The judge determined that state insurable interest laws do not apply to annuities – at least, in this case.
A ruling by a Rhode Island judge in a key lawsuit has raised questions on whether insurers can rely on state insurable-interest laws to stop stranger-originated annuity sales.
In an interim ruling last week, U.S. District Judge William E. Smith of Rhode Island, turned back insurance carriers' attempt to outlaw this type of sale, in which an annuity is sold to a dying person but paid for by a third party, who then holds the value of the annuity and profits on the death of the annuitant.
In suits brought by Western Reserve Life Insurance Co. and Transamerica Life Insurance Co. against a trio of broker-dealers and their registered representatives, the carriers alleged that an attorney had paired up investors with terminally ill individuals, who were paid a small sum to act as annuitants.
But in his decision, which was first reported on last week by the Wall Street Journal, Mr. Smith determined that state insurable interest laws do not apply to annuities – at least, in this case.
Executives at major broker-dealers have argued that if there is a death benefit, there must be an insurable interest in the life of the annuitant.
The judge found that the insurable-interest argument fell flat due to a statutory distinction between annuities and life insurance. State laws define annuities as an agreement to make periodic payments for a given period or a situation in which the payments depend “on the continuance of human life,” except for payments related to a life insurance policy.
“The annuities in question are specific, well-understood financial instruments,” he wrote in his opinion. “And while they also happen to involve monetary exchange connected to the duration of a life, they are not life insurance.”
The trial in Rhode Island has been closely watched by insurance regulators and members of the insurance industry. Many in the industry had hoped the legal actions would provide some clarity on how insurable interest applies to death benefits packaged with annuities.
Mr. Smith did provide some clarity – dismissing Western Reserve and Transamerica's claims for rescission, negligence and civil liability for crimes and offenses. The judge also denied declaratory judgment that the annuity contracts were void. In addition, charges of fraud and civil conspiracy against two of the investors were dismissed. Transamerica's claims of breach of duty of good faith and fair dealing against broker-dealer Lifemark Securities Corp. were also dismissed. The rest of the counts will proceed.
But the decision in Rhode Island is clearly a set-back for insurers.
“This case is still in litigation,” said Brooks R. Magratten, an attorney at Pierce Atwood LLP who is representing Transamerica.
“There isn't much we can say other than that the client is pleased that the court ruled that the case can go forward.” He added that the insurer is reviewing the rest of the ruling and that they haven't determined whether there would be an appeal on some of the findings.
Connecticut insurance commissioner Thomas R. Sullivan, who is also chairman of the National Association of Insurance Commissioners' life and annuities committee, said he was not surprised by the decision. “But keep in mind that it's an interpretation of Rhode Island law,” said Mr. Sullivan. “The one good thing the court did was preserve the rights to further enforcement activities and prosecution—that's still alive and well here.”
Likewise, the American Council of Life Insurers remained undaunted despite the insurable interest finding.
“Procedurally, the trial court's opinion could also be challenged on appeal and reversed or amended,” said ACLI spokesman Jack Dolan. “It is important to remember that individual contracts tend to differ and state insurance laws are not all the same.”
