On a warm summer’s evenin’, on a train bound for nowhere . . . is a dispute over insuring a stranger’s life

 by:  Peter J. Gallagher (@pjsgallagher) (LinkedIn)


I know it is a little obvious, but I couldn't write a post about gambling without using lyrics from "The Gambler." Fortunately, the case this post discusses — Sun Life Assurance Co. of Canada v. U.S. Bank National Association — is anything but obvious. Sun Life involved gambling on another person's life but not in a Deer Hunter, Russian roulette kind of way. In Sun Life, the U.S. Court of Appeals for the Seventh Circuit addressed the enforceability of an insurance policy that insured a stranger's life.

In Sun Life, Judge Posner began his decision by discussing the common law principle that "forbids a person to own an insurance policy that insures someone else's life unless the policy owner has an insurable interest in that life." A wife can have an insurable interest in her husband's or children's lives, a creditor can have an insurable interest in a debtor's life, but "you cannot own an insurance policy on the life of a stranger who you happen to know is in poor health and likely to die soon." The reason is that, by doing so, you are essentially gambling on another person's life, and gambling contracts are generally unenforceable as a matter of public policy. 

The traditional remedy for buying a policy on a stranger's life was to invalidate the policy. But in 1975, Wisconsin enacted a statute that changed this remedy. Rather than cancelling the policy automatically, the insurer was required to honor its promise. Under the statute, "a court with appropriate jurisdiction [could] order the proceeds to be paid to someone other than the person to whom the policy [was] designated to be payable, who is equitably entitled thereto."

The reasons for both the common law policy against insuring a stranger's life and the Wisconsin statute are to correct the perverse incentives created in each situation. First, as Judge Posner observed, "insuring a stranger's life gives the policy holder an incentive to shorten that life." Therefore, it is good public policy to forbid policies like this. Second, the best way to discourage insurance companies from issuing these forbidden policies is to raise the possibility that they would have to pay the benefits. Without this possibility, insurance companies could issue the policy and then argue later, after collecting the premiums, that they did not have to pay out the benefits.

In the Sun Life case, Sun Life issued a $6 million life insurance policy to a "wealthy 81-year-old." Three years before he died, U.S. Bank bought the policy. It did so as an "intermediary" because the policy was either a security or was bundled with other policies to create a security in which others could invest. When the insured died, Sun Life refused to pay the benefit (despite having collected $2.5 million in premiums) and U.S. Bank sued. The district court ruled in favor of U.S. Bank and awarded it the $6 million death benefit along with interest and "bad faith" damages.

On appeal, U.S. Bank argued that the district court's decision should be affirmed because Wisconsin law authorized courts to order that death benefits be paid to someone other than the beneficiary, but only if that someone was "equitably entitled to it." But, nobody had stepped up to claim the death benefit under the Sun Life policy, therefore, U.S. Bank argued, it should receive the payment.

Sun Life argued that it was not required to pay the benefit because Wisconsin law banned all gambling contracts, and an insurance policy taken out on another's life was "a pure wager." The court rejected this argument because Wisconsin law also provides that when the insurance code conflicts with a section of another code, the insurance code governs. Thus, to the extent the Wisconsin statute discussed above conflicted with other parts of the Wisconsin code that banned gambling contracts, the insurance code governed.

Sun Life also argued that the Wisconsin constitution prohibited the legislature from "authoriz[ing] gambling in any form." It argued that, by allowing insurance policies to be taken out on a stranger's life, the legislature effectively authorized gambling. The court rejected this argument as well. The statute discussed above did not change the common law that these insurance policies were forbidden. It just changed the remedy for violating this ban, "from invalidation of the policy to requiring the insurer to cough up the proceeds rather than . . . being allowed to keep all the premiums and pay nothing to the policy holder because the latter had no insurable interest in the property." Therefore, the Seventh Circuit rejected Sun Life's argument, and awarded U.S. Bank the benefit.

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