The federal court in Delaware recently issued the first decision applying the insurable interest standards articulated by the Delaware Supreme Court last year in the context of a life insurance policy purchased with borrowed funds. See Principal Life Ins. Co. v. Lawrence Rucker 2007 Ins. Trust, No. 08-cv-00488, 2012 WL 2401717 (D. Del. Jun. 26, 2012) (“Rucker II”). Rucker II is favorable to the secondary market for life insurance in general, and premium finance in particular.

In Rucker II, the court reversed its own prior summary judgment ruling, and held that an insured’s use of a loan to pay premiums on a life insurance policy will not render the policy void for lack of insurable interest under Delaware law, provided that the loaned funds did not ultimately come from a third-party that lacked an insurable interest in the insured’s life and with whom the insured had a prior agreement or understanding to sell the policy. Rucker II also held that an insured’s intent to transfer a life insurance policy to a third-party without an insurable interest does not, per se, violate Delaware’s insurable interest law. Rather, in order for a violation of Delaware’s insurable interest law to occur, the insured must have: (1) purchased the policy with the intent of immediately transferring it to a third-party without an insurable interest; and (2) received a financial inducement from that particular third-party to purchase the policy. In so deciding, the Rucker Court determined that, in Delaware, like in New York and Pennsylvania, insurable interest cannot be based solely on the intent of the individual insured or the fact that the insured borrowed money to pay the initial premiums.

In Rucker II, Principal Life Insurance Company claimed that a $3.5 million life insurance policy that it had issued on the life of Lawrence Rucker (the insured) was void ab initio for lack of insurable interest and/or material misrepresentations in the policy’s application. The original owner and beneficiary of the policy was an irrevocable life insurance trust, the beneficiaries of which were the insured’s family members. A month after the policy had been issued, the beneficial interest in the trust was sold to an investor. The insured admitted that he had purchased the policy for the sole purpose of selling it to an investor after issuance. The insured also admitted that he had received a loan from Wayne Aery, the broker/agent of record in connection with the procurement of the policy, to pay the initial premium because, contrary to the information provided in the policy’s application, he could not afford to pay it. Thus, Aery, not the investor that ultimately purchased the beneficial interest in the trust, was the source of the funds that the insured borrowed to pay the initial premiums.

In August 2010, the Rucker Court granted summary judgment in favor of Principal, holding that the facts set forth above were sufficient to render the policy void for lack of insurable interest under the Delaware law. Principal Life Ins. Co. v. Lawrence Rucker 2007 Ins. Trust, 735 F. Supp. 2d 130 (D. Del. 2010) (“Rucker I”). Following the Delaware Supreme Court’s summary judgment decision, PHL Variable Ins. Co. v. Price Dawe 2006 Insurance Trust, 28 A.3d 1059 (Del. 2011), the Rucker Court, sua sponte, reconsidered its summary judgment ruling, asking the parties to brief the issues again in light of Dawe.

The Rucker Court noted that, under Dawe, a policy transferred to a third-party without an insurable interest will only be deemed to violate Delaware’s insurable interest law if the policy was procured by someone other than the insured and the policy was a mere cover for a wager. Rucker II, 2012 WL 2401717, at *5. With regard to the insured’s procurement of a policy, the Rucker Court noted that Dawe held that the payment of premiums by the insured, as opposed to by a stranger, was a key factor in determining insurable interest under Delaware law. Id. Although it was undisputed that Aery had loaned the insured the money to pay the initial premiums, the Rucker Court held that use of the loan was not dispositive proof that premiums were paid by someone other than the insured:

Although there was no official loan agreement between [the insured] and Aery, Price Dawe does not foreclose an insured from borrowing money to pay for premiums. An insured’s ability to procure a policy is not limited to paying the premiums with his own funds; borrowing money with an obligation to repay would also qualify as an insured procuring a policy.

Id., at *5.

The Rucker Court reasoned that, under Dawe, in order to establish an insurable interest violation, Principal needed to prove that the investor that purchased the beneficial interest in the trust was also the source of the funds that the insured borrowed to pay the initial premiums. Id. Since the facts developed during discovery indicate that Aery was the source of the funds that the insured borrowed to pay the premiums, and Principal did not submit sufficient evidence that Aery was related to the investor which purchased the insurable interest in the trust that owned the policy, Principal had not met its burden under Dawe regarding third-party payment of premiums. Id., at *6. In Dawe, unlike in Rucker, it was undisputed that the third-party investor that purchased the subject policy was the source of all premium payments for the policy.

Moreover, the Rucker Court explained that “Dawe noted the intent of the policyholder alone to immediately transfer a newly purchased life insurance policy to be insufficient to create a STOLI scheme under Delaware law.” Id. Since there was no irrefutable evidence that the investor had provided the insured with a financial inducement to purchase the policy, Principal had failed to meet its burden that the policy was a cover for wager. Id. Furthermore, the fact that the insured had funded the trust with $100 of his own funds was sufficient to prove that he had created the trust and that the trust was not created by the investor. Id.

Rucker II applies a common sense approach to Dawe’s examination of the source of premium payments. It correctly recognized that it is not uncommon for an insured to borrow funds to pay premiums on a policy, and that an insured’s use of borrowed funds to pay initial premium should not be prima facie evidence that a policy is void for lack of insurable interest. In addition, Rucker II appears to hold that in Delaware, like in New York and Pennsylvania, insurable interest cannot be determined based solely on the intent of the individual insured.

Feel free to contact Elliott Kroll (kroll.elliott@arentfox.com), Jule Rousseau (rousseau.jule@arentfox.com), Michael Cryan (cryan.michael@arentfox.com), James Westerlind (westerlind.james@arentfox.com) or Eric Biderman (biderman.eric@arentfox.com) from Arent Fox LLP’s Insurance Practice Group to discuss this decision or these issues further.