On November 27, 2013, U.S. District Judge Ann D. Montgomery issued a Memorandum Opinion and Order (Order) in a stranger-originated life insurance (STOLI) lawsuit. The plaintiff is PHL Variable Insurance Company, a unit of Phoenix Companies, Inc. The defendant is Bank of Utah. The case is not yet fully resolved. (PHL v. Bank of Utah
, U.S. District Court, District of Minnesota, Case No. 12-cv-1256.)
The lawsuit arose out of a $5 million life insurance policy issued by PHL on the life of William Close, then a retiree aged 74. The policy was issued on September 11, 2007. Close died of lung cancer on November 18, 2011.
In May 2006, Harold Pomper, a broker for Lextor Insurance LLC, approached Close. Pomper said premiums would be paid by a loan, said Close's beneficiary would collect a death benefit if he died during the two-year contestability period, and submitted a preliminary application to PHL.
On August 11, 2007, Pomper and Brad Friedman, a Lextor representative, met with Close and his wife Kathleen. Pomper and Friedman later testified they completed an application at the meeting, but Kathleen did not recall paperwork there. The application listed Close as the proposed insured and the William Close 2007 Irrevocable Trust as the proposed owner of the policy. Friedman testified he and Close went through the questions on the application and Friedman hand wrote the answers provided by Close. Friedman did not request documentation to verify Close's answers. Friedman and Pomper testified they had no reason to doubt the accuracy of Close's answers.
The application said Close had a net worth of $6,675,000, had an annual income of $350,000, had never applied for life insurance and been declined, and had never been convicted of a felony. Actual net worth was less than one-tenth the amount represented. Tax returns for 2006 and 2007 showed adjusted gross income below $20,000 each year. Close had applied for life insurance with another company and had been declined; Friedman's signature as a witness had been on the rejected application. Close had been convicted of a felony in 2002 for receiving illicit kickbacks while serving as a trustee for labor union pension funds.
The application included a client intent form. It asked whether the insured or owner would be borrowing to pay the premiums and, if so, the name of the financing program; the answer was checked "yes" and "CFC of Deleware [sic]" was indicated. The form asked whether the policy was being purchased in connection with any program under which the insured or owner may have been advised of the opportunity to transfer the policy to a third party within five years of issuance; the answer was checked "no." The form asked if the insured or owner had an understanding or agreement providing for a party other than the owner to obtain a legal interest in the policy or entity owning the policy; the answer was checked "no." The form was signed by Close, Friedman, and the trustee.
Kathleen testified they were told "right up front that [the policy] was going to be sold." She recalled Pomper and Friedman saying they would look for an investor to buy the policy within two years, and the Closes would receive $500,000 after the policy was sold. When asked whether there was any discussion about who would pay the premiums, she said: "Well, it definitely wasn't us... we didn't have that kind of income to support the policy."
Friedman and Pomper testified they told Close he could sell the policy after two years and it would be worth a percentage of the death benefit, but testified they did not promise Close $500,000. Friedman testified he informed Close of the option to repay the loan and keep the policy, and it was not his understanding Close obtained the policy to sell it.
The Infolink Report
On receiving the application, PHL obtained an "Infolink Advanced Amplified Life Report" to verify Close's financial and medical representations. The report, dated August 16, 2007, is under seal in the court file pursuant to a protective order. Infolink reports have turned up in other PHL STOLI cases, suggesting the company used them routinely.
The Infolink report was completed using answers given by Close in a telephone interview. The section about financial information was incomplete and inconsistent. Nearly all spaces for breakdowns of income and net worth were blank. The report showed annual income of $375,000 entirely from dividends, and net worth of $6.7 million. The report said the information provided by Close was confirmed by an unnamed personal reference who had known Close for five years. The PHL underwriter who underwrote the policy, when asked about the report, testified he would have wanted to obtain further verification of the information.
The application showed a planned annual premium of $272,025, amounting to 77 percent of Close's claimed income of $350,000. The underwriter and PHL's chief underwriter testified the ratio was unusually high and was something an underwriter would question. The underwriting file lacks evidence showing PHL sought or obtained further information about Close's finances before issuing the policy.
The trust was established to own the policy and perform the obligations under a financing agreement with CFC of Delaware LLC. Kathleen was beneficiary of the trust, and BNC National Bank was trustee. Ryan K. Crayne was trust protector. He testified he served as trust protector for "at least a hundred trusts" associated with CFC.
The Premium Finance Loan
To pay the premium and meet other costs, Close applied for a loan from CFC, which made loans to irrevocable life insurance trusts under a program financed by New Stream Insurance LLC. The loan application provided Close would not pledge any assets, but would personally guarantee 25 percent of the loan if the trust defaulted. The record includes no evidence of attempts by CFC to verify Close's financial information.
CFC approved the loan and entered into an agreement with the trust on September 18, 2007. CFC agreed to lend the trust $330,225, consisting of $272,025 of premium, closing fees of $16,000, an origination fee of $11,200, and $1,000 to terminate the trust. The term of the loan was two years. The trust granted CFC a security interest in the policy. BNC, the trustee, executed a collateral assignment of the policy to CFC and submitted it to PHL, which recorded the assignment on or about October 1, 2007. There is no evidence that CFC performed any underwriting about the trust's ability to repay the loan. The funds were provided by New Stream, a hedge fund that invested in life insurance products; it later entered bankruptcy proceedings.
The Policy Surrender
In July 2009, CFC wrote to the Closes and Crayne, the trust protector, saying the loan to the trust would mature in December 2009. CFC said the four options to repay the loan were (1) refinance with CFC, (2) refinance elsewhere, (3) repay the loan with personal funds, or (4) sell the policy and use the proceeds to repay the loan.
Close spoke with Friedman about selling the policy. Close sent his medical records to Friedman on October 8, 2009. The records showed a mass in his left lung and possible metastatic lesions in both lungs, said Close was under the care of an oncologist, and noted Close's "possible cancer."
Friedman testified he tried to sell the policy but did not recall to or through whom he made the attempt. He further testified the "policy wasn't worth a lot of money at the time" because Close "was relatively healthy, I think." The policy was not sold.
On January 7, 2010, Crayne, the trust protector, without speaking with Close about Close's intent concerning the policy, and without knowledge of Close's medical diagnosis, sent a letter instructing BNC, the trustee, to deliver forms to PHL to change the owner and beneficiary of the policy to New Stream. Crayne directed BNC to wait to receive signed documents from Close and Kathleen. When asked if surrender of the policy was the best option available to Close, Crayne testified he would have expected Close to "scramble to find refinancing" and keep the policy if he was ill.
A week later, Close and BNC executed documents surrendering the policy to CFC in full satisfaction of the trust's obligations to CFC. CFC designated New Stream as assignee of the policy in full satisfaction of CFC's obligations to New Stream relating to the policy. Kathleen executed a document acknowledging the trust's surrender of the policy to New Stream. New Stream submitted change of ownership and change of beneficiary forms to PHL, which recorded the changes.
New Stream transferred the policy to Bank of Utah as securities intermediary. PHL was informed and recorded the transfer. On June 2, 2011, New Stream sold its interest in the policy to Limited Life Assets Services Limited (LLAS) in connection with the liquidation of New Stream's assets in bankruptcy. Bank of Utah became securities administrator for LLAS. In January 2012, after Close's death, Bank of Utah submitted a claim to PHL for the $5 million death benefit.
The PHL Lawsuit
On May 24, 2012, PHL filed a lawsuit against Bank of Utah seeking a declaratory judgment that the policy was null and void ab initio (from the beginning) due to a lack of insurable interest when the policy was issued, and that PHL may retain the premiums. On July 3, 2012, Bank of Utah answered the complaint and filed a counterclaim for breach of contract and unjust enrichment based on PHL's refusal to pay the death claim and retaining the premiums. On August 1, 2013, PHL and Bank of Utah each filed motions for summary judgment, and each filed motions to exclude expert testimony.
In her Order, Judge Montgomery granted in part and denied in part PHL's motion for summary judgment. She ruled the Close policy was void ab initio, but denied PHL's request to retain the premiums pending resolution of Bank of Utah's counterclaim for unjust enrichment. She denied Bank of Utah's motion for summary judgment on its counterclaim for unjust enrichment, thereby leaving the matter to be resolved at trial. She dismissed Bank of Utah's motion for summary judgment on its counterclaim for breach of contract. She denied motions by both PHL and Bank of Utah to exclude expert testimony.
This is one of many STOLI lawsuits involving gross misrepresentations in the application and grossly deficient underwriting by the insurance company. Here are a few excerpts from Judge Montgomery's Order illustrating these characteristics:
There is no dispute the completed Application included gross misrepresentations.
When viewed in totality, the transactions demonstrate that the loan and Trust arrangements among Close, CFC, and New Stream were, in practice, hollow formalities designed to circumvent the insurable interest requirement. The transactions' form will not be allowed to prevail over their substance.
...the record shows PHL had some knowledge of facts that would have put it on notice that the Policy was being procured as a cover for a wager, and that PHL did not investigate those facts.
It remains to be seen whether there will be appeals, and whether Bank of Utah's counterclaim for unjust enrichment will go to trial. Meanwhile, I am offering the 34-page Order as a complimentary PDF. Send me an e-mail request at firstname.lastname@example.org
for Judge Montgomery's Order.