Viaticals, Life Settlements and STOLIs… sound Russian but they are not!

Over the years, many clients have brought investments in life insurance policies to our attention as these have become popular as alternative investment funds. We have always been skeptical of the payouts and liquidity issues, but now two new court rulings show additional risks are involved. Investor beware!

In light of two recent rulings by the Delaware Supreme Court, hedge funds and other investors will need to do their diligence to ensure that their investments abide by certain US state laws. And in any event, they should be prepared for insurance companies to increasingly challenge life insurance policies that are assigned by the insured for the benefit of third party investors.

Both cases decided by the Delaware Supreme Court involve an investment vehicle established by Deutsche Bank AG named the GIII Accumulation Trust. In each case an individual purchased a life insurance policy as part of what the life insurance companies alleged to be a stranger originated life insurance (“STOLI”) scheme, where the individual (through a trust) sold his beneficial interest to GIII shortly after purchasing the policy. The insurance companies attempted to void the applicable insurance policy as an illegal contract wagering on human life.

In each case, the Delaware Supreme Court ruled that a life insurer can contest the validity of a life insurance policy based on a lack of insurable interest, even after the two year contestability period set out under Delaware law. The court reached this result on the basis that life insurance contracts that lack an insurable interest are void ab initio as a violation of public policy against wagering (as opposed to voidable, which would implicate the two year contestability period).

For investors in what may be deemed to be STOLI transactions, the court’s decisions introduce a new element of risk, particularly where life insurance policies are pooled in securitization vehicles and may be difficult to diligence. Under the Delaware court’s decisions, it is clear that insurance companies may seek to void any STOLI policy that is found to lack an insurable interest.