Till Death Do Us Part: Pitfalls of Life Insurance Provisions in Family Law Matters, As Seen in The New Jersey Law Journal – Family Law Supplement (January 25, 2016)
Jan L. Bernstein, Esq. and Thomas Novak, Esq.
A well drafted matrimonial settlement agreement will contain language addressing appropriate security in case of death, for all of the financial obligations included in the agreement. These provisions often are focused on life insurance and can be complex. Without the right language, the security promised may be illusory.
Below is a conversation between a family attorney (Jan L. Bernstein) and an insurance attorney (Thomas Novak), highlighting some of the most recurring questions when drafting a property settlement agreement. Working hand in hand with an insurance lawyer will help you navigate and anticipate murky issues affecting the rights of the financial obligor, beneficiary and, often times, the estate of the deceased.
Jan L. Bernstein: Does a divorced spouse have a continuing insurable interest in his/her former spouse even if the former spouse no longer has any financial obligations under the settlement agreement?
Thomas Novak: A former spouse may have an insurable interest. The statutory definition of “insurable interest” recognizes that an individual has an insurable interest “in the life, health and bodily safety of another individual to whom he is closely related by blood or law,” or where there exists “an expectation of pecuniary advantage through the continued life” of the insured. See N.J.S.A. §17B:24-1.1(a) (2) & (3). However, New Jersey law requires an insurable interest to exist only “at the time when the contract was made, ....” See N.J.S.A. §17B:24-1.1(b). So, if the former wife had an insurable interest when the policy was issued, she should be able to receive benefits even after the former husband’s alimony or other financial obligations end.
This conclusion is buttressed by the fact that an individual who obtains life insurance on his own life is permitted to transfer ownership of the policy to a person or entity that lacks an insurable interest. See Travelers’ Ins. Co. v. Morris, 115 N.J. Eq. 142 (1934) (recognizing legality of assigning insurance policies to parties without an insurable interest); see also N.J.S.A. 178:24-4 (“Nothing in this Title shall prohibit any person insured under an insurance policy or annuity contract, other than group, from assigning or not assigning, as provided by its terms.”).
The bottom line is that if the former spouse had an insurable interest when the policy was issued, he/she can collect benefits after the former spouse’s alimony or other financial obligations terminate. Even if the former spouse purchased a new policy now, he/she would be likely able to assign it to his/her former spouse or anyone else afterward, absent a rescission issue. Beware, however, it is advisable to have an insurance law attorney look at the policy to make sure the policy does not contain language to the contrary.
JLB: To what extent does the law protect the insured if he/she failed to remove the former spouse as a named beneficiary on his/her life insurance policy?
TN: In an unpublished decision, the New Jersey Appellate Division in Hadfield v. Prudential, 408 N.J. Super. 48 (App. Div. 2009), applied New Jersey’s “revocation on divorce” statute, N.J.S.A. 3B:3-14 and held that a decedent’s former spouse was not entitled to the proceeds of a life insurance policy where after obtaining a divorce, the decedent failed to change the beneficiary designation of a life insurance policy on his life, and there was no indication the decedent intended his former spouse to continue to be the beneficiary. N.J.S.A. 3B:3-14, as amended in 2005, provides that a divorce revokes any revocable dispositions made by a divorced individual to his or her former spouse in a governing instrument (which includes a life insurance policy), except as otherwise expressly provided by the insured spouse.
A shortcoming to N.J.S.A. 3B:3-14 is that it is limited to revocations of insurance beneficiaries in a policy owned by an individual, and does not apply to a spouse’s irrevocable insurance trust where the irrevocable trust is designated as the beneficiary. As a result, absent specific language in an irrevocable trust to the contrary, a divorce will not revoke the designation of the irrevocable trust as the beneficiary and will not terminate a former spouse’s rights under the trust. It is also important to note that Section 14 does not apply to ERISA governed retirement plans, such as IRAs, 401(k)’s and other employer-provided plans.
JLB: Is there a designation, such as “irrevocable beneficiary” that protects a beneficiary’s interest in the life insurance of a former spouse from a subsequent spouse or a later disqualified beneficiary? If the spouse was designated as an irrevocable beneficiary, can that spouse then be removed as a beneficiary when the separation agreement permits the termination of the life insurance policy?
TN: In Hirsch v. Travelers Ins. Co., 153 N.J. Super. 545 (App. Div. 1977), the Appellate Division characterized “irrevocable beneficiary” status as meaning that:
The rights of plaintiffs became fixed as of the time that the assured complied with the policy requirements for a change in beneficiary. Any subsequent acts of the employer [or insured] purporting to further change the beneficiaries without their consent cannot serve to destroy their irrevocable right to the proceeds of the policy.
Id. at 522. In other words, once you name an irrevocable beneficiary, you cannot change it. An irrevocable beneficiary’s rights to the insured’s death proceeds vest during the insured’s lifetime, not at death. This means that the owner may not exercise her ownership rights without written permission of the irrevocable beneficiary. The owner cannot borrow against the policy, pledge it as collateral, receive dividends or surrender the policy.
Later, in Flanigan v. Munson, 175 N.J. 597 (2003), the Supreme Court of New Jersey held that a provision in a divorce decree naming the children of the divorced couple as “irrevocable beneficiaries” was enforceable despite the lack of such a designation in the policy, and imposed a constructive trust on the proceeds of the policy. This was a bit like closing the barn door after the cows had already escaped, since the insurer had already paid out the policy to the wrong person. It would be preferable to have the irrevocable beneficiary designation executed as part of the divorce agreement so the carrier enforces the provision, rather than having to sue after the policy proceeds have been distributed. Also, counsel should review the policy to make sure that the change of beneficiary is done in accordance with the policy provisions, as was emphasized in Hirsch. Id. at 554.
An irrevocable beneficiary designation (IBD) is not always optimal depending on the circumstances (whole life or term, assignment or temporary collateral, length of time collateralizing alimony). However, provisions can be added to an agreement to avoid or at least minimize complications. IBD is most appropriate when there is an assignment of a whole life policy with a cash value; otherwise, the assignor/owner could deplete the cash value. IBD (instead of regular beneficiary status) may not be necessary for a term life policy securing alimony for a limited period of time. Regular beneficiary status may suffice. If counsel representing the beneficiary insisted upon IBD for a short term collateral situation, I would recommend that the agreement provide that counsel for the insured spouse obtain a surrender or release of the policy signed by the beneficiary to be held in escrow pending the payout of alimony or child support. Otherwise, once the alimony or child support is paid out, the insured spouse would be in a position of having to chase or sue the beneficiary for the release.
In addition, language may be added to agreements, requiring the insured to provide authorization to the carrier to give the IBD or non-IBD beneficiary notice from the carrier of a change in beneficiaries, lapse in premium payment, loan or other reduction in cash value.
JLB: Is there a designation or clause you would suggest to provide a “priority lien” against the estate of a former spouse or deceased parent to protect a spouse or child whose former spouse or deceased parent failed to maintain a required life insurance policy?
TN: Assignment of ownership of the policy (coupled with irrevocable beneficiary status) is the ultimate protection because the owner controls the policy, receives all notices from the insurer, has the sole right to deal with the insurer, may change beneficiaries, etc. A lien can be imposed upon the estate of a decedent for the benefit of the decedent’s child. In re Estate of Boyle, 2011 N.J. Super. Unpub. LEXIS 616, affirmed the trial court’s finding that a lien against the estate of the decedent was appropriate where the decedent had an obligation under a final judgment of divorce to maintain life insurance in the amount of $250,000 and name both the wife and the wife-as-trustee for the benefit of the parties’ son, as beneficiaries until such time as alimony terminates, and that once alimony terminates the obligation continues naming the child as sole beneficiary.
Given insurance law is ever-evolving and complex, and given the assets in family law cases are becoming more sophisticated, digital and otherwise, as this article demonstrates, we as family law practitioners must carefully examine the issues and craft agreements with the guidance of competent insurance counsel, when appropriate.