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Are Life Insurance Trusts in Jeapordy? |
By: Lawrence N. Berwitz, Esq. & Maureen Rothschild DiTata, Esq.
Berwitz & DiTata LLP
Garden City, New York |
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A recent and controversial decision from the United States District Court for the Eastern District of Virginia, applying Maryland law, may endanger a popular estate planning strategy. Irrevocable life insurance trusts, familiarly AILITs, are utilized to own and act as the beneficiary of life insurance policies in order to avoid estate taxes on the benefits paid at the death of the insured. In Vera Chawla vs. Transamerica Occidental Life Insurance Co., 2005 U.S. Dist. LEXIS 3473, the Court ruled that such a trust did not have an insurable interest in the life of the insured and was, therefore, not entitled to the proceeds of the life insurance policy it owned.
The facts are unique. In May 2000, Harald Geisinger, applied for a $1,000,000 life insurance policy on his life, naming Vera Chawla, his doctor's wife, as the owner and beneficiary. When the insurer declined to issue the policy for lack of insurable interest, the application was made in the name of the Harald Geisinger Special Trust, a trust designating Geisinger and Chawla as co-Trustees and Chawla as beneficiary. The policy was issued to the trust and the premium was paid in full. In September 2000, an application to increase the death benefit to $2,450,000 was approved. The new premium was paid in full. After the insured's death in September 2001, Chawla, as Trustee, demanded payment on the policy. The insurer declined based upon material misrepresentation and lack of insurable interest.
Chawla commenced suit for breach of contract. Both Chawla and the insurer moved for summary judgment. The Court granted the insurer=s motion and denied Chawla's, concluding that the insured had committed material misrepresentation and that the policy was void because the trust maintained no insurable interest in the insured's life.
The Court relied on Maryland Insurance Law, '12-201, which permits the purchase of insurance on one's own life for the benefit of any person and prohibits its procurement on the life or body of another person unless the benefits are payable to: (i) the individual insured; (ii) the individual insured's personal representative; (iii) a person with an insurable interest in the individual insured at the time the insurance contract was made. The statute creates various classes of insurable interest: those related closely by blood or law, a substantial interest engendered by love and affection . . . . a lawful and substantial economic interest in the continuation of the life, health, bodily safety of the individual. The statute specifies, however, that an interest that arises only by, or would be enhanced in value by, the death disablement, or injury of the individual is not an insurable interest.
While insurance laws vary from state to state, generally, to buy insurance on the life of another the buyer must be able to demonstrate that he or she would experience a greater financial loss if the insured were to die. Here, the Court concluded that the trust stood to gain more, financially, upon Geisinger's death than if Geisinger had lived. Interestingly, the Court did not address the fact that Geisinger was the creator and co-trustee of the trust and the life-time beneficiary and had, in essence, purchased the policy on his own life.
New York=s Insurance Law '3205 is, in many ways, similar to the Maryland statute. It provides that a person may procure insurance upon his own life Afor the benefit of any person, firm, association or corporation, and that [n]o person shall procure . . . insurance upon the person of another unless the benefits under such contract are payable to the person insured or his personal representatives, or to a person having, at the time when such contract is made, an insurable interest in the person insured. It defines insurable interest, in the case of persons closely related by blood or law, as a substantial interest engendered by love and affection and, in the case of other persons, as a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.
If Geisinger had purchased the policy, designating himself the owner and Chawla the beneficiary, and then transferred the policy to the trust or outright to Chawla, the insurable interest issue would have been avoided. However, this would have resulted in the inclusion of the policy proceeds in Geisinger's estate for a period of three years following the transfer. The case is under appeal to the U.S. Court of Appeals for the Fourth Circuit. Certainly, estate planning practitioners would be well advised to pay close attention to this issue as it may significantly curtail the utility of irrevocable life insurance trusts as estate and tax planning tools.
Editors Note: The authors are with Berwitz & DiTata LLP, a Garden City based Elder Law firm. This firm concentrates in Estate and Retirement Distribution Planning; Estate Administration and Elder Law.
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