By Cyril Tuohy
An appeals court’s decision to uphold sanctions against a premium finance company is less noteworthy for the case’s legal outcome than it is for the peek into the labyrinth of financial engineering around stranger-owned life insurance (STOLI) policies and for the court’s unusual — and welcome — literary flourish citing a famous T.S. Eliot poem.
Writing for the three-judge panel, U.S. Circuit Judge Ed Carnes of the 11th U.S. Circuit Court of Appeals in Atlanta cited the parallel between T.S. Eliot’s “The Love Song of J. Alfred Prufrock,” and the behavior of a premium finance company labeled as a “nonparty appellant” in the case, Steven A. Sciarretta v. Lincoln National Life Insurance Co.
“J. Alfred Prufrock saw the moment of his greatness flicker and the eternal footman hold his coat and snicker,” the judge wrote paraphrasing a line in the literary classic, a monologue of a man stricken by isolation and physical and mental inertia.
“If there had been an insurance policy on his (Prufrock’s) life like the one that gave rise to this case, Prufrock might have been seen beside the footman a grinning speculator rubbing his hands in gleeful anticipation,” the judge wrote.
“We are all, in the long view, born astride the grave,” Carnes also wrote. “But allowing parties to use life insurance policies to bet on when an unrelated person will drop off into the grave raises public policy concern.”
Many states forbid the practice of parties entering into STOLI-related deals without having an insurable interest in the transaction to prevent companies speculating on the time of death of an insured.
In Sciarretta v. Lincoln, no one knew that better than Imperial Premium Financial. Imperial resorted to an “evasive scheme” to circumvent the insurable interest requirement in the financing of the sale of a life insurance policy, the appeals panel wrote.
A lower court imposed financial sanctions of $850,000 against the premium finance company after it found Imperial had acted in bad faith and purposely ill-prepared its own witness at trial, causing Imperial to appeal.
In the 19-page legal decision, court documents shed light on how companies circumvent the law to extract massive profits through high fees and interest charges from STOLI-related transactions.
In this case, Imperial extended a $335,000 loan to the Barton Cotton Irrevocable Trust and charged a floating interest rate of between 11 and 16 percent and an original fee of $112,000, according to the court.
“The structure of Imperial’s loans made them a sure bet with nothing but upside,” the court found.
For borrowers who managed to pay off the loan on time, Imperial got its fees and interest. If the insured died before the loan matured, Imperial could collect the loan principal, fees and interest owned out of the policy proceeds.
Under the terms of the policy, the beneficiary stood to collect even more, “hundreds of thousands or even millions of dollars upon the death of the insured,” the court found.
“The ticket to that jackpot for Imperial was the clause in the loan agreements allowing it to foreclose on the policies in the event of default,” the court wrote. “In part because of the loans’ oppressive terms, most of Imperial’s loan customers did default.”
That is precisely what happened in the case of the Barton Cotton Irrevocable Trust and its $5 million life insurance policy underwritten by Lincoln National as the 2008 loan for $335,000 ballooned to more than $557,000 by that time it reached maturity Aug. 6, 2010.
Barton Cotton, whose beneficiaries were his wife and children, lied on the insurance application that he was not buying the policy for resale and that he would not finance the premium payments, according to court documents.
“In May 2010, the eternal footman came into view — Barton was diagnosed with esophageal cancer,” Carnes wrote.
“Cotton’s bad news was good news for Imperial because the value of a STOLI policy varies inversely with the life expectancy of the insured. Imperial began marketing Cotton’s policy for sale.”
When Lincoln refused to pay the $5 million to the Cotton Trust on account that the policy had been financed, Sciarretta sued the insurance carrier.
The lower court entered judgment in favor of the trust for the $5 million death benefit and $850,000 in attorney’s fees, costs and interest, after it found that Cotton hadn’t intended to assign the policy to someone with an insurance interest.
Of the $5.85 million, the trust paid $2.24 million to Imperial for principal, interest and fees it owned on the original $335,000 loan and a second loan Imperial made to the Cotton Trust to cover the trust’s costs of litigation.
The appeals court found the $850,000 sanction against Imperial justified as the financing company had “created the issues that led to litigation.”
InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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