Western Reserve Life Assurance Co. v. ADM Associates, LLC

United States Court of Appeals
For the First Circuit
No. 12-2208
WESTERN RESERVE LIFE ASSURANCE CO. OF OHIO,
Plaintiff, Appellant,
v.
ADM ASSOCIATES, LLC,
Defendant, Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. William E. Smith, U.S. District Judge]
Before
Lynch, Chief Judge,
Selya, Circuit Judge,
and Hillman,* District Judge.
Michael J. Daly, with whom Catherine R. Connors, Brooks R.
Magratten, and Pierce Atwood LLP were on brief, for appellant.
Thomas J. Gallitano, Conn Kavanaugh Rosenthal Peisch & Ford,
LLP, Jason P. Gosselin, and Drinker Biddle & Reath LLP on brief for
American Council of Life Insurers, amicus curiae.
Robert F. Weber, with whom Randy Olen was on brief, for
appellee.
December 11, 2013
*
Of the District of Massachusetts, sitting by designation.
SELYA, Circuit Judge. The outcome of this appeal is
controlled by important questions of Rhode Island law and public
policy as to which we have found no dispositive precedent. Because
the Rhode Island Supreme Court is the ultimate arbiter of matters
of Rhode Island law, we certify these unsettled questions to that
court for guidance. See R.I. Sup. Ct. R. 6.
I. BACKGROUND
Joseph Caramadre believed that he had found the Holy
Grail of investment strategies: a way to speculate in high-risk
securities while shielding himself from the adverse effects of
losses. To implement this scheme, he exploited a perceived
loophole in certain annuities issued by, inter alia, plaintiff-
appellant Western Reserve Life Assurance Company of Ohio. Because
certain features of Western Reserve's annuities are integral both
to Caramadre's contrivance and to the issues on appeal, we start by
outlining those features.
The classic annuity offers a person a stream of periodic
payments during his life that are actuarially calculated and fixed
in amount. In exchange, the person makes an up-front, lump-sum
premium payment to the issuing insurance company. For example, an
investor might pay an insurance company a one-time $1,000,000
premium in exchange for a promise to pay him $5,000 per month for
the rest of his life.
-2-
Over the years, annuity products have evolved, and the
WRL Freedom Premier III annuity issued by the appellant is a far
cry from the classic model. We sketch some of the salient
differences.
To begin, the appellant's product is a variable annuity,
not a fixed annuity. Instead of ceding control of his premium
dollars to the insurance company, the investor retains the right to
direct that those dollars be invested in certain pre-selected
securities. Moreover, the annuity does not necessarily entail
fixed periodic payments to the beneficiary; rather, it presents a
diverse menu of payment options, including payouts that are
determined by the value, from time to time, of the acquired
securities. Consequently, the amounts paid to the beneficiary may
ebb and flow with the performance of the investment portfolio.
In addition, the investor in a WRL Freedom Premier III
annuity can use the lifetime of someone other than himself (the
annuitant) as a measuring device to determine how long the annuity
payments will last. The investor (the owner) provides the premium
dollars, directs the investment strategy, and selects the recipient
of the periodic payouts called for by the annuity (the
beneficiary). The beneficiary, who may or may not be the owner,
will receive those payouts as long as the annuitant remains alive.
Significantly, a WRL Freedom Premier III annuity contains no
requirement that the owner and the annuitant be one and the same
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person; in fact, the annuity contract does not require any
extrinsic tie between the two.
Unlike a classic annuity, the WRL Freedom Premier III
annuity allows the owner to infuse more than a single premium
payment into the annuity. Up until a specified date (not relevant
here), the appellant will accept premium payments, as long as the
total investment does not exceed $1,000,000.
Last — but far from least — the owner can elect a "Double
Enhanced Death Benefit" by agreeing to pay an additional daily
charge. An owner who elects this benefit designates a beneficiary,
who, upon the annuitant's death, will be entitled to receive the
greater of: (1) the total premiums invested in the policy, plus
interest accrued at 5% per annum, or (2) the highest value of the
policy (that is, the highest value of its investment portfolio,
adjusted for certain deposits and withdrawals) on any annual
anniversary of the policy. The owner and the beneficiary may be
one and the same person.
Caramadre figured out that if an individual named himself
(or an entity he controlled) as both the owner and the beneficiary
of a WRL Freedom Premier III annuity and elected the death benefit,
that individual could engage in high-risk market speculation
without any downside exposure. Caramadre decided that this scheme
could best be perpetrated by applying for an annuity with a
relatively low initial premium, invested conservatively so as to
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avoid red flags. The owner/beneficiary (whether Caramadre himself
or his nominee) would subsequently deposit a substantially more
munificent incremental premium and steer the investment of the
aggregate premium dollars into speculative securities. The upshot
was a "heads I win, tails you lose" scenario: if the investment
gamble paid off, he would reap the fruits of his speculation when
the annuitant died; and if the speculation backfired, the death
benefit guaranteed that he would fare no worse than a full return
of premiums paid (plus interest). In the latter event, the
insurance company would be left holding a collection of nearly
worthless securities.
Despite the cleverness of Caramadre's scheme, there was
a rub: one had to be sure that the death benefit would be triggered
within a relatively short time after the risky investments were
made.1 That timing would ensure that the owner/beneficiary of the
annuity (Caramadre or his nominee) would receive either the benefit
of a strike-it-rich investment gamble or, at worst, the return of
his bet. Thus, the linchpin of the scheme was locating and
recruiting potential annuitants whose lifespans were predictably
short: the terminally ill.
1
After all, if the annuitant lived a long life, the
owner/beneficiary's funds would be tied up. Even worse, he would
have no hedge against near-term investment losses and could be
stuck paying the daily fees for the death benefit for many years.
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Caramadre rose to this challenge. Among other
recruitment tools, he circulated flyers promising up-front cash
payments to terminally-ill patients for agreeing to let their names
be used.
Charles Buckman, a Rhode Island resident suffering from
chronic obstructive pulmonary disease, received one of Caramadre's
flyers from a visiting nurse. His interest piqued, Buckman
followed up on the flyer and contacted Estate Planning Resources,
a Caramadre-controlled company.
To make a tawdry tale tolerably terse, Buckman accepted
a cash payment to identify himself as the annuitant on an
application for a WRL Freedom Premier III variable annuity. The
application designated a Caramadre nominee, defendant-appellee ADM
Associates, LLC (ADM), as the prospective owner and beneficiary of
the annuity. The application specifically requested inclusion in
the annuity contract of the Double Enhanced Death Benefit. Buckman
and ADM were wholly unrelated parties; indeed, up to that point
Buckman had never heard of ADM.
The appellant received the application on or about
September 11, 2008. Four days later, it approved the application
and issued a WRL Freedom Premier III annuity (the Policy).
Pertinently, the Policy provided that it would be "incontestable
from the Policy Date."
-6-
The application had been accompanied by an initial
$250,000 premium payment. Roughly four months after the Policy
went into effect, ADM made an additional premium payment of
$750,000.
At some point, the appellant apparently learned of
Caramadre's scheme and came to believe that the Policy was an
iteration of it.2 It developed an acute case of seller's remorse
and, approximately a year after the Policy's inception date,
notified both Buckman and ADM that it intended to rescind the
Policy.
Acting on this stated intention, the appellant sued ADM
in the United States District Court for the District of Rhode
Island, seeking rescission of the Policy and a declaration that the
Policy was either void ab initio or had been properly rescinded.
It also asserted claims for fraud, civil liability for crimes, and
civil conspiracy.3
2
The scheme apparently began to unravel when the federal
government launched an investigation into the legitimacy of
Caramadre's actions. In due course, the government charged
Caramadre with sixty-five counts of fraud, conspiracy, identity
theft, and money laundering. See United States v. Caramadre, 882
F. Supp. 2d 302, 304 (D.R.I. 2012). The indictment alleged that
Caramadre had conspired since the 1990s "to make millions of
dollars by securing the identities of terminally-ill people through
material misrepresentations and omissions to be used to purchase
variable annuities and corporate bonds with death-benefit
features." Id.
3
The appellant's complaint named additional defendants as
well. For ease in exposition, we limit our discussion of the suit
to the appellant's claims against ADM.
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ADM moved to dismiss the complaint. The district court
heard this motion along with motions in similar cases. After
careful consideration, the court dismissed the claims brought
against ADM. See W. Reserve Life Assurance Co. v. Conreal LLC, 715
F. Supp. 2d 270, 276-81 (D.R.I. 2010). With respect to the
appellant's prayers for rescission and declaratory relief, it held
that the presence of the death benefit did not transform the Policy
into a life insurance contract under Rhode Island law. See id. at
276-79. Hence, the absence of an insurable interest neither
rendered the Policy void nor justified its rescission. See id.
Although the court acknowledged that "the whole point of the
[scheme] was to capitalize on the death benefits," it concluded
that the "[d]efendants [had] figured out how to game a flaw in the
product." Id. at 278.
The district court based its dismissal of the tort claims
on the incontestability clause. See id. at 280-81. In holding
that this provision did not offend public policy, the court
reasoned that Rhode Island's default two-year incontestability
period can be supplanted by any shorter period more favorable to
the insured. See id. at 280 (citing R.I. Gen. Laws § 27-4-6.2(a)).
The appellant filed an amended complaint. The district
court dismissed this complaint on substantially the same grounds.
See W. Reserve Life Assurance Co. v. Caramadre, 847 F. Supp. 2d
329, 349-50 (D.R.I. 2012). With no claims remaining against ADM,
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the court certified the judgment as final as between ADM and the
appellant. See Fed. R. Civ. P. 54(b); Nystedt v. Nigro, 700 F.3d
25, 29-30 (1st Cir. 2012). This timely appeal followed.
II. DISCUSSION
This case implicates two important issues of state law,
either or both of which may determine the outcome of this
litigation. We describe these issues and, for what assistance it
may provide, limn the considerations that have prompted us to
certify them to Rhode Island's highest court.
A. The Insurable Interest Question.
We begin with the question of whether ADM's status as a
stranger to its annuitant invalidates the Policy. Over a century
ago, the Rhode Island Supreme Court declared that "a purely
speculative contract on the life of another" procured by one
without an insurable interest is contrary to public policy and "may
properly be held to be void." Cronin v. Vt. Life Ins. Co., 40 A.
497, 497 (R.I. 1898). The Rhode Island General Assembly
subsequently endorsed the insurable interest concept, requiring
relatives named as beneficiaries to have "a substantial interest"
in an insured's life "engendered by love and affection," and other
beneficiaries to have "a lawful and substantial economic interest
in having the life, health, or bodily safety of the individual
insured continue." R.I. Gen. Laws § 27-4-27(c). ADM concedes that
it did not have an insurable interest in the life of its annuitant.
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The question, then, reduces to whether the Policy is the kind of
contract that Rhode Island's insurable interest requirement renders
infirm.
The answer may depend on taxonomy: that is, on whether
the Policy should be classified either as an "insurance contract"
or as an "annuity." If the former rubric applies, the statutory
iteration of the insurable interest requirement, which prohibits
the procurement of "any insurance contract upon the life or body of
another individual" if "the benefits under the contract are payable
to" someone other than the insured, his personal representatives,
or "a person having . . . an insurable interest in the individual
insured," id. § 27-4-27(a), may resolve the question. In other
words, if the death benefit makes the Policy an insurance contract
upon the life of the annuitant, the want of an insurable interest
would defeat the Policy.
Were an inquiring court to look solely at the label that
the appellant affixed to the Policy, the premise of that
proposition would be easily refuted: the document designates itself
as a variable annuity, not an insurance contract. But labels can
be misleading, and the Rhode Island courts have sometimes looked
beyond the title of a document to deem its substance to be
insurance. For example, in Sisson ex rel. Nardolillo v. Prata
Undertaking Co., 141 A. 76 (R.I. 1928), the Rhode Island Supreme
Court went beyond the "burial contract[]" designation attached to
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certain agreements and held that those agreements actually
comprised burial insurance. Id. at 76-77.
There is some reason to believe that such label-piercing
might be appropriate here. The common understanding of life
insurance encompasses "[a]n agreement between an insurance company
and the policyholder to pay a specified amount to a designated
beneficiary on the insured's death." Black's Law Dictionary 1010
(9th ed. 2009). The General Assembly seems to have embraced that
understanding, declaring that life insurance is simply "every
insurance upon the lives of human beings and every insurance
appertaining to that life." R.I. Gen. Laws § 27-4-0.1(c).
In this instance, an insurance company (the appellant)
issued the Policy, which obligated it to pay at least the aggregate
premiums invested in the annuity (plus interest) upon the
annuitant's death. To this extent, the Policy is, at least in
part, the functional equivalent of a life insurance policy. See
Kendall J. Burr et al., Stranger-Initiated Annuity Transactions and
the Case for Insurable Interest, 19 Conn. Ins. L.J. 113, 126
(2012).
Here, however, there is more to the story. Unlike a
traditional life insurance policy, the death benefit did not
promise a defined sum upon death but, rather, promised either the
market value of the Policy or the aggregate premiums paid into it
(whichever was greater). Moreover, the appellant did not treat the
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Policy as if it were life insurance: though cognizant of the
insurable interest requirement for life insurance, it made no
effort to verify that the owner of the Policy had any relationship
with the annuitant. By the same token, it did not engage in the
sort of medical underwriting that might have enabled it to
calculate the annuitant's mortality risk.
Last, the appellant chose to structure and market the
transaction as an annuity; and venerable precedent indicates that
annuities (unlike life insurance contracts) are not normally deemed
violative of public policy for want of an insurable interest. See
Cronin, 40 A. at 497. This distinction between life insurance and
annuities is firmly entrenched in positive law. The General
Assembly's definition of annuities explicitly excludes "payments
made in connection with a life insurance policy." R.I. Gen. Laws
§ 27-4-0.1(a).
As the appellant reminds us, though, the Policy is not a
nineteenth-century annuity. In that era, the "annuities" to which
courts referred had "traditionally and customarily . . . been fixed
annuities, offering the annuitant specified and definite amounts
beginning with a certain year of his or her life." SEC v. Var.
Annuity Life Ins. Co. of Am., 359 U.S. 65, 69 (1959). Variable
annuities (particularly those carrying death benefit riders) are a
fairly recent innovation. See id. (noting that the first variable
annuity appeared in or about 1952). Thus, the Policy is twice
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removed from its nineteenth-century ancestors — once by reason of
its variable nature and once again by reason of its death benefit.
It is not clear to us whether these innovations are sufficient to
bring the Policy outside the boundaries of Rhode Island's historic
exclusion of annuities from the insurable interest requirement.
We are equally uncertain as to how the relatively recent
Life Settlements Act, see R.I. Gen. Laws §§ 27-72-1 to 27-72-18,
affects this inquiry. Through that legislation, the General
Assembly made pellucid that "[s]tranger-originated life insurance"
— that is, "a practice or plan to initiate a life insurance policy
for the benefit of a third-party investor who, at the time of
policy origination, has no insurable interest in the insured" — is
forbidden under Rhode Island law. Id. § 27-72-2(26); see id.
§§ 27-72-2(9)(i)(A)(X), 27-72-14(a)(1). This proscription
expresses hostility to certain classes of transactions that are
different than, but obviously similar to, the transaction in this
case.4
There is one further complication. The appellant's
attack on the Policy focuses on the unseemly nature of the scheme
that Caramadre devised. Nevertheless, an insurable interest
requirement for contracts like the Policy would not only affect
vulture-like arrangements in which the payoff is geared toward the
4
We hasten to add that the Act neither mentions annuities nor
explicitly pretermits transactions of the kind at issue here.
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annuitant's quick demise but also contracts in which the payoff is
geared to the annuitant's longevity. For instance, an owner who
purchases a variable annuity measured by the life of a 22-year-old
healthy man might do so with a long-lasting income stream in mind
and without any thought of capitalizing on the opportunity for
risk-free speculation associated with the annuity's death benefit.
This type of hypothetical owner would come much closer than an
owner in the Caramadre model to being a counterpart of the owner of
a conventional fixed annuity. And that would be so even though
both the hypothetical owner and the Caramadre-style owner had
purchased essentially the same variable annuity.
The short of it is that the Policy does not seem to fit
neatly into either the category of life insurance contracts or the
conception of annuities. And to muddy the waters further, we think
that it might be plausible to treat the Policy as a hybrid. If so,
the analysis would likely turn to whether requiring an insurable
interest would comport with the broader purpose undergirding the
insurable interest requirement.
This possibility prompts us to take a step back in time.
Historically, the insurable interest requirement prevented a
contract from becoming a vehicle for gambling. In Cronin, for
example, the court traced the insurable interest requirement for
life insurance to the English Parliament's Life Assurance Act of
1774, 14 Geo. 3, c. 48, § 1 (Eng.), which "prohibited insurance on
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the life of a person in which the beneficiary shall have no
interest, or by way of gaming or wagering." 40 A. at 497. That
rule was followed in the United States "as declaratory of the
common law." Id. By requiring owners of life insurance policies
to have "an interest of some sort in the insured life," courts
could ensure that these contracts did not become "mere wager
policies." Conn. Mut. Life Ins. Co. v. Schaefer, 94 U.S. 457, 460
(1876); see Winward v. Lincoln, 51 A. 106, 112 (R.I. 1902)
("[P]ublic policy forbids the enforcement of all wagers by our
courts, and it has been so held by this court."). Without such an
interest, a life insurance policy could afford a perverse incentive
for the "early termination" of the insured's life. Warnock v.
Davis, 104 U.S. 775, 779 (1881).
Whether an insurable interest was required for the Policy
may therefore depend on whether it can be fairly characterized as
a contract wagering on life. The outcome of such an attempt at
characterization seems problematic. On the one hand, a
straightforward argument can be made that, without an insurable
interest, the Policy is a wager on life. From that vantage, the
owner/beneficiary of the Policy, a stranger to the annuitant, will
receive money when the annuitant dies and, thus, cash in on what
amounts to a wager. See Winward, 51 A. at 112 (defining a wager as
"an agreement between two or more that a sum of money or some
valuable thing, in contributing which all agree to take part, shall
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become the property of one or some of them on the happening in the
future of an event at the present uncertain").
On the other hand, there is a strong counterargument: a
rule requiring an insurable interest for the Policy could also
sweep up any contract with a death benefit. That result would
propel the insurable interest requirement far beyond the
traditional province of life insurance.
Furthermore, the connection between ADM's wagering gain
and the life of the annuitant is indirect. In a typical life
insurance wager, there is a direct correlation between the timing
of the insured's death and the policy owner's reward. Here, by
contrast, the primary source of anticipated gains is apt to come by
way of market performance; the predictably short life of the
annuitant simply hedges against the possibility of investment
losses. This may be a relevant distinction: one might be hard-
pressed to say that an owner who pays $1,000,000 in premiums plus
death benefit fees for an annuity and is assured of receiving no
less than $1,000,000 (plus interest) upon the death of his
annuitant is much of a gambler.
In sum, we find three aspects of the insurable interest
question puzzling. First, we are uncertain as to how best to
classify the Policy (as an annuity, a life insurance contract, or
a hybrid). Second, we are uncertain as to whether the absence of
an insurable interest renders the Policy infirm. Third, we are
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uncertain as to whether the Policy constitutes an unenforceable
wagering contract.
B. The Incontestability Question.
The second issue with which we are concerned revolves
around the Policy's incontestability clause. On its face, that
clause appears to bar any challenge, including one based on the
lack of an insurable interest, to the validity of the Policy. But
this case presents two potential obstacles to such an unconditional
reading.
The threshold obstacle is the possibility that Rhode
Island public policy would refuse to countenance an
incontestability clause — like this one — that wholly eliminates
any contestability period. The Rhode Island Supreme Court has not
spoken definitively to this question, and courts elsewhere are
divided. See 16 Richard A. Lord, Williston on Contracts § 49:95
(4th ed. 2013).
The Rhode Island cases dealing with incontestability
clauses have sent mixed messages. For example, the Rhode Island
Supreme Court has observed that a two-year incontestability clause
is "not an absolute stipulation to waive all defenses and to
condone fraud." Murray v. State Mut. Life Ins. Co., 48 A. 800, 800
(R.I. 1901) (dictum). This dictum is suggestive, especially since
the fear of condoning fraud has led some courts to refuse to
enforce incontestability clauses analogous to the clause at issue
-17-
here. See, e.g., Reagan v. Union Mut. Life Ins. Co., 76 N.E. 217,
218 (Mass. 1905).
But Murray offers some solace to proponents of an
incontestability clause that does away entirely with any
opportunity to contest the bona fides of a policy (what we shall
call an "immediate" incontestability clause). There, the court
emphasized the importance of holding the underwriter of a policy to
its duty "to fulfill its plain and deliberately assumed
obligation." 48 A. at 801. This emphasis might be seen as
favoring the literal enforcement of incontestability clauses,
particularly those that operate in favor of the insured. Cf. R.I.
Gen. Laws § 27-4-6.2(a) (condoning in the life insurance context
contracts that are "more favorable to policyholders" than that
required by statute).
In addition, the special risk of fraud associated with
immediate incontestability clauses may be offset by a built-in
protection. Thus, some courts have upheld immediate
incontestability clauses, noting that the insurer had an unlimited
time, prior to issuing the policy, to investigate the incidence of
fraud. See, e.g., Pac. Mut. Life Ins. Co. v. Strange, 135 So. 477,
478 (Ala. 1931).
Even if the potential obstacle presented by the immediacy
of an incontestability clause can be overcome, an issue remains as
to the force of such a clause with regard to a defense premised on
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the lack of an insurable interest. This, too, is an issue that is
largely unaddressed in Rhode Island case law — and there is no
consensus across other jurisdictions.
A majority of courts hold "that a life insurance policy
lacking an insurable interest is void as against public policy and
thus never comes into force, making the incontestability provision
inapplicable." PHL Var. Ins. Co. v. Price Dawe 2006 Ins. Trust ex
rel. Christiana Bank and Trust Co., 28 A.3d 1059, 1065, 1067 n.18
(Del. 2011) (collecting cases); see also 7 Lord, supra, § 17:5.
Cronin — a century-old decision that did not specifically address
the insurable interest requirement in the context of an
incontestability clause — hints that Rhode Island might align
itself with this view. See Cronin, 40 A. at 497 (commenting, in
dictum, that "a purely speculative contract on the life of another
. . . may properly be held to be void").
Some courts, however, have held that an insurable
interest defense cannot trump an incontestability clause. See,
e.g., Bogacki v. Great-West Life Assurance Co., 234 N.W. 865, 865-
67 (Mich. 1931). These courts hold that the lack of an insurable
interest renders an insurance policy merely voidable, not void ab
initio, so that an insurable interest defense can be defeated by an
incontestability clause. See, e.g., New Eng. Mut. Life Ins. Co. v.
Caruso, 535 N.E.2d 270, 272-73 (N.Y. 1989); cf. Monast v. Manhattan
Life Ins. Co., 79 A. 932, 936 (R.I. 1911) (deeming it "clear both
-19-
upon principle and authority that a life insurance policy is not
void because the premiums have been paid . . . by one having no
insurable interest in the life of the assured"). This minority
position has evolved subsequent to the Cronin dictum.
For all of these reasons, we conclude that it is fairly
debatable whether Rhode Island would permit an immediate
incontestability provision to thwart the assertion of a defense
predicated on the absence of an insurable interest.
III. CERTIFICATION
Against this chiaroscuro backdrop, we certify to the
Rhode Island Supreme Court the following questions:
1. If the owner and beneficiary of an annuity with a
death benefit is a stranger to the annuitant, is the annuity infirm
for want of an insurable interest?
2. Does a clause in an annuity that purports to make the
annuity incontestable from the date of its issuance preclude the
maintenance of an action based on the lack of an insurable
interest?
We wish to make it clear that these questions may be
considered in whatever sequence the Rhode Island Supreme Court
prefers and that a particular answer to one question may obviate
the need for answering the other. We also wish to make it clear
that we would welcome the advice of the Rhode Island Supreme Court
on any other aspect of Rhode Island law that the Justices believe
-20-
should be clarified in order either to aid in the proper resolution
of the certified questions or to give context to their response.
The Clerk of this court is directed to transmit to the
Rhode Island Supreme Court, under the official seal of this court,
a copy of the certified questions and this accompanying memorandum,
along with a copy of the district court record and copies of all
briefs and appendices heretofore filed in this court. We stay
proceedings before us, while retaining jurisdiction, pending the
Rhode Island Supreme Court's determination of the certified
questions.
So Ordered.
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