Ruling clouds status of insurance trusts
March 28, 2005
Worries over the decision effectively quashed a trust deal for John K. Bacci, a certified financial planner with Foundation Financial Advisors Inc. in
"The minute the attorney gets cold feet, it's done, it's over," Mr. Bacci said. "Attorneys are freaked from what I can see."
In the case of Vera Chawla vs. Transamerica Occidental Life Insurance Co., a federal court judge ruled that a multimillion-dollar life insurance policy was void because a trust was the owner and beneficiary of the policy.
Potential impact 'enormous'
"The potential impact is enormous," said Mr. Bacci, who has about a dozen clients with irrevocable life insurance trusts, or ILITs.
"If it's upheld under appeal, then we have reinvented estate planning."
While the case has roiled advisers and estate-planning lawyers in
William Crispin, who represented the trustee, Ms. Chawla, said the judge's holding, if sustained, could be adopted by courts in Alabama, Arkansas, Illinois, Kentucky, Louisiana, Michigan, Missouri and possibly South Carolina.
"For financial planners, just think of the situation they are in," said Mr. Crispin of Crispin & Associates PLLC in
If an adviser, particularly in
But the American Council of Life Insurers in Washington and the Association for Advanced Life Underwriting in Falls, Church, Va., believe the judge's decision was specific to the unique facts of the case and doesn't have broad implications.
"We think it is unlikely that a position that an insurance trust lacks an insurable interest will be upheld on appeal," said Tom Korb, AALU director of government affairs.
Other lawyers and advisers share that belief.
As Michael Kitces, a financial planner in
"The classic line that most lawyers use is, bad facts make for bad law," added Mr. Kitces, director of financial planning at Pinnacle Advisory Group Inc. of
The Chawla case involves Harald Giesinger, a single man in his 70s who tried to take out a $1 million life-insurance policy with the beneficiary being Ms. Chawla, a friend in her 50s who was the wife of Mr. Giesinger's physician.
The insurance company,
Insurable interest is typically associated with family members or business associates who stand to lose financially because of a person's death.
Mr. Crispin said Mr. Giesinger and Ms. Chawla had a "business relationship" and did some real estate investments together.
"But there was a personal side to the relationship," Mr. Crispin said. "He is a single guy and has no family and he became the godfather of the Chawlas' children. He lived at the house a good part of the time. They took care of him."
Mr. Giesinger took out a policy - later increased to $2.45 million - in which the owner and beneficiary was a trust, meaning Mr. Giesinger and Ms. Chawla were co-trustees.
But when he died in 2001, Transamerica denied the claim, saying that Mr. Giesinger had misrepresented his medical history on his application, including failing to mention he had undergone surgery to remove a brain tumor.
In the subsequent lawsuit, U.S. District Court Judge Claude M. Hilton in
But some say the judge took his ruling a step further than he had to, deciding that life-insurance trusts in
"If a family in
Mr. Crispin is also baffled as to why Transamerica would raise the insurable-interest issue.
"Is there a business reason, apart from winning this case, that any insurance company would shoot itself in the head like this and fight for a rule that would hurt its own business?"
Mr. Crispin asked. He is appealing before the 4th U.S. Circuit Court of Appeals.
In a prepared statement, Bill Tate, Transamerica's senior vice president and chief marketing officer, said the company does not view the ruling as "having any application to trusts generally, including those set up for estate planning purposes."
"We believe that because this particular decision was based on facts unique to this case, it does not call into question the insurable interest in policies owned by trusts," he said.
Still, William H. Van Pelt IV, president of the Mid-Continent Companies Ltd. in
"An unintended consequence is that sophisticated clients and their advisers are going to ask the question: Do we have to worry about a carrier just fighting the claim based upon a fact pattern that may be complicated?"
Steven Oshins, a lawyer with Oshins & Associates LLC in
"I have probably set up a thousand life insurance trusts and I can't have the thousand people terminate their insurance and buy new insurance because of one case that probably is wrong," he said.
"I am not nervous," he added, "but I am sweating just a little bit."