Ruling preserves life insurers’ ability to offer loans

In Wishnev v. The Northwestern Mutual Life Insurance Company, 2019 DJDAR 10528 (Nov. 14, 2019), the California Supreme Court held that life insurance policy loans are not subject to a provision contained in a 1918 initiative that prohibited lenders from compounding interest unless authorized in a document signed by the borrower. This ruling preserves life insurers' ability to offer policy loans, a valuable and widely used feature that allows policyholders convenient access to the cash values of their insurance policies while providing flexible repayment schedules.

Wishnev was one of four cases brought by plaintiffs who claimed that subsequent initiatives in 1934 and 1979, which authorized exemptions from the 1918 usury initiative, did not repeal the requirement that any agreement to compound interest be in a signed writing. Even though the policies expressly provided that interest on policy loans would be compounded, the plaintiffs argued that those provisions were unenforceable because the agreement was not signed by the policyholder. Although three U.S. district judges dismissed the plaintiffs' claims, the district court in Wishnev agreed that the subsequent initiatives did not affect the 1918 initiative's requirement of signed authorization by the borrower.

The decision, if permitted to stand, would have impaired insurers' ability to offer a valuable benefit to policyholders. Policy loans permit policyholders to access the cash value of their life insurance policies. The loan proceeds are not taxable, even if the amount borrowed exceeds the premiums paid, so long as the policy remains in force. Policy loans also offer more flexibility than traditional loans. Because the loan is effectively secured by the cash value that accumulates over time in the insurance policy, policyholders may take loans without the need for underwriting or credit checks. There is no set schedule for repayment of principal. Policyholders may elect to repay principal at any time, as a lump sum, through installment payments, or, in the event the policyholder dies before the loan is repaid, through a deduction from the death benefit. Policyholders may therefore use policy loans to pay for unexpected expenses, large purchases, capital for a new business, or as a tool in retirement planning, in which the insured may use a combination of policy withdrawals and loans as a tax-advantaged source of cash for retirement.

The widespread use of policy loans is the clearest evidence of their value and the impact of an adverse ruling. Data from the National Association of Insurance Commissioners show that at the end of 2017, outstanding loans to policyholders against their life insurance policies amounted to $136.5 billion. Approximately $16.7 billion of that total reflects loans taken on life insurance policies taken in California.

Applying the 1918 initiative to policy loans would have also impacted the streamlined processes unique to policy loans. While most consumer loans involve applications and agreements signed shortly before a loan is approved, the insurance contract that contains the loan agreement is often delivered years before any loan is taken. While the insured signs an application (which is then incorporated into the policy), the insurance policy is formed when the policy is delivered and accepted by the policyholder. The contract is not formed by the signature of the purchaser but by his or her acceptance of the policy.

The Supreme Court's opinion addresses some of the challenges presented by initiatives. Neither the 1918 nor the 1934 initiative had extensive legislative history to provide guidance as to the intent underlying specific provisions. The primary evidence of what was in the voters' minds in 1934 is the ballot arguments in support of the initiative, which comprise more advocacy against loan sharks than explanation of the specific provisions of the initiative. The court also had to respect the 1918 initiative status as a popular initiative. Because the 1918 initiative did not permit amendment by the Legislature, it could only be amended by another initiative, even if its provisions had proved ineffective or unworkable. The 1934 initiative, while clearly intended to repair gaps in the regulation of loans, did not identify the scope of its intended repeal with precision, leaving the perceived gap that the Wishnev plaintiffs sought to exploit. While the court did resort to canons of statutory construction, it also recognized the importance of furthering the broadly stated purpose of the initiative -- to fix the "one-size-fits-all" approach of the 1918 initiative, which had "failed miserably." The court therefore reasoned that voters for the 1934 initiative, when granting the Legislature the authority to regulate "in any manner," intended to vest the Legislature with broad authority to tailor regulations to the unique features of exempted lenders. 