Delaware's highest court dealt a blow last week to hedge funds and other investors who seek to buy life-insurance policies from people in order to collect the proceeds when they die.
In a pair of closely-watched cases, the court ruled that insurers can challenge the legitimacy of a policy that had changed hands at any point, even after the standard two-year window for contesting policy payouts has expired. That may embolden insurers to challenge more policies, and raises the risks for investors who own the policies.
The decisions arm the insurance industry with valuable ammunition for shedding what it argues are unsavory policies that could tarnish its reputation with consumers and lawmakers. Investors who buy the policies assume responsibility for future premiums, so they gain more financially if the insured person is dead.
The rulings also threaten to stifle a potential revival of the so-called life-settlement market, which already is reeling from a three-year downturn.
The rulings involve two policies held by a Deutsche Bank AG investing entity named GIII Accumulation Trust.The bank declined to comment.
Attorneys for other investors in life settlements conceded the decision was a setback, but argued they would still prevail on other legal fronts.
Nevertheless, the impact of the Delaware's Supreme Court rulings could be felt far beyond the small state's borders. Judges in other states may adopt Delaware's reasoning. Delaware is also home to a number of trust companies, and many contested sales were done through family trusts, ostensibly for tax-planning purposes, according to lawyers and industry executives.
That means the fate of a disproportionate volume of the disputed policies could be decided by the rulings.
"It's a great win for us," said Thomas Hetherington, a partner with Edison, McDowell & Hetherington LLP, which represented a life-insurance unit of Phoenix Cos. in one of the two cases. "This will have a substantial impact on cases pending all over the country."
The rulings come as hundreds of lawsuits are working their way through state and federal courts across the country, the fallout from the once-booming life-policy secondary market.
The market emerged more than two decades ago, when AIDS patients and older Americans sold their policies to pay for medical treatment and other needs.
During the boom years of the mid-2000s, some Wall Street firms began packaging policies into investments. Demand for the policies surged, prompting commission-hungry agents and other middlemen to fill the pipeline. Market experts estimate that thousands of people took out policies for quick flipping to investors between 2004 and 2008. The industry, like many financial markets, froze in 2008.
Insurers have alleged that agents and other middlemen hid the involvement of investors to trick the carriers into dubious sales. In many instances, court filings show, applicants claimed to need a multimillion-dollar policy for tax planning, when they actually were of modest means and aimed to flip the policy.
Investors in some lawsuits have responded that insurers, eager for six-figure premiums, failed to determine if applicants could afford to maintain the policies they purchased. They contend the insurers now want to void the policies because they have proved less profitable than expected.
In one of the Delaware rulings, the high court wrote that a measure of whether a policy is "bona fide" is whether the consumer himself pays the initial premiums.
The ruling involved a $9 million policy issued in 2007 by Phoenix on the life of Price Dawe, then 71 years old, through a Delaware statutory trust. Mr. Dawe claimed a net worth of $14 million and annual income of $500,000 in applying for the policy for estate-planning purposes, court filings show.
Mr. Dawe died in 2010. As Phoenix investigated the death claim, according to the insurer's filings, it learned the GIII investing entity purchased the beneficial interest of the Dawe trust for $376,111 less than two months after the policy went into force. As for Mr. Dawe's alleged wealth, he actually had "negligible income and assets," the insurer's filings state.
Phoenix then sought to void the policy, while GIII argued the period to contest the policy had expired.
In the other case, a unit of Lincoln National Corp. and its attorneys at Drinker Biddle & Reath LLP sought to void a $6 million policy that was also sold to GIII in a similar arrangement.
The two rulings come on the heels of a win by investors last November by New York's highest court, in a dispute over $56 million in policies taken out by the late Arthur Kramer, a prominent attorney who died in 2008. Just after taking out the policies, Mr. Kramer sold them to hedge funds.
The New York justices ruled it was legal under state law for somebody to take out a policy and immediately sell it to a stranger.
In addressing New York's ruling, the Delaware judges said it involved "unique New York insurance statutes."
The Delaware "ruling will certainly be referred to by the carriers," said Jule Rousseau, an attorney at Arent Fox LLP who filed a brief in the Kramer case for the Life Insurance Settlement Association.
In particular, the decision to remove the two-year window for challenging policies could make it "an uphill battle" for many investors across the U.S. seeking payouts on older policies, he said.
Market Data 
Markets 
AI
