Seventh Circuit Holds that Insurers Cannot Challenge Policies for Lack of Insurable Interest Under Wisconsin Law

On October 12, 2016, the United States Court of Appeals for the Seventh Circuit, in an opinion authored by Judge Richard Posner, affirmed a district court decision finding that securities intermediary U.S. Bank, N.A. is entitled to $6 million in life insurance policy proceeds, plus statutory interest and bad faith damages, from insurer Sun Life Assurance Company of Canada. In its decision in the case, Sun Life Assurance Co. of Canada v. U.S. Bank National Association, as Securities Intermediary, the Seventh Circuit made clear that, pursuant to applicable Wisconsin statutory law, an insurance company cannot avoid its obligation to pay the death benefit on a life insurance policy, even if the policy was issued to a stranger lacking an insurable interest in the insured life. And if it fails to timely pay a claim on such a policy, a carrier may be held liable for statutory interest and additional damages for acting in bad faith. The ruling applies to policies governed by Wisconsin law that were issued prior to November 1, 2010, when the Wisconsin legislature amended the applicable law.

The insurance policy in this case was issued in 2007 by Sun Life on the life of wealthy octogenarian Charles Margolin. In 2011, U.S. Bank purchased the policy on behalf of an investor (i.e., as securities intermediary), and in 2014, Mr. Margolin died. Even though Sun Life had collected $2.5 million in premiums and knew about all of the transactions concerning the policy that occurred between 2007 and 2014, it refused to pay the policy proceeds without first investigating the policy’s validity. U.S. Bank, as the owner and beneficiary of the policy, invoked a Wisconsin statute requiring the insurer to pay claims within 30 days and brought a lawsuit against Sun Life to force a payment.

After the district court ruled in favor of U.S. Bank, Sun Life asserted three arguments in its appeal: (1) that its refusal to pay the claim was authorized by a Wisconsin statute prohibiting illegal wagering contracts; (2) that the Wisconsin Constitution expressly prohibits the legislature from authorizing gambling in any form; and (3) that Sun Life had both “reasonable proof” and a “reasonable basis” for nonpayment, and did not act with “knowledge or reckless disregard” of its obligations to pay the claim, allowing it to avoid statutory interest and damages for bad faith. The Seventh Circuit rejected all three arguments.

In affirming the decision in favor of U.S. Bank, the panel relied primarily on Wisconsin Statute § 631.07(4), which states that “[n]o insurance policy is invalid merely because the policyholder lacks insurable interest or because consent has not been given,” but allows a court to order the policy proceeds to be paid to a person, other than the designated beneficiary, that is “equitably entitled thereto.” According to the panel, the Wisconsin legislature, in passing the statute, reasoned that the best way to make sure that insurance companies did not issue policies to individuals without an insurable interest was to make the insurance companies responsible for paying the death benefit in all circumstances, as opposed to allowing them to collect premiums and then offer a public policy defense when a loss occurred. In other words, the Wisconsin legislature determined that the best way to deter insurance companies from issuing policies without an insurable interest was to put the onus on the insurance companies to investigate before issuing the policy.

The panel therefore found that under Section 631.07(4), U.S. Bank, as the beneficiary under the policy, was entitled to the proceeds. It also held that Section 631.07(4) superseded a separate Wisconsin statute that voided all gambling contracts and that its ruling was consistent with the Wisconsin Constitution’s general prohibition on gambling. The Seventh Circuit reasoned that  Section 631.07(4) did not authorize wagering contracts benefiting those without an insurable interest, which were prohibited under Wisconsin law. Rather, Section 631.07(4) specified that the remedy for a violation of this prohibition was not the invalidation of such insurance contracts. The panel also affirmed the award of statutory interest and bad faith damages because Sun Life had no reasonable basis for delaying payment to U.S. Bank, and knew or recklessly disregarded that it lacked a reasonable basis for its delay.

Although Wisconsin changed its law in 2010, the Sun Life decision reinforces the statutory principle that, at least for Wisconsin policies issued prior to November 1, 2010, insurance companies are barred—and should be deterred—from challenging any insurance policies on the basis of a lack of insurable interest. There is one caveat, however: Wisconsin law and the Seventh Circuit’s decision in this case leave the door open to suits by an insured’s heirs who may claim an “equitable entitlement” to the proceeds of a policy held by an investor.