A California federal judge has ruled that non-recourse premium financing of life settlement policies held by trusts and other third parties is allowed under state law.

The ruling by Judge Stephen G. Larson of the U.S. District Court for Central California’s Eastern District rejected Lincoln National Life Insurance Co.’s efforts to rescind the policies because the loan amounted to a stranger originated life insurance (STOLI) “scheme” to get the insured person to obtain a life insurance policy that would later be assigned to a third party and sold on the secondary market, according to a statement from lawyers involved in the case.

Larson’s ruling marks the first time a California federal judge has addressed the validity of life insurance policies originated using non-recourse premium financing.

The case, Lincoln v. Fishman, has been watched closely by the industry because of its potential effect on life settlements and other policies that are financed through non-recourse loans.

STOLI policies have been thwarted in a number of states, while others continue to seek to make them illegal, arguing that their use can take advantage of the seniors who buy the policies expecting a big payoff.

Larson granted summary judgment to the defendants, including Mutual Credit Corp., a premium finance lender, and Spurling Group II LLC, a trust.

In October 2007, Lincoln filed suit against Dr. Gordon Fishman, the Gordon R. A. Fishman Irrevocable Life Trust, the trustee and several of Fishman’s family members, Mutual Credit Corp. and Spurling Group II over a premium finance transaction in which Fishman set up the trust to hold life insurance policies that were issued by Lincoln and paid for with funds loaned to the Mutual Credit Corp. trust.

The loan was secured by a collateral assignment of the policies, which were the sole collateral for the loan.

Lincoln alleged that the life insurance policies it issued to the trust were procured at the behest of or for the benefit of parties possessing no insurable interest in Fishman’s life, including MCC, which funded the purchase of the policies through a non-recourse loan. The complaint also alleged various misrepresentations by Fishman and sought rescission of the policies.

Lincoln settled its misrepresentation claims against Fishman, his family and the trust, but continued to press its efforts to rescind the policies until Larson ruled that the loans complied with California’s insurable interest laws.

California law provides that, for an insurance policy to be valid, it must, at its inception, have been held by someone with an insurable interest in the person so insured under the policy, or, more specifically, by someone who has an interest and advantage in the “continued life, health, bodily safety of”’ the policyholder and who would suffer “consequent loss.”

Larson ruled that “it is hard to deny that, based on the formalities taken by the defendants, an insurable interest (a real or potential beneficial interest) existed at the time the policies were issued.”

Larson also said the law “as it presently exists allows this kind of insurance arrangement to be valid.”