Chawla Revisited

Chawla v. Transamerica Occidental Life Ins. Co., CIV.A. 03-CV-1215, 2005 WL 405405 (E.D. Va. Feb. 3, 2005), sent shock waves across the nation because the court, interpreting Maryland law, determined that a life insurance trust has "no insurable interest in the life of the decedent" and that the policy is consequently void.  Judge Hilton explained that the trust would suffer no detriment from the insured's death and, in fact, the trust would gain more from the life insurance proceeds than it would if the insured continued to live.

The case is especially interesting because of a highly unusual set of facts which could have easily allowed the judge to reach the same end result by finding that the insured misrepresented his health condition by not disclosing brain tumor surgery and chronic alcoholism treatment.

In The Chawla Case, Insurance Trusts and the Insurable Interest Rule: "Houston, We Have a Problem," 31 ACTEC J. 125 (2005), Mary Ann Mancini provides a detailed analysis of this case and its ramifications.  Ms. Mancini concludes that Chawla

did not cause a problem in the area of insurable interests, it merely brought a problem that already existed, albeit largely ignored, to light. As more practitioners look at holding insurance in entities, whether it is an insurance trust or other type of entity, and as investor owned insurance policies become more popular, this issue will be raised more often. Eventually the determination of whether an insurance trust or other type of entity has an insurable interest in the insured will have to be developed by the individual state courts, if it is not addressed proactively with a legislative solution. If the courts address the issue, it will be addressed one case at a time, in one state at a time, which will quickly turn the area of insurance trusts and other entities holding life insurance policies into a legal quagmire. The better solution is the enactment of a uniform insurable interest law that specifically addresses trusts and is retroactive in effect. This may not be the most desirable solution, but so long as there is uncertainty with respect to which state law would apply to each transaction, a uniform law seems to be the only viable solution and it has more likelihood of passage than the likelihood that Congress will change section 2035 so that it no longer applies to transfers of incidents of ownership in life insurance policies.