Insurable Interests: Aprés Chawla, le Deluge?

Mary Ann Mancini of Washington,D.C.and Howard M. Zaritsky of Vienna, Virginia have published their article InsurableInterests: Aprés Chawla, le Deluge? in the Winter 2006 ACTEC Journal.

Here is the introduction:

Life insurance is a key element ofmany estate plans. Estate planning practitioners routinely help their clientsidentify when the additional cash provided by life insurance will be useful inmeeting their financial, business, and estate planning needs. Practitionersthen help their clients decide how much insurance will be needed, when it willbe needed, and what type of life insurance policy best meets these needs. Theyalso help clients identify situations in which the benefits of the policy wouldbest meet the clients’ needs if they were made available to someone other thanthe insured or his or her estate. Quite often, the client’s needs are bestserved by having the policy held in an irrevocable trust, partnership, orlimited liability company.

The insurable interest rules areimportant whenever a life insurance policy is owned by someone other than theinsured or payable to someone other than the personal representative of the insured’sestate. A life insurance policy is void ab initio if the person to whom thepolicy is issued or to whom the benefits are paid (or both, depending upon thecontrolling state law), lacks an insurable interest in the life of the insured.An insurance company may, if the requisite insurable interest does not exist,decline to pay the death benefit, and merely return to the owner of the policyor the insured’s estate the premiums paid, plus statutory interest. If theinsurance company does pay the death benefit, under some state laws, theapplicable state court or insured’s estate or members of the insured’s familymay force the recipient to disgorge the payment. Other results that may arisefrom a lack of an insurable interest are inclusion of the death benefit in theinsured’s taxable estate and the treatment of the death benefit as taxableincome to the recipient.

Estate planning practitioners must,therefore, understand the insurable interest rules in effect in those states inwhich their clients resided when the policy was delivered, as well as thosestates whose law may otherwise control the clients’ life insurance policies.Practitioners must identify those situations in which an insurable interest maynot exist, and determine how best to assure that the expected and promiseddeath benefits will, in fact, be paid.

This issue has been largely ignoredby estate planners, until the rather dramatic decision of the U.S. District Courtfor the Eastern District of Virginia, in Chawla ex rel Giesinger v. TransamericaOccidental Life Insurance Co.1 Now, however, estate planning practitionersmust face this complex issue, with respect to both new and existing irrevocablelife insurance trusts and other arrangements in which someone other than theinsured becomes the owner and beneficiary of a life insurance policy.