other
than the insured from procuring or causing to be procured insurance, unless the benefits are
payable to one holding an insurable interest in the insured’s life.”).
105 See Schlanger, 28 A.3d at 441(“[I]f a life insurance policy lacks an insurable interest
at inception, it is void ab initio because it violates Delaware’s clear public policy against
wagering. . . . As a result, the incontestability provision does not bar an insurer from
asserting a claim on the basis of a lack of insurable interest after the [ ]contestability period
106 Kramer, 940 N.E.2d at 542.
107 Id. at 537.
109 Id. at 538.
110 Id. at 537–39.
ing, however, does avoid the Chawla problem155 of a trust not having an
insurable interest in the life of the insured, even when the insured was the
settlor and creator of the trust.156 Here, a trust can have an insurable interest.
The enforcement mechanism that the Delaware Supreme Court created
is similar to that in its response to the second certified question presented:
“In cases where a third party either directly or indirectly funds the premium
payments as part of a pre-negotiated arrangement with the insured to
immediately transfer ownership, the policy fails at its inception for a lack of
insurable interest.”157 Not only is this enforcement mechanism difficult to
discern through decades-old financial statements, but it also creates a
current problem. Since individuals now are disallowed from procuring
insurance policies funded by a third party, either directly or indirectly, persons
seeking to invest in the life insurance market will engage in a black market
for investment in such policies. That black market will be created by
unspoken agreements to fund the inception of life insurance policies, thus
artificially creating the appearance of an insurable interest. Therefore, what is
allowed to be express and written down under New York law—that is, that
an insurance policy is intended for immediate transfer—must remain
unspoken under Delaware law.158
Furthermore, even if the Delaware ruling is completely enforceable, it
limits investment in life insurance policies to the wealthy, or to those
individuals who can bona fide purchase expensive life insurance policies for
later sale. Suppose a person of lower financial means desired to enter the
market for life insurance because he or she is of current good health and
needs an investment that will yield cash quickly. If the Delaware ruling
were taken to its logical conclusion, this person would have to take out an
insurance policy and pay all of its premiums up front in the hopes that an
investor would purchase the policy at a later date. Taken one step further, if
this individual did not have the money to purchase the policy now, and
sought a loan for the payment of the proceeds, so that he can later cash it
out, such a loan would look like an attempt by a third party to induce the
purchase of an insurance policy, which may lead to its invalidation at a later
date. Thus, derivatively, the market for loans to help low-income
individuals procure life insurance will dry up due to the legal uncertainty now
155 See supra Part II.C.3.a.
156 Chawla, 2005 WL 405405.
157 Dawe, 28 A.3d at 1078.
158 It should be noted that this scenario in life-policy loan industry has recently come
under scrutiny in Florida. See Leslie Scism, Life-Policy Loans Under Scrutiny, Wall St. J., Oct.
4, 2011, at C1 (“Federal and state courts long have upheld consumers’ rights to sell their
policies to outside investors. What insurers say sets . . . [life-policy loans] apart from these
longstanding policy sales is the role of agents and other commission-based middlemen in
allegedly inducing older people to take out policies with the intent to sell them.”).
ciated with an unlimited ability by insurance companies to challenge the
insurable interest underlying an insurance policy. Logically, then, if
individuals of lower financial means learn of the legal uncertainty associated with
such a market, they will either be driven out, or they will be exploited by
persons who induce them to use whatever means they have to pay for the
premiums of a policy now, on unwritten promises that these persons will
purchase the policy after the applicable contestability period has run.
It should be clear from the above analysis that while the Delaware
Supreme Court had good intentions in strengthening the insurable interest
doctrine to prevent wagers, its decision merely created a market where what
can be in writing in New York—due to Kramer—has been relegated to the
status of a sub rosa black market. Not only does the Dawe ruling create an
internal investment problem for the life insurance market within Delaware,
but it also creates interstate uncertainty, as a severe conflict of law is
created between Delaware and New York’s standards for the insurance market.
With its ruling in Dawe, Delaware also falls behind its peer capital markets
in England and Australia, which have engaged in the modernization of their
insurance markets by eliminating the insurable interest doctrine and, thus,
streamlining regulation of the markets.
III. A DOCTRINE CREATES A MARKET: INSURABLE INTEREST
AND THE LIFE SETTLEMENT INDUSTRY
A. The Secondary Life Insurance General Market Structure and Size
The legal structure described in Part II lays the groundwork for the
modern market for secondary life insurance, where most interesting
questions about insurable interest dwell. This part will seek to explain how
legal tools are used to create the life settlement market, the structure of which
is driven primarily by the insurable interest doctrine. This part will also
seek to show that the insurable interest doctrine causes market contortions
that create unnecessary transaction costs without any payoff.
The need for cash flow by insurance policy holders has created the
three different types of life settlement products discussed above: viatical
settlements,159 life settlements, and pure stranger-originated life insurance.
159 This interesting nomenclature of “viatical settlement” was traced by the Fourth Circuit
fairly recently in Life Partners, Inc. v. Morrison:
A “viaticum” in ancient Rome was a purse containing money and provisions for a
journey. A viatical settlement, by which a dying person is able to acquire
provisions for the remainder of his life’s journey by selling his life insurance policy, is
thus thought to provide a viaticum. In the language of the industry, the insured is
the “viator,” who sells his policy at a discount to a “provider” of the viaticum.
484 F.3d 284, 287 (4th Cir. 2007).
A more recent iteration on the life settlement market is stranger-originated
annuity transactions, which function in essentially the same way as the
other three products, with the exception that the underlying insurance product
is an annuity.160 Viatical settlements are important because they are viewed
as the beginning of the modern market for secondary life insurance
policies.161 As the AIDS epidemic raged on in the 1980s, medical care became
increasingly expensive, while individuals with AIDS had predictably short
life spans.162 Thus, many individuals with AIDS who had life insurance
policies sought to cash out the policies and avoid paying their premiums by
alienating their estate’s rights to collect the death benefit of the policies.163
In essentially the same manner as previously described,164 an investor (or
group of investors) would pay the insured a sum discounted from the face
value of the policy, but more than the cash-surrender value. In return for an
up-front cash value, as well as a guarantee that the premiums for the
insurance policy will be paid, the insured (or the insured’s beneficiaries) transfer
the right to collect the death benefit to the investors. Viatical settlements
qualify as a distinct category because they are generally regarded to be
properly issued to individuals with (a) an illness; and (b) 24 months or less
left on their life expectancy.165 Life Settlements, on the other hand, are
issued to individuals with greater than 24 months to live.166 Generally, these
settlement transactions are engaged in with a growing group of elderly
individuals and retiring baby boomers who already have high net worth but are
seeking cash. The legal structure of life settlements does not differ in any
material respect from viatical settlements.
Stranger-originated life insurance policies engage with trust law in an
interesting way. These policies engage in various ways to thwart the
insurable interest doctrine. They are generally structured as follows: (1) an
investor induces a person, typically falling into the viatical or life settlement
category, to purchase a life insurance policy that the person likely would
not have otherwise purchased; (2) the person applies for the policy
(becoming the insured) with the prior understanding that he or she will cede control
of the policy to the investor; (3) the investor and the insured agree that at
the end of a state’s contestability period for an insurance policy, ownership
of the policy will be transferred to the investor, or some third party, who
160 INSURABLE INTEREST AMENDMENTS TO THE UNIFORM TRUST CODE §113(b) (Nat’l
Conf. of Comm’rs on Unif. State Laws 2010).
161 See Life Partners, Inc. v, 484 F.3d at 287.
162 See id.
163 See id.
164 See supra notes 68–69 and accompanying text.
165 SEC REPORT, supra note 98, at n.2.
expects to receive the death benefit when the insured dies.167 The two
parties must wait the duration of the contestability period provided for
insurance policies by a state—typically two years—before transferring the
policy, because during that time insurance companies may seek to have the
policies judicially invalidated for want of an insurable interest.168
Generally, after the contestability period of a life insurance policy runs, the insurer
is prohibited from contesting the policy based on misrepresentations by the
Conning Research and Consulting, Inc., an insurance industry
observer, reports on the life settlements industry and produces an annual study. In
2007, Conning Research estimated that the market, then estimated at $12
billion in face amount of life insurance settled,170 would grow to $90–$140
billion in face amount settled by 2016.171 Conning Research later estimated
that $11.7 billion of face amount in life insurance was settled in 2008,172
ing growth in the market from 2007
at slightly below zero.
BusinessWeek estimated the market for unwanted life insurance policies at
$15 billion in face amount during 2008.173 More recently, the amount
settled has declined due
to the economic recession of 2008
. Conning Research
estimated that $8 billion of life insurance face value settled in 2009,174
while annual volume dropped to $3.8 billion face in 2010, reflecting
sustained buyer’s market conditions.175 Even if these estimates are off by
several magnitudes, it is clear that there is massive market demand for such
products, even despite the massive drop in the face value of such products
B. Actors Effectuating the Mechanics of Subverting the Insurable Interest
In order to get around insurable interest laws effectively, a number of
market intermediaries become necessary to effectuate the secondary life
insurance market. Although life settlement transactions may be termed in the
above three different ways (viatical settlements, life settlements, and
STOLI), they typically involve an insured individual, or the owner of the
policy, a producer who may be a financial advisor or an insurance agent,
one or more settlement brokers who may also be insurance agents, one or
more life expectancy underwriters, one or more providers who typically
represent the party acquiring the policy, and one or more investors.176 A
2010 Securities and Exchange (“SEC”) Report on this subject provides a
compelling graphical representation of all of the players in the market: 177
As the SEC image illustrates, the number of actors involved in the
creation of just one single life insurance transaction make transaction costs in
this area high, as parties to the investment must go through several
intermediaries in order to transact in the sphere. But, the SEC characterization does
not capture all of the relevant actors in the life settlement, viatical
settlement, and stranger-originated life insurance markets,178 which include: the
insured,179 owner,180 broker,181 provider,182 investment agent,183
176 See SEC REPORT, supra note 98, at 6.
178 See generally Heady, supra note 68.
179 “[T]he person covered under the policy being considered for sale in [the secondary
market for life insurance],” is generally referred to as the ‘insured.’ LIFE SETTLEMENTS
er,184 financing entity,185 special purpose entity,186 and life insurance
proMODEL ACT § 2I (Nat’l Conf. of Ins. Leg
180 “[T]he owner of a life insurance policy or a certificate holder under a group policy,
with or without terminal illness, who enters or seeks to enter into [a settlement on the
secondary market for the benefits of their life insurance policy]” is the ‘owner.’ Id. § 2N; see
also VIATICAL SETTLEMENTS MODEL ACT § 2T (Nat’l Ass’n of Ins. Comm’rs 2009).
181 The broker is “a Person who, on behalf of an Owner [or viator] and for a fee,
commission or other valuable consideration, offers or attempts to negotiate [the settlement] between
an Owner [or viator] and [settlement] Providers.” LIFE SETTLEMENTS MODEL ACT § 2B
(Nat’l Conf. of Ins. Leg
); see also VIATICAL SETTLEMENTS MODEL ACT § 2M
(Nat’l Ass’n of Ins. Comm’rs 2009).
182 The provider is “a person, other than an Owner [or viator], who enters into or
effectuates a [settlement on the secondary market for life insurance] with an Owner [or viator].”
LIFE SETTLEMENTS MODEL ACT § 2S (Nat’l Conf. of Ins. Leg
); see also
VIATICAL SETTLEMENTS MODEL ACT § 2P (Nat’l Ass’n of Ins. Comm’rs 2009).
183 The investment agent is “a person who is an appointed or contracted agent of a
licensed . . . provider who solicits or arranges the funding for the purchase of a viatical
settlement [or life settlement] by a viatical settlement [or life settlement] purchaser and who is
acting on behalf of a viatical settlement [or life settlement] provider.” VIATICAL
SETTLEMENTS MODEL ACT § 2O (Nat’l Ass’n of Ins. Comm’rs 2009).
184 As the Life Settlements Model Act explains:
A Person who pays compensation or anything of value as consideration for a
beneficial interest in a trust which is vested with, or for the assignment, transfer or sale
of, an ownership or other interest in a life insurance policy or a certificate issued
pursuant to a group life insurance policy which has been the subject of a
[settlement on the secondary market for life insurance],
is known as the “purchaser.” LIFE SETTLEMENTS MODEL ACT § 2U (Nat’l Conf. of Ins.
); see also VIATICAL SETTLEMENTS MODEL ACT § 2R(1) (Nat’l Ass’n of Ins.
185 As the Life Settlements Model Act explains:
[A]n underwriter, placement agent, lender, purchaser of securities, purchaser of a
policy or certificate from a Provider, credit enhancer, or any entity that has a direct
ownership in a policy or certificate that is the subject of a [settlement on the
secondary market for life insurance] . . . whose principal activity related to the
transaction is providing funds to effect the [settlement] or purchase one or more of the
policies; and . . . who has an agreement in writing with one or more Providers to
finance the acquisition of [settlements for life insurance on the secondary market],
is deemed the “financing entity.” LIFE SETTLEMENTS MODEL ACT § 2F (Nat’l Conf. of Ins.
); see also VIATICAL SETTLEMENTS MODEL ACT § 2E(1) (Nat’l Ass’n of Ins.
Comm’rs 2009). Investors or purchasers who are non-accredited are not considered
financing entities. VIATICAL SETTLEMENTS MODEL ACT § 2E(2) (Nat’l Ass’n of Ins. Comm’rs
2009); LIFE SETTLEMENTS MODEL ACT § 2F (Nat’l Conf. of Ins. Leg
A corporation, partnership, trust, limited liability company, or other legal entity
formed solely to provide either directly or indirectly access to institutional capital
markets . . . for a financing entity or provider; or . . . in connection with a
transaction in which the securities in the special purpose entity are acquired by the owner
or by a “qualified institutional buyer;”
In an effort to get around insurable interest laws, these actors coalesce
typically around individual insured persons as the locus of activity. Arthur
Kramer’s case illustrates how these actors function with each other in a
highly complex dance with trust law to shield the insurance policies from
the insurable interest hurdle:188 (1) Steven Lockwood (acting as the broker),
the principal of Lockwood Pension Services, approached Mr. Kramer to
solicit his participation in a stranger-owned life insurance arrangement; (2)
two trusts were created (acting as the special purpose entities) to hold
insurance policies issued by the three insurance companies; (3) an employee of
the insurance broker was named trustee of the trust; (4) several children of
Kramer (the insured), or other persons with an insurable interest, were
named as beneficiaries of the trusts; (5) the trusts were then funded with
insurance policies (from a provider), with death benefits in the millions of
dollars; (6) after the trusts were formed and funded, the beneficiaries of the
trusts then assigned their beneficial interests to a stranger investor (the
purchaser), relatively immediately.189 Typically, financing is arranged so that
the premiums for the insurance policy are paid first by the insured—through
loans provided by financing entity, and solicited by an investment agent—
then paid by investors after the transfer is effectuated.
As the above explanation elucidates, in order for consumers to
effectively seek cash-out of an insurance policy, or the market potential for such
a policy, they must go through a series of legal slights of hand to get at
those monies. Even for an investor to capitalize on the earning potential of
an investment in life insurance policies, it must put an individual on the
hook (with the consonant ramifications of default) for premium payments in
the interim, if not long-term. Thus, in contrast to investment in other
product types, where the equity in the product stands alone, investment in an
or “the securities pay a fixed rate of return commensurate with established asset-backed
institutional capital markets,” is defined a “special purpose entity.” LIFE SETTLEMENTS MODEL
ACT § 2X (Nat’l Conf. of Ins. Leg
187 “Any person licensed . . . as a resident or nonresident insurance producer who has
received qualification or authority for life insurance coverage or a life line of coverage
pursuant” to the applicable statutes in each state in which they operate is considered a “life
insurance producer.” LIFE SETTLEMENTS MODEL ACT § 2K (Nat’l Conf. of Ins. Leg
); see also VIATICAL SETTLEMENTS MODEL ACT § 2G (Nat’l Ass’n of Ins. Comm’rs
188 See Kramer, 940 N.E.2d at 536–37.
189 There is a question here in many states about “good faith,” and whether an insurable
interest policy should be upheld if it was not taken out in good faith by the insured.
However, STOLI structurings typically wait for the completion of a contestability period to transfer.
As reflected in Kramer, the New York system does not consider good faith and allows
policies to be immediately transferred. See id. at 541–42. But see N.Y. INS LAW § 7815
(McKinney 2007) (“No person shall directly or indirectly engage in any act, practice or
arrangement that constitutes stranger-originated life insurance.”).
surance product requires that you have some legal interest in the
continuance of the product. Indeed, if the insurable interest doctrine existed in
other spheres, the idea of “shorting” a stock might seem morally abhorrent as a
bet against a product creating a negative interest in the particular item.
C. How Insurable Interest Functions in Indemnity Policies
The indemnity principle differentiates life insurance policies as
nonindemnity policies from those that are strictly indemnity policies to
remunerate for the value of lost property.190 The indemnity line of insurance is
the sister strand to life insurance, and it was the one first regulated by
English statute, as discussed above.191 “The notion that the purpose of
insurance is to protect the insured against suffering a loss, not to create the
opportunity for gain,” forms the basis for why an insurable interest doctrine
exists for insurance policies relating to property.192 In contrast to
contestability periods for life insurance, indemnity policies have stricter
constructions in the courts than those for life insurance.193 Most courts hold that an
indemnifying insurer cannot be estopped to assert that there was no
insurable interest at all and cannot be held to have waived the requirement194—a
stark contrast to the life insurance industry’s statutorily mandated
contestability period.195 Indeed, courts permit an indemnifying insurer to question
the extent of an insurable interest after a loss has occurred in order to guard
There are four different tests for insurable interest in a piece of
property.197 First, a legal or equitable interest in property will always suffice,
subject sometimes to the condition that the interest have at least some value.198
However, while the legal interest doctrine prevailed historically, a second
“factual expectations” test has emerged over time to allow an insurable
interest to vest if the beneficiary expects to derive actual economic gain from
the property’s continued existence.199 Third, a contract right that depends
190 KENNETH S. ABRAHAM, INSURANCE LAW AND REGULATION 201 (4th ed. 2005).
191 See supra Part II.
192 ABRAHAM, supra note 190 (citing the twin English acts of 1746 and 1774 in
establishing this notion).
193 Id. at 202.
195 Statutorily mandated contestability periods are usually two years in length. See, e.g.,
DEL. CODE ANN. tit. 18, § 2908 (2011) (“There shall be a provision that the policy shall be
incontestable after it has been in force during the lifetime of the insured for a period of not
more than 2 years after its date of issue . . . .”).
196 ABRAHAM, supra note 190, at 202.
199 See Jacob Loshin, Insurance Law’s Hapless Busybody: A Case Against the Insurable
on the continued existence of property also supports an insurable interest in
that property.200 Finally, the potential for suffering legal liability for the
destruction of property will support an insurable interest in that property.201
One can notice that these tests bear a very close resemblance to those in the
While one might assume that the insurable interest tests in the
indemnity area would be clearer than any for life insurance, as contracts for
property involve measurable losses, they are not actually so. The four tests for
insurable interest in indemnity are muddy fact-based determinations akin to
the “blood or affinity” tests or “pecuniary interest” tests developed in the
non-indemnity arena. Indeed, it can be said that it is even more difficult to
determine who has an insurable interest in a piece of property insured, than
in the life of an individual insured.203 The space between the “factual
expectation” and “legal interest” tests creates an opportunity for individuals to
exploit the insurable interest doctrine as it is applied in the different states.
D. Litigation Costs due to the Insurable Interest Doctrine
Yet another transaction cost created by the insurable interest doctrine
is long, drawn-out litigation and its attendant substantial uncertainty as to
the result. Insurable interest generally gets litigated only if the following
three things happen: (i) the insurance company has issued the policy and the
insured represented at the time of issuance to having an insurable interest;
(ii) the contestability period has run on those representations by the insured;
and (iii) the insured event has happened, or is very close to happening.204 If
the policy does not pay out, and it is surrendered for its cash value, or it
lapses altogether, an insurance company will likely not litigate the insurable
interest issue. Currently, the majority of states have no requirement that an
insurance company disclose to an insured that there is a life settlement
option prior to permitting the lapse or surrender of a life insurance policy.205
Six states require insurance companies to inform senior citizens or the
chronically ill who are about to surrender life insurance policies for cash
value, or let the policies lapse entirely, about the option of privately selling
that asset to a third party in a life settlement transaction.206
Interest Requirement, 117 YALE L. J. 474, 486 (2007).
200 See ABRAHAM, supra note 190, at 202 (noting that secured creditors fall into this
201 Id. (citing Vill. of Constantine v. Home Ins. Co., 427 F.2d 1338 (6th Cir. 1970)).
202 See supra Part II.A and Part II.B.
203 JOHN F. DOBBYN, INSURANCE LAW IN A NUTSHELL 82 (3d Ed. 1996).
205 SEC REPORT, supra note 98, at 7.
206 The six states are California, Kentucky, Maine, Oregon, Washington and Wisconsin.
Id. at 7 n.29.
Insurance companies will often assert the insurable interest doctrine as
a defense to being compelled to pay out an insurance policy that has
vested.207 Thus, insurance companies have a very high incentive to maintain
the doctrine, and its concomitant transaction costs, instead of writing
insurable interest considerations into their underwriting policies up-front. The
insurable interest defense essentially acts as an embedded option built into
insurance policies.208 If an insured event never happens, the option is
useless, but the insurer does not need to pay out on the policy anyway. If the
insured event happens, the insurer can assert the defense—after the
contestability period has run—and, in effect, get a second chance at invalidating
the policy after more information has been gained and premiums have been
paid into the insurers coffers. If the insurable interest doctrine defense is
successful, the insurer need only pay back premiums, but retains the value
of the death benefit—creating massive cost savings. Thus, the option value
increases as the probability of invalidation increases,209 with the caveat that
there is some uncertainty about whether or not the insurer will be able to
convince a court that no insurable interest exists—this determination will be
made according to murky fact-based tests.210 But, even that litigation
uncertainty works in favor of the insurable interest doctrine as a defense
because, even in the most strained scenarios, factually uncertain tests are still
worthwhile for an insurance company to submit to, as they create some
probability of invalidation. Thus, most of the benefit of the insurable
interest doctrine accretes to the insurance company—with very little in terms of
social welfare going to the initial insured or investor in a policy.
For example, the insurance company in Chawla v. Transamerica
Occidental Life Insurance Co.211 likely saw an opportunity to have an
insurance policy invalidated for want of an insurable interest when the insured
used a life insurance trust as a transaction vehicle, since Maryland law (the
applicable law) had never addressed the question of whether a life insurance
trust can have an insurable interest in the life of the insured. As previously
discussed, the court deciding the case held that the trust did not have an
insurable interest in the life of the insured, even though the insured was the
settlor and the creator of the trust.212 Significant costs must have been
incurred in litigating this case. In the end, the insurance company reaped all
207 See, e.g., Chawla v. Transamerica Occidental Life Ins. Co., No. CIV.A. 03-CV-1215,
2005 WL 405405 (E.D. Va. Feb. 3, 2005), aff’d in part, vacated in part, 440 F.3d 639 (4th
208 See Loshin, supra note 199, at 495.
210 See supra Parts II.B (for life insurance) & III.C (for property insurance).
211 2005 WL 405405 (E.D. Va. 2005), aff’d in part, vacated in part, 440 F.3d 639 (4th
212 Id. at *6.
the benefit of the risk taken on the insurance policy by invoking the
insurable interest doctrine, leaving the insured and his successors in interest with
no value for years of premiums paid. In addition, as a direct result of the
Chawla decision, the NCCUSL drafted yet another patch to the insurable
interest law.213 That patch attempts to create an insurable interest for
trustees,214 as part of the definition of what type of relationship qualifies for an
insurable interest in an insurance policy that funds a trust.215 In an attempt
to expand or contract what is within the ken of the insurable interest
doctrine, many states and Model Act drafters have adopted varying solutions,
creating an uneven landscape of regulation.216 The information inequality
created by an uneven regulatory landscape, of course, can really only mean
additional cost and burden being placed on the uninformed or misinformed
insured—the precise individuals the insurable interest doctrine was meant
E. Additional Policy Problems Arising From Market Structure
Since its English beginnings, the insurable interest doctrine has been
held up as an area where individuals are protected against being used as an
object of wager.217 A slightly more modern interpretation implies that
moral hazard is the real reason to keep the insurable interest doctrine around.
That is, the insurable interest doctrine protects individuals against the risk
of being killed for their insurance monies. Taking these justifications as
given, the doctrine still exhibits both internal definitional problems and
external effects problems with its existence. Thus, the insurable interest
doctrine should be abolished.
1. Definitional Problems
If the main purpose of the insurable interest doctrine is to protect the
dignity of the individual and the individual’s right not to be used as a wager
or a hedge without consent, the insurable interest doctrine has been a
nonstarter from the beginning. Many employers purchase insurance policies
insuring the lives of their employees. These policies, generally referred to
as “corporate-owned life insurance” (COLI) or “employer-owned life
insurance” (EOLI), are used to fund employee benefit plans and buy-sell
agreements, and to protect employers against the financial consequences of the
213 See INSURABLE INTEREST AMENDMENTS TO THE UNIFORM TRUST CODE §113(b) (Nat’l
Conf. of Comm’rs on Unif. State Laws 2010).
214 Id. §112(b).
215 Id. §112(b)(2).
216 See supra Part II.
217 See supra Part II.B.
death of a key employee.218 The insurable interest doctrine has always
allowed employers to take out insurance policies on the lives of their
employees without the consent of the insureds, because a company has a pecuniary
interest in a key employee or officer of its firm.219 Second, the insurable
interest doctrine has always allowed an interest in the life of an insured by
his or her spouse.220 This doctrine says nothing, though, of when an
insurable interest ends if a spouse has become estranged. It likewise says nothing
of co-domiciled couples or same sex civil unions. Third, issues involved
with how an insurable interest arises as to a contract of indemnity are
complex and unnecessary.221 The existence of four tests as to how an interest is
created222 engenders substantial market uncertainty that harms consumers of
such products writ large. So, if one heeds dignity concerns, one should
eliminate the need for an insurable interest doctrine for the holding of, but
not for the inception of, a policy. At the very least, insureds remain as a
clearinghouse for insurance policy transferability. This allows for cashing
out of a policy, but does not eliminate the massive transaction costs
associated with life settlements or the definitional problems described above.
Thus, this half-measure would likely be insufficient to allow for a market to
operate without a plethora of unnecessary actors and would also keep the
insured on the hook for his or her policy and premiums.
2. Systemic Concerns
A healthy secondary insurance market enhances liquidity for
policyholders.223 By extension, a market unhampered by the insurable interest
doctrine will further increase the liquidity of these policies, as policies will
be unhampered by the legal uncertainty introduced by litigation at the time
the settlement pays out. A result of this increased liquidity, though, as
insurance companies argue, is that the price of life insurance will rise,
because “lapse rates” for insurance policies will drop in the absence of a
robust insurable interest doctrine.224 As explained by the SEC:
Currently, insurers may experience economic gains associated with
218 Craig E. Behrenfeld & Erica Good Pless, Employer-Owned Life Insurance After the
Pension Protection Act of 2006, 83 FLA. B. J. 47, 47 (2009).
219 See, e.g., Mayo, 354 F.3d 400.
220 As exhibited by both English and Australian statutes, and the statues of the several
221 See supra Part III.D.
222 See supra Part III.C.
223 See Neil A. Doherty & Hal J. Singer, The Benefits of a Secondary Market for Life
Insurance Policies, 38 REAL PROP. PROB. & TR. J. 449, 469 (2003).
224 Hanming Fang & Edward Kung, How Does Life Settlement Affect the Primary Life
Insurance Market? 2 (Nat’l Bureau of Econ. Res., Working Paper No. 1576
available at http://www.nber.org/papers/w15761.pdf.
lapsed policies because insurers will have received premiums for
these policies but will not be liable for payment of death claims
associated with these policies. These economic gains may be used to
subsidize remaining policy owners. Since life settlements provide
policy owners with an alternative to allowing their policies to lapse,
they may cause lapse rates to decline and reduce the subsidies
available to the remaining policy owners.225
Thus, because they are denied the return on lapsing or surrendered
policies, life insurance companies claim that “the life settlement market . . .
increases the costs of providing policies in the primary market,” and further
allege that “these costs will have to be passed on to consumers, which
would ultimately make the consumers worse off.”226
Life insurance lapse rates are based upon experience, so it is difficult
to predict when lapse rates will rise or fall.227 However, the industry
already prices insurance policies with very conservative predictions of
lapse.228 Therefore, an open and free transferability market, or insurance
procurement market, will likely have a very small effect on both pricing and
profitability of insurance companies.229 Indeed, according to one analysis,
“a life settlements transaction generally has minimal or no impact on the
anticipated profitability of a life insurance contract because the persistency of
an unhealthy policyholder is precisely what is assumed at the time of
original pricing.”230 Thus, because the risk of an unhealthy policyholder is
already priced into the market, and low lapse rates are assumed, the
maximum amount prices in the insurance market would rise would be by the
value of the option in favor of the insurance company created by judicial
invalidation of a policy.231 In addition, current lapse rates have come under
fire from state insurance regulators as it has become known that insurers
abuse notice requirements in insurance policies to increase lapse rates and
avoid the payment of the death benefit.232 The elimination of the insurable
225 SEC REPORT, supra note 98, at 19.
226 Id. at 19 n. 82.
228 See Christian Kendrick, Special Report: Return of Premium Products, SCOR (Jul. 13,
2007, 12:00 AM), http://www.scorgloballifeamericas.com/Media/media_associateArticle.
229 SEC REPORT, supra note 98, at 20.
230 DELOITTE CONSULTING LLP & UNIV. OF CONNECTICUT, THE LIFE SETTLEMENT
MARKET: AN ACTUARIAL PERSPECTIVE ON CONSUMER ECONOMIC VALUE 12 (2005), available
231 See Loshin, supra note 199.
232 Leslie Scism, MetLife Defends Itself On Death-Policy Tack, WALL ST. J., May 20,
2011, at C1 (explaining that MetLife “used a database that tracked deaths when doing so
proved beneficial for one side of the company, but for years didn’t use the same database
when doing so could have meant more payouts to families of its life insurance clients who
interest doctrine would create greater efficiency by creating more vigilant
policyholders and preventing lapse from occurring.
There is an additional concern that the free transferability of life
insurance policies will lead to securitization of these policies. If the insurable
interest doctrine is eliminated, the argument goes, life policies will be
treated akin to any other security, and an unhealthy number of unsophisticated
market participants will enter the market for life insurance, akin to the
collateralized debt obligation or credit default swap markets.
In 2010, the SEC examined state securities laws, and concluded that
almost all states treat life settlements as securities under state law,233
although the actual sources of that law are in great disarray. The SEC found
that the definition of life settlements as a security falls into four (yes, four!)
different tranches. First, “[a] majority of states include life settlements in
their statutory definition of ‘security,’ either directly in that definition, or as
part of the definition of ‘investment contract.’”234 Second, “[i]n a number
of other states that do not include life settlements in their statutory
definition of security or investment contract, courts or state regulators found life
settlements to be a security under an investment contract analysis.”235
Third, “[a] few other states have concluded that life settlements are
securities pursuant to a statement of policy issued by state securities
regulators.”236 Finally, “[o]nly two states have not made a determination as to
whether life settlements are securities under state law.”237 As of July 2010,
no public securitizations of life insurance products have ever been done, but
some privately offered life settlement securitizations have occurred.238 A
market for “mortality swaps” does exist, and such swaps are rated by the
Fitch rating agency.239 As it stands, mortality swaps are only available to
insurance companies.240 However, the ability to hedge against such risk
should not be available only to one side of the ledger (insurance companies)
and not the other (consumers). This evidence of disparate types of
securities, ranging from mortality swaps to the actual securitization of life
policies, shows both that the market for securities based upon an individual life
as the relevant equity is widely accepted, but also that a great deal of legal
uncertainty exists due to non-uniformity among the products in this field.
States are the primary regulators of the life insurance settlement
market because Section 3(a)(8) of the Securities Act of 1933241 exempts from
federal regulation by the SEC any “insurance . . . policy” or “annuity
contract” issued by a corporation that is subject to the supervision of a state
insurance commissioner, state bank commissioner, or similar state regulatory
authority.242 However, this exemption does not apply to “variable life
insurance policies,” or policies where the cash value and/or death benefit vary
based on the performance of the assets in which the premium payments are
invested.243 In contrast to a variable life insurance policy, a standard
insurance policy merely allocates a set death benefit, and the premiums go to the
general account of the insurer.244 This divergence shows that the nature of
the insurance market has always been vexing even for securities regulators.
Further reflecting this point, the D.C. Circuit245 and the Eleventh Circuit246
are split regarding the status of fractional interests in life settlements as
securities under the federal securities laws. The SEC recently recommended
that standard life settlement contracts be pulled into the definition of a
security under the Securities Act of 1933 and the Securities Exchange Act of
1934.247 Uniform regulation, coupled with the elimination of the insurable
interest doctrine, would allow alienated life insurance contracts to be
securitized, to be sure, but it would force sunlight onto pre-existing
securitization under state schemes and (most importantly) would allow for consistent
treatment of and standards for investors and consumers.
If litigation under the current regime is any indication, the life
settlement market is extremely flawed for insured individuals because the
insurable interest doctrine pushes the market sub rosa. For example, at the
height of the secondary market for life insurance in the last decade, “tens of
die sooner than expected to institutional investors.”).
241 15 U.S.C. § 77a (2010).
242 Id. § 77c(a)(8); see also SEC REPORT, supra note 98, at 21.
243 SEC REPORT, supra note 98, at 21 n.89.
244 Id. at 21 n.89.
245 See SEC v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996), reh’g denied, 102 F.3d
587 (D.C. Cir. 1996).
246 See SEC v. Mut. Benefits Corp., 408 F.3d 737 (11th Cir. 2005).
247 SEC REPORT, supra note 98, at 39.
thousands of older people sought to make fast cash by taking out
multimillion-dollar policies to sell to investors.”248 However, as explained above,
the insurable interest doctrine forces insured individuals to pay premiums
on policies in the time between the origination of the policies and their sale
to investors.249 Thus, once the market weakened at the end of the decade,
“older people who took out life policies on assurances that could flip them
to investors are suing agents, lenders, and insurers, claiming they were
misled into shelling out premiums on policies that ultimately found no
buyers.”250 Thus, when no buyers are found for a life insurance policy, the
insured loses past premiums paid and receives no cash remuneration for the
policy. The insured is then forced to stop paying premiums on the policy,
the policy lapses, and the insurance company gets to retain the insurance
premiums without the obligation to pay out on the policy. All of this is
because the insurable interest doctrine requires that a “cloak” be used, as
explained above, in order to effectuate the cash out of these STOLI policies.251
The elimination of the doctrine would allow investors to invest in the life
insurance market without forcing an insured individual to be on the hook
for premium payments. The great advantages of this approach are certainty
and the streamlining of the number of persons involved in an insurance
Because the insurable interest doctrine forces several third parties252
into a transaction that is essentially an arrangement to take out a futures
contract on a person’s life, it creates massive informational problems for
investors. This problem arises in the actuarial component of the current life
settlements market. For example, Life Partners Holdings Inc., in Waco,
Texas, arranged for investors to buy several billion dollars of life insurance
policies from their original owners.253 However, Life Partners had to
engage in the procedure of analyzing the life expectancies of the insured
individuals because it is a crucial part of the investment equation.254 Generally,
the shorter an insured person’s expected life span, the more Life Partners
could charge for the policy, because investors could expect a faster
payout.255 Life Partners marketed to investors that they should expect a ten to
248 Leslie Scism, New Life-Policy Fallout: Suits From Insured, WALL ST. J., Feb. 2, 2011,
249 See Dawe, 28 A.3d at 1065 (explaining that the whole purpose of incontestability
clauses was to reduce the uncertainty of paying premiums into a policy that would be
rendered ineffective at a later date via litigation by an insurance company).
250 Scism, supra note 248.
251 See supra Part II.C.3.a.
252 See supra Part III.B.
253 Maremont & Scism, supra note 70, at C1.
fifteen percent payout if they invested in a pool of life insurance policies
tagged to individuals with a certain lifespan.256 However, these life
expectancies were calculated by a Reno, Nevada physician who testified that he
sometimes did dozens of these life expectancy estimates a day and didn’t
review his prior predictions for accuracy.257 Therefore, because of the flaw
in these life expectancy estimates, returns on these policies began to miss
their ten to fifteen year mortality targets, and investors alleged that they
were misled by Life Partners’ marketing schemes.258 In the meantime, as
the arranger of deals between insureds and investors, Life Partners had
extracted “often-hefty fees in the deals.”259 Essentially, a firm like Life
Partners exists at the behest of the insurable interest doctrine by creating the
necessary cloak to bring together investors and insureds. The elimination
of the doctrine would force these transactions out from under the cloak and
allow for greater informational clarity. Investors will demand that
insurance companies make actuarially accurate guesses about the life span of an
individual insured, and insurance companies will be on notice about to
whom and where the policy will pay out at its inception.
One final traditional concern in this area is that if insurance policies
are able to be taken out by “strangers” to an insured, then moral hazard will
either dictate that the subject of the policy (a person in life insurance
scenarios, or an object in indemnity policy scenarios) will be destroyed by the
person taking out the policy and/or there will be an incentive to take less
good care of a person who is the subject of the insurance. The first concern,
about moral hazard leading to the untimely demise of an individual, is
obviated by laws in other areas, notably trust and estate law, called “slayer”
laws.260 Codified statutorily in many states, but generally stemming from
common law, slayer laws prohibiting inheritance by a person who murders
someone from whom she stands to inherit.261 Some states’ case law even
goes so far as to limit the right of the killer’s descendants to take property
under a will or the relevant intestacy statutes.262 Since insurance payments
from the death benefit pay into a trust under the most common policies, or
are reviewed by the insurance company prior to payment, slayer laws would
likely prevent murderers from collecting on these policies. The second
issue of taking less good care of an individual from whom an insurance
policy is supposed to pay out is already an issue that exists under the current
257 Mark Maremont & Leslie Scism, Life Partners will Change Sales Method. WALL ST.
J., Jan. 27, 2011, at C1.
258 Maremont & Scism, supra note 70, at C1.
260 JESSE DUKEMINIER ET AL., WILLS, TRUSTS AND ESTATES 149 (8th ed. 2009).
262 Id. (citing In re Estate of Mueller, 655 N.E.2d 1040 (Ill. App. 1995)).
life settlement regime, and the risk of such lower care of that may not
necessarily be any different under a regime which is merely less cumbersome
because of the elimination of the insurable interest doctrine.
IV. A NATURAL EXPERIMENT: THE DEATH OF INSURABLE
INTEREST IN AUSTRALIA
The argument that the insurable interest doctrine should be eliminated
is further bolstered by the Australian experience. The insurable interest
doctrine is effectively dead in Australia.263 In 1982, the Australian Law
Reform Commission recommended the insurable interest doctrine be
eliminated for property.264 The Commission also intimated that the policy should be
eliminated for life insurance:
The need to allow policyholders to use policies as a form of property,
together with the uncertainty that would be introduced into insurance
practice if the policyholder were required to have an interest at the
date of death of the life insured, constitute[s] an adequate
justification for not restricting the existing freedom of assignment.265
The road to the modern day status of insurable interest in Australia is
instructive for the American system, as the two systems share the same
roots in two English statutes266 and similar trajectories in the creation of a
complex market for secondary life insurance products.
In Australia, the requirement of an insurable interest was said to serve
three main policies: (i) to discourage wagering on lives in the form of
insurance; (ii) to minimize the risk of destruction of the object of the insurance;
and (iii) (in the case of property) to restrict the insured to no more than a
full recovery for its actual loss.267 Given Australia’s English provenance,
the English Marine Insurance Act of 1745 and Life Insurance Act of 1774
remained in effect to govern the insurance world until they were altered by
the Australian Marine Insurance Act of 1909268 and Insurance Contracts Act
of 1984.269 Australia’s Marine Insurance Act of 1909 stated that marine
insurance that amounted to a wager was void; but, if a contract of marine
insurance were entered into with the intention of obtaining an insurable
263 See SUTTON, supra note 11, at 531.
264 AUSTL. LAW REFORM COMM’N, INSURANCE CONTRACTS 87–88 (1982).
266 Marine Insurance Act, 1745, 19 Geo. 2, c. 37 (Eng.); Life Assurance Act, 1774, 14
Geo. 3, c. 48, § I (Eng.).
267 See Kosmopoulos v. Constitution Ins. Co.,  1 S.C.R. 2, 25 (Can.) (citing
Bertram Hartnett & David V. Thornton, Insurable Interest in Property: A Socio-Economic
Reevaluation of a Legal Concept, 48 COLUM. L. REV. 1162, 1178–83 (1948)).
268 Marine Insurance Act 1909 (Cth) ss 5–6 (Austl.).
269 Insurance Contracts Act 1984 (Cth) ss 5–7 (Austl.).
est, it was held valid.270 That legal stance, while statutorily applying to only
marine contracts from the 1909 law, is said to have applied more broadly to
non-marine risks in property until 1984.271 The Life Insurance Act of 1945
altered the landscape for insurable interest for life insurance by delineating
five categories where an insurable interest would arise.272 An insurable
interest was given to: (i) the parent of a child under 21; (ii) a wife to a
husband and vice versa; (iii) any person who depended upon the support of the
insured in whole or in part; (iv) a corporation or other person in the life of
an officer or employee; and (v) a person who had a pecuniary interest in the
duration of the life of another person.273 Thus, until 1984, essentially the
same legislation and case law as the English system governed the
Australian system, with a few differences in how far an insurable interest would
extend. At least one scholar and court indicate that there was a presumption
during this time in favor of finding an insurable interest because it was
often a technical objection—made by insurance companies—after premiums
had been paid to an insurer by an insured.274
In 1984, Australia made a sharp break with its American and English
contemporaries by eliminating the insurable interest requirement for
indemnity contracts and other property insurance contracts.275 Section 16 of
the Insurance Contracts Act of 1984 provides that a contract of “general
insurance” is not void if the insured did not have an insurable interest in the
subject of the insurance at the time that the contract is formed.276 The 1984
Act effectively abandons the “legal interest” test outlined in Macaura in
favor of a test based in economic loss for indemnity contracts.277 Therefore,
since an insured normally has to show that “he or she has suffered loss as a
result of an event insured against before he or she can recover under the
policy . . . proof of loss is equivalent to proof of interest.”278 Thus,
somewhat elegantly, “[f]lexibility to both insurer and [insured] is achieved
without in any way promoting gaming and wagering in the form of insurance or
adding to the risk of the destruction of the property insured.”279 However,
the 1984 Act stops short of eliminating an insurable interest for life
270 See SUTTON supra note 11, at 506.
271 Id. at 515.
272 Life Insurance Act 1945 (Cth) s 86(1) (Austl.).
273 Id. s 86(1)(a)–(f).
274 See SUTTON, supra note 11, at 524 (citing Stock v. Inglis,  12 Q.B.D. 564, 571
275 Insurance Contracts Act 1984 (Cth) s 11(1) (Austl.).
276 Id. s 16(1).
277 See SUTTON, supra note 11, at 528.
278 Id. at 527.
279 Id. at 528.
ance contracts.280 By delineating life insurance contracts broadly as a
separate category of insurance still requiring traditional insurable interest
requirements at the time of contract formation,281 the insurable interest
doctrine was only partially abrogated.
In 1995, Australia took yet another break from the common law and its
contemporaries by abolishing the insurable interest requirement for life
insurance altogether.282 According to one scholar, “[t]he rationale behind the
previous insistence on [the] requirement—the reduction of the temptation to
murder the life insured in the hope of obtaining the proceeds from the life
insurance, and the discouragement of wagering and gaming—apparently no
longer holds sway.”283 Since the common law does not require an interest
in the life of the insured at the time of death,284 and the 1995 Life Insurance
Act no longer requires such an interest at the time of formation,285 the
insurable interest doctrine is gone in Australia. Up until 1995, the market for
the assignment of life insurance policies had grown in Australia to the point
where the law recognized the assignments of life policies, subject only to
compliance with the necessary convoluted procedure involving cloaks
similar to the U.S. system described above.286 In exactly the same fashion,
many American jurisdictions recognize the assignment of life policies,
subject to procedures that satisfy the insurable interest doctrine.287
The 1995 Act allows the transfer of life insurance policies by simple
assent of the transferor and the transferee, subject to disclosure
requirements.288 The process was simplified because the Australian Law Reform
Commission thought that life insurance ought to be treated as property;
[T]he need to allow policy holders to use policies as a form of
property, together with the uncertainty that would be introduced into
insurance practice if the policy holder were required to have an interest
at the date of death of the life insured, constitute an adequate
justification for not restricting the . . . freedom of assignment.289
280 Insurance Contracts Act 1984 (Cth) s. 16(1) (Austl.).
281 Id. s. 18.
282 Life Insurance Act 1995 (Cth) s 200 (Austl.).
283 See SUTTON, supra note 11, at 531.
285 Life Insurance Act 1995 (Cth) s 200 (Austl.) (deleting s 16(2) from the Insurance
Contracts Act of 1984 and repealing s 18 of the same act, eliminating the necessity for an
insurable interest in either property contracts or life insurance contracts).
286 See SUTTON supra note 11, at 531; see also supra Part II.C.
287 See supra Part III.
288 See Life Insurance Act 1995 (Cth) ss 200(2)(a)–(f) (Austl.).
289 AUSTL. LAW REFORM COMM’N, supra note 264, at 87.
Moreover, the law, as written, eliminates the requirement for the insured to
have an insurable interest at any point of an insurance transaction.290 Thus,
the Australian legislature seems to have made a balanced decision on the
elimination of the insurable interest doctrine completely. On the one hand,
the legislature was prepared to accept the risk that the risk of wagering or
gaming on the lives of others will increase. On the other hand, in exchange
for eliminating the insurable interest doctrine, it created a comprehensive
regulatory scheme intended to streamline the market; and, it eliminated the
need to draft detailed provisions as to whether an insurable interest could
exist in certain relationships and as to whether and what type of loss was
necessary to occur to effectuate an insurance policy ex post.
To be sure, the Australian authorities did not enact the 1995 Act
without any regard for regulation. The elimination of the insurable interest
doctrine came with the creation of a comprehensive regulatory scheme in two
major divisions of the Australian government. In 1998, the Australian
Prudential Regulation Authority was created to administer the Life Insurance
Act of 1995.291 Furthermore, the Australian Securities and Investments
Commission is charged with administering the Insurance Contracts Act of
1984.292 These two regulatory bodies maintain the difference between
indemnity contracts dealing with property and life insurance policies dealing
with life insurance regulation that began in the eighteenth century and
continues to press against law today.
After the introduction of the 1995 Act, the Australian securitization
market developed rapidly into one of the most active outside the U.S.293
The Australian insurance industry is not suffering either, according to
statistics released as recently as June 2010.294 Net profit after tax was $2.765
billion Australian dollars ($2.229 billion USD), up from $1.985 billion
Australian dollars in the previous year. Industry revenue totaled $29.896 billion
Australian dollars ($3.155 billion USD), up from $24.448 billion in the
previous year. In what is likely to have been a remarkable year, the return on
net assets for the life insurance industry alone was 17.3%. As is clear from
these statistics, a robust, profitable insurance market can (and does) exist in
the absence of the insurable interest doctrine as a “safety valve.”
290 See Life Insurance Act 1995 (Cth) ss 200–29 (Austl.).
291 See About APRA, AUSTRALIAN PRUDENTIAL REGULATION AUTHORITY (APRA),
(last visited Oct. 5, 2011)
292 See Our Role, ASIC, http://www.asic.gov.au/asic/ASIC.NSF/byHeadline/Our%20role
(last visited Mar. 5, 2012).
293 Alvin Liaw & Guy Eastwood, The Australian Securitisation Market (Australian
Prudential Regulation Authority, Working Paper 6, Oct. 2000).
294 Australian Prudential Regulation Authority, Statistics: Half Yearly Life Insurance
(Jan. 5, 2011)
, available at
B. History of the Insurable Interest Doctrine................................. 98
C. Current U.S. Law Governing the Insurable Interest ............... 105
Settlement Industry........................................................................ 120
and Size................................................................................... 120
Insurable Interest Law............................................................. 123
C. How Insurable Interest Functions in Indemnity Policies ........ 126
D. Litigation Costs due to the Insurable Interest Doctrine .......... 127
E. Additional Policy Problems Arising From Market Structure .. 129
Australia ........................................................................................ 136
Conclusion ..................................................................................... 140
1 Leslie Scism , Regulators Rein In Murky Life Policies, WALL ST. J. (June 21 , 2010 ),
YWORDS=insurable+interest#printMode. 47 The history of the insurable interest doctrine is dealt with in greater depth and thor-
and markets in the United States. 48 3 Yeates 458 , 464 (Pa. 1803 ). 49 Id. (emphasis in original). 50 See Lord v . Dall , 12 Mass. ( 11 Tyng.) 115 ( 1815 ). 69 Richard J. Fidel & Elizabeth M. Fohl , 2010 in Review: Ten Key Insurance Regulatory
Topics That Shaped the Year , 2010 EMERGING ISSUES 5465 ( 2011 ) (LEXIS); see also Scism,
supra note 1 . 70 Mark Maremont & Leslie Scism, SEC Probes Company over Life-Span Data , WALL
ST. J. , Jan . 20 , 2011 , at C1. 71 See infra Part III. 72 A viatical settlement is a policy that is sold on the open market where the insured has
less than 24 months to live . See Life Partners, Inc. v. Morrison, 484 F.3d 284 , 287 (4th Cir.
2007 ). 73 A life settlement is a policy that is sold on the open market where the insured has more
than 24 months to live. See LIFE SETTLEMENTS MODEL ACT § (2 )(L) (Nat'l Conf . of Ins. Leg-
islators 2007 ), available at http://www.ncoil.org/Private/2007/annual/AdoptedLifeSettle
mentsModel.pdf. 74 Stranger-originated life insurance policies are policies that are taken out by an insured,
testability period in a state expires. See id. § (2)(Y). 75 VIATICAL SETTLEMENTS MODEL ACT (Nat'l Ass'n of Ins . Comm'rs 2009 ), available at
http://www.naic.org/committees_index _model_description_r_z.htm#viatical_act. 91 LIFE SETTLEMENTS MODEL ACT § 2(H)(1)(a)(x) (Nat'l Conf . of Ins. Legislators 2007 ). 92 LIFE SETTLEMENTS MODEL ACT § 11(N) (Nat'l Conf . of Ins. Legislators 2007 ). 93 See 26 U.S.C. § 101 (g)( 2)(B)(ii)(I) ( 2010 ). 94 VIATICAL SETTLEMENTS MODEL ACT §§ 8-9 (Nat'l Ass'n of Ins . Comm'rs 2009). 95 Rev. Rul. 2009-13 , 2009 -21 I.R.B. 1029 . 96 See Tax Implications of Life Settlement Transactions, LIFE INS . SETTLEMENT ASS'N,
http://www.thevoiceoftheindustry.com/content/42/Tax-Implications- of- Life- Settlement-
Transactions. aspx (last visited Oct . 3 , 2011 ). 97 See Heady, supra note 68, at 866-74. 102 See Dawe , 28 A. 3d 1059; Lincoln Nat'l Life Ins . Co. v. Joseph Schlanger 2006 Ins.
Trust, 28 A.3d 436 (Del. Sept . 20 , 2011 ). 103 See Kramer, 940 N.E.2d at 542. 167 See SEC REPORT, supra note 98 , at 11 . 168 RUSS & SEGALLA, supra note 2, § 240 : 1 . 169 Id. 170 Press Release, Conning Research and Consulting, Life Settlements-New Challenges
to Growth (Oct. 8 , 2008 ), available at http://www.conning.com/pressreleasedetail.
aspx?id=154 . 171 See Sam Rosenfeld , Life Settlements: Signposts to a Principal Asset Class 3 (Wharton
Financial Institutions Center , Working Paper No. 09 - 20 ), available at
http://fic.wharton.upenn.edu/fic/papers/09/0920.pdf (citing Conning Research and Consult-
ing's 2007 publication LIFE SETTLEMENT MARKET: INCREASING INVESTOR AND CAPITAL
DEMAND) . 172 Press Release, Conning Research and Consulting, Life Settlements: A Buyers' Market
for Now (Oct. 8 , 2009 ), available at www.conning.com/pressrelease-detail. aspx?id=3447 . 173 Matthew Goldstein , Why Death Bonds Look so Frail, BUS . WK. (Feb. 25 , 2008 , 5 : 00
PM) , http://www.businessweek.com/magazine/content/08_08/b4072040348943.htm. 174 Press Release, Conning Research and Consulting, U.S. Life Settlements Annual Vol-
ume Dropped 36 % in 2009 (Oct. 28 , 2010 ), available at www.conning.com/pressrelease-
detail. aspx?id=4818 . 175 Press Release, Conning Research and Consulting, Life Settlements: An Asset Class
Resets (Oct. 5 , 2011 ), available at http://www.conning.com/pressrelease-detail.aspx?
died.”). 233 See SEC REPORT, supra note 98 , at 36. “ Some states, however, exclude from the def-
Dakota , Ohio, Utah, and Wisconsin . Id. at 36 n.173. 234 Id. at 36 . These states are Alaska, Arizona, Arkansas, California, Colorado, Florida,
Vermont , West Virginia , and Wisconsin . Id. at 36 n.174. 235 Id. at 36 . These states are Delaware, Louisiana, Maryland, Massachusetts, New
Hampshire , New York, Oregon, Virginia, and Washington. Id. at 36 n.175. 236 Id. at 36 . These states are Alabama, Pennsylvania, Rhode Island, and Texas . Id. at 36
nn. 175 - 76 . 237 Id. at 36. These states are Connecticut and Wyoming . Id. at 36 n. 177. 238 Id. at 5 . 239 Katy Burne, 'Mortality Swaps' Coming Alive: Fitch Issues Rating on Insurer's Death-
Risk Transaction , WALL ST. J., Nov . 12 , 2010 , at C1 (explaining that a “transaction in ques-