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.

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 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."

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 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

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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

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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

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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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