Creditor Claims Against Life Insurance Death Benefit

Your Question: Decedent dies, pretty much insolvent with a mortgage debt greater than the equity in the decedent’s home. Decedent’s life was insured, with the designated beneficiaries of the life insurance policy being the decedent’s siblings. Can creditors of the decedent’s estate, i.e. the mortgagee, attach the death benefit that is payable to the decedent’s siblings to satisfy the deficiency judgment reflecting the mortgage deficiency?

Answer: Given the specific facts, there is a good chance that the decedent’s mortgagee-creditor could [if it ever learns of the existence of the life insurance policy] seek to recover part of the death benefit that is directly paid by the life insurance company to the decedent’s siblings by virtue of how Michigan’s statute is worded. The statute by its terms seems to only protect surviving spouses and children of the insured who are named as the policy beneficiaries.

Background: While I have generally advised clients over the years that life insurance and cash surrender values are protected from the insured’s creditors, the law unfortunately is not all that clear in Michigan. Michigan’s statutes provide that the proceeds paid under a life insurance policy to the decedent-insured’s spouse or children, or to a trust that is established for their benefit, including policy cash surrender values, is exempt from the deceased-insured’s creditors.

However, two court cases have nonetheless permitted creditors to garnish the cash value of the insured-debtor’s existing life insurance policy despite the protection the statute seems to afford the cash surrender value of an existing life insurance policy. In Chrysler First Business Credit Corporation v Rotenberg v John Hancock Life Insurance Co, 789 F. Supp. 870 (1992) a federal court permitted the garnishment of the cash surrender values in three life insurance policies on the life of the debtor-insured. No reference was made to the Michigan statutes that exempt the cash surrender value from claims of creditors; rather the sole focus was whether the life insurance company had to honor the garnishment without the policy owner demanding the payment of the cash surrender values. In Schenck Boncher & Prasher v. Vanderlaan, 2003 Mich. App. Lexis 2082 (2003) an unpublished decision, and thus of no precedential value in Michigan court proceedings, the Michigan Court of Appeals did not refer to the Michigan exemption statute, going so far in a footnote to observe ‘life insurance proceeds are not exempt under any statute’ –wrong!)

Statutes: The Michigan Insurance Code contains two statutes that deal with creditor claims against a life insurance policy or its death benefit. One deals with protecting insurers and the other protects the beneficiaries named under the life policy.

MCL 500.4054 (1) provides that a life insurer possesses the power to hold the proceeds of any life contract issued by it ‘with such exemptions from legal process and the claims of creditors of beneficiaries other than the insured.’
MCL 500.4054 (2) provides that any life insurance contract entered into by the life insurer may provide that the proceeds or payments made under the contract ‘shall not be subject to the claims of creditors of any beneficiary other than the insured or any legal process against any beneficiary other than the insured; and if the contract so provides, the benefits that accrue under the policy to such beneficiary other than the insured shall not be subject to encumbrance or process.’ Note the repeated exception language ‘other than the insured’ which would not protect the policy proceeds from creditor claims held against the insured, so it would seem by the exclusionary ‘other than the insured.’
MCL 500.2207(1) is the statute that attempts to protect beneficiaries of the life insurance contract. Key is the following phrase, applicable to either a wife or a husband (so noted since this old-time statute distinguishes husbands and wives.) ‘It shall be lawful for any husband to insure his life for the benefit of his wife, and for any father to insure his life for the benefit of his children, or any one or more of them; and in the case that any money shall become payable under the insurance the same shall be payable to the person or persons for whose benefit the insurance is procured, his, her, or their representatives or assigns, for his, her or their own use and benefit free from all claims of the representatives of such husband or father, or any of his creditors;’…..and the proceeds of any policy of life or endowment insurance, which is payable to the wife, husband or children of the insured or to a trustee for the benefit of the wife, husband or children of the insured, including the cash surrender value thereof, shall be exempt from execution or liability to any creditor of the insured; and said exemption shall apply to insurance heretofore or hereafter issued; and shall apply to insurance payable to the above enumerated persons or classes of persons, whether they shall have become entitled thereto as originally designated beneficiaries, by beneficiary designation subsequent to the issuance of the policy, or by assignment (except in the case of transfer with intent to defraud creditors.) Restated, if the life insurance policy proceeds are paid to a spouse or children of the insured, the policy proceeds are exempt from claims of the insured’s creditors or his estate representatives, but the surviving spouse and children of the insured are the only ‘enumerated persons or classes of persons’ entitled to this statutory protection.
MCL 500.2207(2) is a variation on the prior statutory exemption. It provides ‘if a policy of insurance is effected by any person on his own life.. or if a policy of life insurance is assigned or in any way made payable to such person, the lawful beneficiary or assignee thereof (other than the insured or the person effecting such insurance or his or her executors or administrators) shall be entitled to the proceeds and avails (including the cash value thereof) against the creditors and representatives of the insured and the person effecting the same… but the company issuing the policy shall be discharged of all liability thereon by payment of its proceeds in accordance with its terms…’ If I understand this section correctly [the language and manner of presentation of the 1956 statute is very confusing], an assignee of an existing life insurance policy, e.g. a transfer of the ownership of the policy in exchange for consideration paid, protects the policy assignee (and his/her investment in the life insurance policy) from claims of the insured’s creditors. This seems the equivalent to the protection given to a ‘buyer in the ordinary course of business’ under the Uniform Commercial Code, so that if a person acquires a life insurance policy on another’s life e.g. paying to become the ‘new’ policy owner, then the ‘new’ owner who is probably also the named beneficiary of the policy on another’s life, can take the death benefit free from the claims of the insured’s creditors or the insured’s estate representatives.

To conclude, since the decedent-insured’s siblings are the designated beneficiaries of the life insurance policy on the decedent’s life, the death benefit paid to them will not be exempt from the decedent’s estate creditors. How the estate representatives learn of the existence of the life insurance and its death benefit is another matter. If the decedent had named a spouse or children, then the death benefit would be exempt from outstanding creditor claims. Still unclear is how Michigan courts will view a creditor’s claim against the cash surrender value of a whole life policy where the owner-insured’s spouse or children are the designated beneficiaries. The statute seems to clearly protect the cash surrender values of such a policy from creditor claims, but the two court decisions seem to blissfully ignore the exemption language of MCL 500.2207(1). Kinda makes me nervous when appellate courts write decisions completely ignoring statutes that are directly on point.