To be clear, the following comments are those of Ben Schwartz, individually, and do not represent the position of the American Council of Life Insurers, its member companies or any other lawyer or law firm.

The Delaware Supreme Court issued an opinion today (here) dealing with Stranger Originated Life Insurance (STOLI). STOLI is the practice of investing or wagering on human lives by procuring life insurance on strangers. If they die before the insurance companies’ actuaries project, then the investors make money. A lot of people find the practice morally unacceptable, though it has been going on for hundreds of years.

Several cases were filed in the United States District Court inDelawareby life insurance companies seeking to avoid having to pay out on fraudulent STOLI contracts. The District Court inDelawareis the federal court. The District Court needed questions aboutDelawarelaw answered by the State ofDelaware’s highest court, the Supreme Court, so they certified a number of questions of law. Here are the questions, paraphrased for simplicity:

1) Can an insurance company contest the validity of a life insurance contract more than two years after it is created? Delaware has a two-year contestability statute at 18 Del.C. § 2908.  The Delaware Supreme Court decided Yes, a life insurance policy with no insurable interest is void from the beginning, so the contestability limitations period does not apply.

What is an “insurable interest”, you ask? An insurable interest is some expectation of benefit from the continued life of the subject of the insurance policy. For example, if father works for DuPont as a chemist, and he obtains a life insurance policy naming mother as beneficiary, then mother has an insurable interest. She expects to receive a benefit from father’s continued life because he will be expected to continue to work as a chemist and bring home wages. An insurance policy in that situation is entirely proper.

2) Does 18 Del. C. § 2704(a) and (c)(5) prohibit a person from taking out a life insurance policy on himself, then immediately transferring the policy to others, such as an investment trust, with no insurable interest in his life? The Supreme Court answered No, a validly issued life insurance policy can be assigned to anyone subject to limitations in the policy itself. That said, a STOLI investor cannot induce a person to obtain a life insurance policy naming as beneficiary someone with an insurable interest, and then later assign it to the investor for the purpose of evading the insurable interest requirement. The Supreme Court seems to require payment of the premiums to be made by the person obtaining the life insurance policy on his own life, not by anyone else.

3) Does 18 Del. C. § 2704(a) and (c)(5) confer an insurable interest in the following situation: a person takes out a life insurance policy on himself, then names a trust as the beneficiary. The person does not intend for the trust to be funded with the proceeds of the life insurance for his wife or children, but instead intends for the trust to be sold to STOLI investors. The way I read it, the Supreme Court answered Yes, that is fine as long as the individual who buys the life insurance policy on his own life creates the trust and pays the premiums with his own money, he can assign the benefits to whomever he wants. But if the STOLI investors pay for the life insurance, then that’s a wagering contract and it’s void.

Here is the bottom line, as far as I’m concerned: STOLI contracts are illegal in Delaware because they are essentially wagering contracts where investors are betting that people will die sooner rather than later. As a matter of public policy, we don’t want people betting on that, and in fact, the Delaware Constitution prohibits wagering. So if you are asked to invest in a STOLI policy, a pool of life insurance policies, or securities backed by pools of STOLI life insurance policies, forget about it.