Anyone in the life insurance business also knows that you need an insurable interest to buy a life insurance policy on a person.  Buying an insurance policy on the life of a stranger is nothing more than a wager, with a built-in temptation to enhance one's odds, clearly a violation of public policy.  The insurable interest may be familial.  It also can be a business interest such as a buy-sell agreement between business partners or security for a loan.  Making a loan to pay premiums on a life insurance policy clearly creates a legitimate insurable interest.  But for how much?

There are an abundance of court decision throughout the country that state the insurable interest cannot cannot exceed the principal and interest on the loan.  In the typical non-recourse life insurance transaction however the lender takes much more than principal and a high interest rate on the loan for the premiums.  We have seen a number of variations.  One claimed a "closing fee" of $150,000 on the sale of a policy for $5 million.  Another claimed a share of the profit on the sale of a $4.4 million policy that amounted to nearly $200,000.  One claimed contingent interest on the sale of a $5 million policy.  The last one amounts to a compounded interest rate on the loan of about 75 percent.

The promoters of these deals rely on court rulings in many states that say only an insurance company can raise the issue of insurable interest.  Generally an insurance company cannot raise the issue after the two-year non contestability period expires.  But the promoters tread on dangerous ground.

Florida, for one, has not limited the insurable interest defense to insurance companies.  A Florida court allowed a divorced husband to terminate his former wife's ownership of an insurance policy on his life based on the insurable interest rule.  The policy was given to secure payments of child support that had been fully satisfied.  Even the landmark United States Supreme Court case, Grigsby v. Russell, which stands for the rule that an insured has the right to sell an insurance policy to a stranger, without violating the insurable interest rule, warned that the rule does not always apply.  It said the sale to a stranger "to cloak what is, in its inception a wager...allowing a stranger...to pay the premiums and receive the greater part of the benefit..." would be improper.

And it probably occurred to you that there is something wrong with an interest rate return of 75 percent.  It is called usury.  The promoters try to get around that by having policies issued to trusts or limited liability companies to be governed by a state with liberal usury laws.

Designating the law of a particular state to apply is common in commercial transactions but has not been tested in Florida in the context of the financing of a life insurance policies bought for personal reasons.

When the two year period is about to expire, lenders push hard for the insured (or the trust of LLC that owns the policy) to sign it over or waive his rights.  This is the time when an agent can be of service to clients.  Don't let them sign.  The lender is not entitled to anything more than principal and reasonable interest and fees on the loan.  Agents who speak up will be fulfilling their responsibility to their clients, guiding thousands of dollars in profits to clients that otherwise would go to lenders, and likely securing satisfied and loyal clients for life.