The Viability of Life Insurance Trusts After Chawla

Reagan N. Clyne (2007 J.D. Candidate, University of Connecticut School of Law) has recently published her Note entitled The Chawla Decision: A Death Knell For The Use of the Life Insurance Trust in Estate Planning?, 13 Conn. Ins. L.J. 147 (2006-2007).

Here is the introduction to her Note:

Chicken Little ran around telling anyone who would listen that the sky was falling. According to some commentators today, the sky may well be falling again – at least as far as estate planners and the insurance industry are concerned. Troubling to all is a recent judgment that, if broadly read and widely applied, could render billions of dollars in life insurance policies void and eliminate the use of a widely used, basic estate planning tool: the trust funded by life insurance proceeds.

In February 2005, the Eastern District of Virginia issued a decision in Chawla v. Transamerica Occidental Insurance Co., wherein the district court denied the claim of the trustee for the proceeds of a life insurance policy owned by the trust and taken out on the decedent, a co-trustee. Although the court initially based its decision on the existence of a material misrepresentation of fact on the application, the case quickly gained notice for its alternate holding that the trust lacked an insurable interest in the life of the insured, and therefore was void.

Until the meaning of the holding is clarified on appeal, estate planners and the insurance market are in limbo as to the wisdom of using life insurance in trusts as a tool of estate planning. While there is significant disagreement over the possible effect of the decision, billions of dollars of life insurance policies could ultimately be affected if the decision is upheld and followed by other courts with statutes similar to the one governing the policy in issue.

After a review of the facts of the case and the district court decision, this Note will examine the general insurable interest requirement and the Maryland insurable interest statute at the heart of the case in order to analyze how the appellate court may decide the matter. This Note will then discuss the implications of various outcomes and possible responses.