CHICAGO - Oral arguments in a key insurable-interest case are to be heard next week in federal appeals court in Baltimore.
The case, Chawla v. Transamerica Occidental Life Insurance Co., involves the late Harald Giesinger, who set up a life insurance trust in 1995 naming himself and his friend Vera Chawla as trustees (InvestmentNews, Aug.29). In 2000, they first sought to buy a $1 million life insurance policy on Mr. Giesinger from Transamerica Occidental Life Insurance Co. in Los Angeles, naming Mrs. Chawla as the policy's owner and beneficiary.
Mr. Giesinger died in 2001, but the company refused to issue the policy, saying that Mrs. Chawla, his doctor's wife, did not have an insurable interest in Mr. Giesinger under Maryland state law.
It defines insurable interest as a lawful and substantial economic interest in the continuation of the life, health and bodily safety of the individual.
A life insurance trust is a legal entity established for the purpose of owning a life insurance policy. If the insured is the owner of the policy, the proceeds of the policy will be subject to estate tax when he dies. But if he transfers ownership to a life insurance trust, the proceeds are free of estate taxes that can run as high as 46%. A life insurance trust can save an estate several hundreds of thousands of dollars in estate taxes.
However, an insurance trust as a separate entity does not meet any of the requirements set forth in most state statutes for having an insurable interest, and life insurance policies are being treated essentially like investments, said Mary Ann Mancini, partner in the trusts and estates practice at Williams Mullen, a law firm in Washington. She wrote an article about the case for the Washington-based quarterly ACTEC Journal, a publication of the American College of Trust and Estate Counsel in Los Angeles. "[Insurance policies] are being treated like another security to invest in, and people are profiting from taking out these policies with no insurable interest. The insurance industry is very worried and upset over this," Ms. Mancini said. "In my research, I've found that the best outcome for the case would be for Chawla to win."
To buy a life insurance policy on someone else's life, the purchaser must have an interest in that person's remaining alive or expect emotional or financial loss from that the death to establish insurable interest. Without this requirement, it would be very easy to make a living by purchasing life insurance policies on elderly strangers and then collecting the proceeds when they died. The insurable interest requirement also prevents people from buying a life insurance policy on someone and then causing or hastening that person's death.
An insurance trust, as a separate entity, does not meet any of the requirements set forth in most state statutes for having an insurable interest in the insured, Ms. Mancini said.
"The issue was whether the beneficiary had an insurable interest in the insured. The case involved Geisinger's doctor's wife, Mrs. Chawla, as the beneficiary - quite a reach by any standard," said Clark Allison, founder of and attorney with Allison Consulting in Folsom, Calif. Many insurance trusts involve family members and business partners, relationships that clearly have an insurable interest, according to California law.
Insurable-interest requirements generally are thought of as a public policy arising out of an aversion to wagering on human life, said Michael Nelson, vice president and trust offer with Iowa Savings Bank in Carroll.