Thursday, August 11, 2022

A true story, which occurred more than a century ago:

John C. Burchard was the owner of a life insurance policy on himself. Burchard had made two premium payments on the policy, but was under financial duress and currently late on the third payment. Burchard also needed a surgical operation, but had no money for the procedure.

In an effort to solve both his financial and health issues, Mr. Burchard made the following proposal to Dr. A.H. Grigsby: Burchard would sell his life insurance policy to Dr. Grigsby in exchange for $100 and the operation. Dr. Grigsby also would assume the responsibility for paying future premiums. In doing so, Dr. Grigsby, as the new owner, could determine the beneficiary and take control of any other policy benefits, including the cash values. The two parties agreed to the arrangement, completed paperwork to define the terms, and executed the agreement.

About a year later, Burchard died.

Dr. Grigsby, as owner of the policy, attempted to file a claim and receive the death benefits. The insurance company initially declined the claim, saying Dr. Grigsby did not have an insurable interest. R.L. Russell, the executor of Burchard’s estate, then filed suit to have the proceeds be paid to the estate. At first, Grigsby was vindicated, but Russell challenged the decision in Appeals Court and the ruling was reversed. This led to Grigsby appealing to the U.S. Supreme Court. On November 10 and 13, 1911, the Supreme Court heard the case, and on December 4, 1911, returned a decision—in favor of Dr. Grigsby. Justice Oliver Wendell Holmes Jr. delivered the majority of the court. The essential issue at the heart of his opinion is contained in this brief excerpt:

“…(L)ife insurance has become in our days one of the best recognized forms of investment and self-compelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property…To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”

The Impact of Grigsby vs. Russell

Justice Holmes’ decision formally established an important characteristic of life insurance: even though a relationship of insurable interest must exist between the insured and the owner of the policy at the time it is issued, ownership privileges can be transferred or assigned at a later date to parties who do not have a relationship of insurable interest.

While most consumers have some awareness of the primary benefits of life insurance (the amount paid if a death occurs, and in some instances, the cash value accumulations), they may not be aware of the “property” advantages to owning life insurance.

Life Settlements

Through most of the 20th century, the ability of the policy owner to assign benefits was rarely considered outside its use in lending agreements. But the AIDS crisis during the 1980s uncovered a new application for policy owners to assign their policies.

At that time, individuals diagnosed with AIDS faced an extremely short life expectancy. If the AIDS-infected individual owned a life insurance policy, there was the opportunity to make an absolute assignment of the policy in exchange for a lump sum cash payment representing a percentage of the death benefit. Under this arrangement, called a viatical settlement, a third party became the new owner of the policy, paid the premiums, and received the full benefit when the individual passed away.

Advances in medical treatments mean improved health prospects for AIDS patients, but the absolute settlement of life insurance has expanded to other groups of policy owners, particularly those over age 65. Now known as life settlements, older policy owners may consider receiving a lump sum payment today in exchange for assigning the future benefit to an investor or financial institution. Any decision to enter into a life settlement must be carefully evaluated, but integrated with other facets of one’s financial program, the settlement option may offer significant benefits in some circumstances.

Some variations of the life settlement concept push the legality of the Grigsby ruling and may have harmful financial repercussions. Stranger-owned Life Insurance, known as STOLI, is life insurance purchased with the intent of transferring ownership shortly thereafter to a third party, usually investors. In recent years, several STOLI transactions have resulted in legal cases, and while the courts have continued to uphold the right of the owner to assign the policy to a third party, there is concern that the concept of insurable interest is being violated. Even Justice Holmes addressed this issue in his 1911 opinion, saying, “A contract of insurance upon a life in which the insured has no interest is a pure wager that gives the insured a sinister counter-interest in having the life come to an end.” Further, obtaining life insurance for the purpose of selling it may impede one’s ability to obtain additional life insurance intended to benefit heirs.

Elozor Preil is Managing Director at Wealth Advisory Group and Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). He can be reached at epreil_wagroupllc.com See www.wagroupllc.com/epreil for full disclosures and disclaimers. Guardian, its subsidiaries, agents or employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.

By Elozor M. Preil

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