The importance of insurable interest
By Ken Godfrey
Life Insurance Financial Evaluations, LLC
Numerous plan designs continue to be marketed that are designed to evade life insurance insurable interest rules. For example, stranger owned life insurance plans involve purchasing a life insurance policy with the intent to transfer ownership to an investor or group of investors that do not have an insurable interest in the insured.
Current state laws require a policyowner to have an insurable interest in the insured at the origin of a life insurance policy. The basic principle is that the policyowner has a bona fide interest that the insured remains alive and well, as opposed to profiting only upon the insured’s death.
For instance, a person or business can have an insurable interest in important relationships such as a family member or key employee.
If no insurable interest exists between the policyowner and the insured at policy issuance, the life insurance policy will be little more than a bet or wager on the insured’s life. This is contrary to the purpose of life insurance and is a detriment to consumer safety. However, determining an insurable interest can be difficult and insurance carriers and agents sometimes attempt to push the envelope.
For example, in the late 1980s to early 1990s, some carriers in the life insurance industry deemed a company to have an insurable interest in all active employees. A number of insurance carriers allowed employers to insure all active employees, without their consent and knowledge, for some corporate owned life insurance plans known in the industry as leveraged COLI.
The life insurance industry continues to deal with negative publicity from the Wall Street Journal and other publications that still refer to all corporate owned life insurance plans, not just leveraged COLI, as "janitor's insurance" even though they haven’t been sold in this manner for many years.
Although the tax laws changed in the 1990s eliminating the tax benefits associated with leveraged COLI plans, the Pension Protection Act of 2006 was implemented to eliminate the perceived abuses of leveraged COLI plans and similar transactions. Many life insurance professionals and groups such as AALU and ACLI had been lobbying for these types of provisions and safeguards for years.
The requirements from the Pension Protection Act of 2006 are incorporated into Section 101(j) of the Internal Revenue Code. Key provisions within Section 101(j) require that the purchaser have an insurable interest in the person being insured and that the insured provide consent to be insured.
Unfortunately, numerous plan designs continue to be marketed that are designed to evade life insurance insurable interest rules. For example, stranger owned life insurance plans involve purchasing a life insurance policy with the intent to transfer ownership to an investor or group of investors that do not have an insurable interest in the insured. Many of these STOLI plans involve inducements such as cash payments to encourage the insured to agree to the transaction.
Given the history of issues associated with some life insurance plans that push the envelope with insurable interest such as STOLI plans, I read with great intrigue a Huffington Post article that described a plan under Gov. Rick Perry’s administration to allow the Texas Teachers Retirement System to purchase life insurance on retired teachers. If the article is accurate, this plan is a variation of STOLI and has violated the industry best practices for consumer protection described above because there was a lack of insurable interest in the retired teachers by the TRS.
Fortunately, according to the Huffington Post article, the plan was never put into effect.
According to the article, Jose Montemayor, a Perry appointee, agreed to grant a special waiver on insurable interest regulations to allow the Texas Teachers Retirement System to buy life insurance on retired teachers. Regulators and insurance commissioners are supposed to protect consumers from being taken advantage of, not help businesses skirt the rules.
Life insurance insurable interest laws are meant to ensure consumer safety. If the insurable interest laws are upheld and fully informed consent is provided by the teacher without inducements or coercion, then I have little issue with this type of program. However, if a state insurance commissioner agrees to skirt the rules that are designed to protect the consumer and eliminate abuse, I view this as very concerning.
Fortunately this life insurance plan was never enacted, but similar ethical issues surrounding insurable interest rules remain in the life insurance industry today.
*Please note the purpose of this article is not to confirm or reject the accuracy or political views of the Huffington Post article. However, this article is meant to highlight the importance of having insurable interest rules to eliminate abuses inherent in some life insurance strategies.
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