'Til Death Do Us Part: Avoiding Pitfalls Associated with Life Insurance Provisions in Family Law Matters
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. This article is a conversation between a family attorney and insurance attorney, 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.
JLB: 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?
TN: 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. 17B: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.”).
Today, there is a cottage industry in so-called STOLI policies (stranger originated life insurance) purchased in what is called the “life settlements” market. In some STOLI cases, investors induce a person to take out a policy and agree to fund the premiums in return for subsequent assignment of the policy to the investors. The case of Lincoln National Life v. Calhoun, 596 F.Supp 2d. 882 (D.N.J. 2009) by Judge Pisano contains an informative discussion of STOLI policies.
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 afterwards, 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 NJ 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.
The decedent in Hadfield was divorced prior to the 2005 amendment, but died after the 2005 amendment. The former spouse argued that the amended version of the statute should not apply because it was not in effect at the time of the divorce. The court rejected this argument and retroactively applied the amended statute, reasoning that the former spouse had no vested right in the insurance because the decedent could have changed the beneficiary designation at any time.
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 “[t]he 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. In Hirsch, the court held that an irrevocable beneficiary so designated in accordance with policy provisions was entitled to the proceeds of one policy, but where the change of beneficiary form for another policy did not say that it was irrevocable, the putative beneficiary was not entitled to the other policy’s proceeds where the beneficiary was subsequently changed. 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. “It is well-settled that a change of beneficiary can only be effected so as to bind the insurance company if it is accomplished in substantial compliance with the policy requirements. 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 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 NJ 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. At the time of decedent’s death the son was 19 and enrolled full time in college. Decedent maintained the insurance and when the alimony obligation to his former wife terminated changed the designated beneficiary to his son. Due to health reasons, his support was reduced by the court, but his life insurance obligation remained in place. He died before the son was emancipated. The son had not received notice of termination insurance although he was the primary beneficiary. He sought payment from the estate assets in the amount of $250,000. Finding that the decedent breached his obligation to maintain a life insurance policy for the benefit of his son the trial court entered a judgment awarding him $250,000 from the estate. The Appellate Division affirmed, finding unpersuasive the estate’s argument that payment of $250,000 would result in an unfair windfall. The court noted that there were no step- down or reduction provisions, concluding the intent was for the son to receive the entire death benefit. Id. at 15. The court distinguished the facts before from an earlier case, Konczyk v. Konczyk, 367 NJ Super. 551 (Ch. Div. 2003) aff’d, 367 NJ Super. 512 (App. Div. 2004) wherein the trial court limited the funds payable to a former wife to the extent to which she was due based on the remaining balance on the 5 year//$100 monthly limited duration alimony owed at the time of the decedent’s death, not the entire amount of the $15,000 life insurance policy he was required to maintain under the Property Settlement Agreement to secure his alimony obligation. The obligation was calculable. Id. at 514, unlike In re Estate of Boyle, supra, where the amount of the obligation was not finite or calculable. 211 NJ Super. at 15–16.
Issues surrounding life insurance in a family law context regularly arise. In Fox v. Lincoln Financial Corp., 439 NJ Super. 380 (App. Div. 2015) the Appellate Division affirmed the trial court’s decision to deny a claim of a spouse, who was a Brazilian national awaiting citizenship approval to her deceased husband’s life insurance policy in which he named his sister as sole beneficiary. She unsuccessfully argued that husband promised her he would place her name on accounts including life insurance “as conditions permitted” in light of her not yet having a social security number. Id. at 384-385. The court distinguished this case from Vasconi v. Guardian Life Ins. Co. of Am., 124 NJ 338 (1991) wherein the decedent’s former wife and decedent’s estate made competing claims to his life insurance policy. They had divorced and executed a property settlement agreement providing mutual waiver of all claims, including claims against each other’s estate. At the time of decedent’s death, his former wife was still the named beneficiary on his policy. The court held that where there is a divorce and a property settlement agreement settling “all questions pertaining to their respective interests in distribution of the marital assets”, life insurance is encompassed within the terms of the settlement agreement, serves as a waiver of interest in the property of the deceased spouse presumptively revokes the non-probate transfer of the insurance proceeds. Id. at 387 citing Vasconi, supra, 124 NJ at 346. The wife in Fox asserted that Vasconi should be applied reciprocally to “trigger a presumption that each spouse thereby intends to make the other the primary beneficiary under any life insurance policy, absent evidence of contrary intent.” Id. at 387. The court observed that “the Legislature enacted N.J.S.A. 3B:3–14 to provide that divorce automatically revokes a disposition of property made by a divorced individual to his former spouse in a governing instrument which, by definition, includes an insurance policy . . . it could similarly pass legislation granting presumptive beneficiary rights to a spouse upon marriage should it determine to do so. “ Id. at 389.
JLB: Thank you, Tom.
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.