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Insurance: Life Insurance Contestability for Lack of Insurable Interest After Expiration of Contestability Period

Posted by Ted A. Schmidt | Jul 28, 2023 | 0 Comments


Our friend, Greg Gadarian, points out that the policy at issue in Columbus Life Insurance Co. originated in 2003.  In 2008, Arizona added ARS. Sec 20-443.02. That section states:

A. Intentionally practicing or planning to initiate a life insurance policy for the benefit of a person or entity that lacks an insurable interest and that, at the time of policy origination, has no insurable interest in the insured is a violation of section 20-1104.  Stranger originated life insurance practices include situations in which life insurance is purchased with resources or guarantees from or through a person or entity that, at the time of policy inception, could not lawfully initiate the policy himself or itself, and if, at the time of policy inception, there is an agreement to directly or indirectly transfer the ownership of the policy or the policy benefits to a person or entity that lacks an insurable interest.  Trusts that are created to give the appearance of insurable interest and that are used to initiate policies for the benefit of investors with no insurable interest violate section 20-1104 and the prohibition against wagering on life. Intentionally practicing or planning does not include a policy owner's lawful assignment of the policy owner's life insurance policy.

Thus, beware that policies originating after the enactment of the 2008 statute, likely would be voidable despite the running of the two year contestability period.

Insurance: Life Insurance Contestability for Lack of Insurable Interest After Expiration of Contestability Period

Columbus Life Ins. Co. v. Wilmington Trust, N.A., No. CV-22-0202-CQ (July 27, 2023) (J. Bolick)


The United States Federal District Court certified the question of the contestability of the validity of a life insurance policy to the Arizona Supreme Court involving a an alleged “Stranger Originated Life Insurance”[STOLI] policy.  The insureds purchased this $2.5 million “second to die” life insurance policy naming a family trust as the beneficiary.  The policy provided, in compliance with A.R.S. § 20-1204, that it could not be contested after it had been in effect, during the insureds' lifetimes, for two years.  All premiums were timely paid. Shortly after the running of the two-year contestability period the beneficiary designations were changed through assignment to Wilmington Trust.  Upon the death of the insureds Wilmington sought to collect the $2.5 million and the insurer refused to pay instituting a declaratory relief action in federal court seeking an order that the policy was void and that while it was entitled to keep the premiums it was not required to pay the death benefit.

It was alleged that STOLI policies violate the A.R.S. § 20-1104(A) which prohibits procuring life insurance on someone where the named beneficiary is not the insured, the insured's personal representative or another person who does not have an insurable interest in the insured. ("'Insurable interest' as used in this section means any actual, lawful and substantial economic interest in the safety or preservation of the subject of the insurance free from loss, destruction or pecuniary damage or impairment.” A.R.S. §20-1105.) It was further alleged that companies, like Wilmington prey upon senior citizens, inducing them to purchase these policies only to ultimately assign the beneficiary designation back to the company in exchange for cash up front.  The insurer here further alleged this practice violates the criminal prohibition against benefiting from unregulated gambling. A.R.S. § 13-3304(C).

Under both common law and statute in Arizona, insurance policies taken on the lives of others by third parties who have no insurable interest violate public policy and are considered wagers on the lives of others. Contracts that violate public policy are void ab initio (one that that never had any legal existence).  However, in Arizona this common law principle has been properly modified by the state legislature in A.R.S.§ 20-1204 which requires life insurance policies in Arizona contain a provision stating that the policy “shall be incontestable, except for nonpayment of premiums, after it has been in force during the lifetime of the insured for a period of two years from its date of issue.” A.R.S.§ 20-1204(B) provides a civil remedy to the insured or his or her's estate to recover benefits wrongfully paid to someone without an insurable interest.

Accordingly, the Arizona Supreme Court here found:

Reading these statutes in concert indicates a comprehensive

statutory scheme governing the types of policies at issue here and

establishing exclusive remedies. First, it is unlawful for someone lacking

an insurable interest to procure such a contract. Second, doing so exposes

the purchaser to a misdemeanor penalty. Third, life insurance policies must

contain an incontestability provision limiting challenges to the policy's

validity to two years. Fourth, the only exception to the two-year limitation

is nonpayment of premiums. Fifth, the civil remedy for an impermissible

third-party insurance contract is recovery of proceeds from the beneficiary

by the insured's estate.

As such an insurer cannot contest the validity of an insurance contract claiming the beneficiary lacks an insurable interest once the two-year contestability period has run. “[O]nce the legislature displaces common law, we shed our policy role and confine ourselves to statutory interpretation.”

About the Author

Ted A. Schmidt

Ted's early career as a trial attorney began on the other side of the fence, in the offices of a major insurance defense firm. It was there that Ted acquired the experience, the skills and the special insight into defense strategy that have served him so well in the field of personal injury law. Notable among his successful verdicts was the landmark Sparks vs. Republic National Life Insurance Company case, a $4.5 million award to Ted's client. To this day, it is the defining case for insurance bad faith, and yet it is only one of several other multi-million dollar jury judgments won by Ted during his career. He is certified by the State Bar of Arizona as a specialist in "wrongful death and bodily injury litigation".


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