Maryland Life Insurance Trusts
As currently drafted, MD Code, Insurance, § 12-201 provides, in relevant part,
"a person may not procure or cause to be procured an insurance contract on the life or body of another individual unless the benefits under the insurance contract are payable to…a person with an insurable interest in the individual insured at the time the insurance contract was made."
In February 2005, the U.S. District Court for the Eastern District of Virginia, applying Maryland Law, held in Chawla v. Transamerica Occidental Life Insurance Company that a trust lacked an insurable interest in the life of the insured, the grantor and lifetime beneficiary of the trust. The court's holding allowed the insurance company to deny payment of the trust's claim to the life insurance proceeds.
Interpreting Maryland law, the court described an insurable interest as a person's "lawful and substantial economic interest in the continuation of life, health and bodily safety of the individual," which interest would not be enhanced in value only by the death, disablement or injury of such individual.
In applying this standard, the court analyzed the Trust as an entity separate from its beneficiaries, identifying it as the "person" holding the insurable interest, rather than looking through the Trust at the aggregation of its beneficiaries. Since the Trust itself had no economic interest in the continuation of the grantor's life and would only benefit upon the death of the Grantor, the court held that the Trust did not meet Maryland's insurable interest requirement.
The court probably did not err in ruling in favor of the insurance company since the life insurance contract was based on an application containing material misrepresentations. However, if the court's holding that a trust lacks an insurable interest in the life the grantor is upheld, then a vast majority of insurance trusts would not have an insurable interest in the insured, and the insurance company could potentially void the life insurance policy.
The Chawla case is currently on appeal to the United States Court for the Fourth Circuit, with oral arguments expected on January 31, 2006.
Also, on January 25, 2006, the Maryland House of Delegates of the Maryland General Assembly introduced House Bill 271, which would repeal and reenact, with amendments, Section 12-201 of the Maryland Code.
The bill includes a provision which indicates that,
"the trustee of a trust has an insurable interest in the life of the insured under the life insurance policy owned by the trustee if, on the date on which the policy is issued the insured is the grantor, a close relative of the grantor, or one in whom the grantor has an insurable interest and the life insurance proceeds are primarily for the benefit of trust beneficiaries having an insurable interest in the life of the insured."
The bill is currently pending before the Health and Government Operations Committee of the Maryland House of Delegates.
As we monitor the outcome of the appeal and further legislative developments on this issue, feel free to call Esther A. Streete at 301-441-2420 regarding the formation of life insurance trusts as an estate planning tool.
1 Chawla v. Transamerica Occidental Life Ins. Co., No. 03-1215 (ED Va. Feb. 3, 2005)