The Beneficiary in Life Insurance [Reprint 2016 ed.] 9781512804249

Table of contents :
Preface
Contents
THE S. S. HUEBNER FOUNDATION FOR INSURANCE EDUCATION
SIGNIFICANCE OF THE BENEFICIARY
DESIGNATION OF THE BENEFICIARY
ASSIGNMENTS OF LIFE INSURANCE POLICIES
RIGHTS OF CREDITORS IN LIFE INSURANCE
RIGHTS OF CREDITORS IN LIFE INSURANCE
DEVELOPMENT OF OPTIONAL SETTLEMENTS
PLANNED SETTLEMENTS: CURRENT PRACTICES
FINANCIAL ASPECTS OF OPTIONAL SETTLEMENTS
COROLLARY LEGAL ASPECTS OF SUPPLEMENTARY CONTRACTS
BUSINESS LIQUIDATION INSURANCE AND OPTIONAL SETTLEMENTS
TAXATION OF LIFE INSURANCE POLICY PROCEEDS
PROGRAMMING TO MEET BENEFICIARY NEEDS
Appendix A. ATTITUDE OF STATES TOWARD ASSIGNMENT
Appendix Β. ASSIGNMENT OF LIFE INSURANCE POLICY AS COLLATERAL
Appendix C. SUMMARY OF CASES
Appendix D. BLANK LIFE INSURANCE COMPANY. PLANNED SECURITY
INDEX

Citation preview

T H E BENEFICIARY IN LIFE INSURANCE

T H E S. S. H U E B N E R F O U N D A T I O N FOR INSURANCE E D U C A T I O N LECTURES Edited by David McCahan

LIFE INSURANCE: TRENDS AND PROBLEMS T H E BENEFICIARY IN LIFE INSURANCE

THE BENEFICIARY IN LIFE INSURANCE Edited by

David McCahan, Ph.D., (C.L.U.) Executive Director The S. S. Huebner Foundation for Insurance Education

Philadelphia UNIVERSITY OF PENNSYLVANIA PRESS LONDON: GEOFFREY CUMBERLEGE OXFORD UNIVERSITY PRESS

1948

Copyright

1948

UNIVERSITY OF PENNSYLVANIA PRESS Manufactured

in the United States of America

PREFACE

Although the publication policy of the Foundation is quite broad in scope, the Administrative Board of the Foundation has felt that, within its framework, considerable emphasis should be placed upon the publication of material which would be especially useful to college or university teachers of insurance in their instructional work. This attitude has been influenced by the following primary considerations: (1) T h e conviction that every teacher who keeps faith with the ideals of his profession wants to be fully informed on all matters of consequence in the realm of his specialty. (2) T h e realization that college and university instruction in insurance has already reached, and will continue to reach, far more students in the broad domain of economics, government, sociology and their subdivisions than in such specialized vocational subjects as insurance law, actuarial science and insurance medicine. (3) T h e recognition that a teacher in the social science subjects must obtain a broad comprehension of the life insurance institution as a whole in its social setting. This must be an "over-all" view which not only includes the structure, functions and services of this institution but also its manifold interrelationships with other institutions which make u p American life today. (4) The realization that analysis and thorough study of all the technical literature in life insurance is a time-consuming process which is frequently prohibitive for the teacher whose duties require that he have an equally broad grasp of other important economic and social institutions. T o keep himself conversant with all the developments and the new ideas which are presented in the journals of the actuarial societies, the medical directors, the agency executives, the insurance lawyers, the life underwriters, etc., and to be reasonably well informed on matters of importance which have not been there presented, is no small task.

vi

PREFACE

This is the second publication comprising a series of lectures given under the auspices of the Foundation at the University of Pennsylvania. Each of the lectures in the present series, save one, was delivered at a dinner meeting attended by fellows and scholars of the Foundation and teachers from the Insurance Department faculty. In following this procedure, members of the Foundation's Administrative Board had in mind the desirability of enabling these present and future teachers of insurance to enjoy the privilege of hearing outstanding authorities, with a background of broad experience in the life insurance field, discuss the subjects assigned to them. T h e primary directing principle followed in the selection of the speakers was their capacity to make a worth-while contribution to the thinking of this teaching group. Publication of these manuscripts was authorized by the Administrative Board of the Foundation with the sincere hope, and in the confident belief, that their range of usefulness might be extensively widened through making them available to other teachers and students of insurance who could not hear the original presentation. It was felt that such publication would be in full accord with the policy above set forth. As was the case with the first volume of lectures, this one is of significance, not alone because of the high standing in the life insurance world of those who have made it possible and the inherent quality of their respective contributions to it, but because it reflects the continuance of an organized effort to provide a literature especially intended for teachers in the broad field of the social sciences. Conscious as these teachers are of the complexities and ramifications of the subjects with which they deal and the frequent inconclusiveness of the researches therein, they are nevertheless zealous to broaden their understanding and enrich their teaching. To them this volume is dedicated. Through them it is hoped that research may be stimulated. From them will be welcomed substantial participation in the subsequent studies, monographs and other materials which are published under the auspices of this Foundation. Development of a lecture series built around a central theme which, when published as a whole, would be coordinated, balanced and unified, obviously presented a number of problems.

PREFACE

vii

These were met in part by the prior preparation of a detailed outline in connection with which the editor had the advice and guidance of many persons, including Robert Dechert, S. S. Huebner, Frank L. Jones, M. Albert Linton, Harry J. Loman, Joseph B. Maclean, Samuel Milligan, Ray D. Murphy and Adolph A. Rydgren. They were further met by the wholehearted assistance of the various speakers who displayed an interest in the project and a degree of teamwork which made this joint project an inspiration and a source of genuine pleasure to the editor. T o all of those who participated so graciously, competently and generously, and to Miss Mary Drever who has rendered valuable editorial assistance, the editor expresses his indebtedness and appreciation. It should in no wise detract from the quality of the volume to point out that expressions of opinion which may appear in publications of the Huebner Foundation are those of the authors and not of the Foundation itself. D.McC. Philadelphia March 1948

CONTENTS PAGE

PREFACE

V

SIGNIFICANCE OF T H E BENEFICIARY, D E S I G N A T I O N OF T H E BENEFICIARY,

by David McCahan by James S . Burke

Insurable Interest of Beneficiary Revocable and Irrevocable Beneficiaries — Including Rights Retained and Rights Given Uniform Simultaneous Death Act and Its Effect Partnerships, Associations, Corporations, and Trustees as Beneficiary The Minor as Beneficiary Form and Problems of "Class" Designations Effecting Change of Beneficiary Ownership Rights A S S I G N M E N T S OF L I F E I N S U R A N C E POLICIES, by Robert Dechert Concept of a Life Insurance Policy Assignment and Change of Beneficiary Compared "Absolute" and "Collateral" Assignments Need for Change of Beneficiary Before an Assignment Insurable Interest Required of Assignees of Life Insurance Policies Failure to Give Notice of the Assignment to the Insurance Company Progress Through Use of American Bankers Association Form of Assignment R I G H T S OF CREDITORS IN L I F E I N S U R A N C E ( I ) , by Howard C. Spencer Two Races of Men Statutory Pattern General Statutes Married Women's Type (Restricted Exemption) Married Women's Type (Unrestricted Exemption) Distribution Type Procedural Type "55-a" Type Comprehensive Type Special Statutes Fraternal, Assessment, etc., Type Group Type Disability Income Type Annuity Type Spendthrift Type ix

l 4 4 7 12 14 16 17 18 19 22 22 25 27 28 31 36 36 39 39 43 44 44 45 46 47 48 51 52 52 53 53 54 56

χ

CONTENTS ΡΛΟΒ 60 61 63 63 64

Welfare Type T h e First Hundred Years in New York Federal Statutes Veterans' Payments Bankruptcy R I G H T S OF CREDITORS IN L I F E I N S U R A N C E

(II),

by Howard

C. Spencer Case Law Interpretations Of Matters Relating Principally to the Statute Problems of Constitutionality Scope of Exemptions Application to Pre-existing Debts Problems of Meaning Application to Pre-existing Debts Distributive Aspects Interrelationships Between Statutes Scope of Exemptions Problems of Choice — Which Law Governs W h a t ? Of Matters Relating Principally to the Creditor T h e Premium Payer as Creditor Payer Without an Interest Payer With an Interest T h e Federal Tax Collector as Creditor In General Insured's Interest in Cash Value Insured's Interest in Death Proceeds Beneficiary's Interest in One Sum Death Proceeds Beneficiaries' Interest in Deferred Settlement Proceeds T h e Welfare Official as Creditor T h e Wife as Creditor T h e Insurer as Creditor T h e "Necessaries" Creditor Of Matters Relating Principally to the Debtor T h e Insolvent Debtor In General Fraudulent Transfers T h e Bankrupt Debtor Relation Between State and Federal Statutes Disposition of Policies Not Exempt Under State Law Nature of Bankrupt's Interest T h e Effector-Beneficiary Debtor Of Matters Relating Principally to the Life Insurance Types of Benefits Protected Cash Values Dividends Disability Income

66 66 66 66 66 68 69 69 70 73 73 74 78 78 78 79 80 80 80 81 82 82 82 83 84 85 85 85 85 86 91 91 92 93 94 96 96 96 99 99

CONTENTS

xi ΡΛΟΕ 100 101 101 102 104 106 106 107

Endowment Policies Annuities Group Insurance Deferred Settlement Proceeds Right to Change Beneficiary Reversionary Interest in Insured Policy Payable to Trustee Conclusion DEVELOPMENT OF OPTIONAL

SETTLEMENTS,

by Richard C .

Guest Chronology of Economic Highlights Settlement Options and Their Development Instalments for a Fixed Period Fixed Income Until Proceeds Exhausted Annuity for Fixed Period and for Life Life Annuity Cash Refund Life Annuity Instalment Refund Life Annuity Joint and Survivorship Life Annuity Proceeds at Interest The Payment of Proceeds by the Insuring Company to Corporate Trustees Security of Principal Security of Income Flexibility Cost Public Acceptance of Options Factors Causing Acceptance Concluding Observations PLANNED

SETTLEMENTS — CURRENT

PRACTICES,

by

M . Thoré Introduction Factors Responsible for Variations in Practice Definitions Types of Planned Settlements Policy Options Contract Limitations Procedure for Election Basic Rules of Practice Duration of Planned Settlements Withdrawal Privilege Right to Change from One Option to Another Right to Increase Payments Primary and Secondary Beneficiary Miscellaneous Practice Problems

109 111 112 113 113 114 115 116 116 117 117 118 119 119 120 121 121 122 124

Eugene

126 126 127 127 128 129 130 130 131 131 132 133 134 135 137

xii

CONTENTS Remarriage Clause Spendthrift Clause Common Disaster Clause Dividing Proceeds Settlements with Minor Beneficiary Designation of Unborn Children or Future Spouse A New Approach to Planned Settlements Standardized Agreements Proposal for New Option Conclusion

F I N A N C I A L A S P E C T S OF O P T I O N A L S E T T L E M E N T S ,

by Edward

W. Marshall

146

Varying Concepts on Financing Outstanding Policies Bases of Optional Settlement Guarantees in New Policies Interest Rate Mortality Rates Expense Rates Anti-selection Cash Withdrawals Are Optional Settlements Still on Trial? COROLLARY LEGAL A S P E C T S OF S U P P L E M E N T A R Y

156

Supplementary Contract Distinguished from Trust Supplementary Contract as a Disposition of Property Application of Rule Against Perpetuities Restraints on Alienation Testamentary Disposition Conclusions Addendum — Election of Deferred Settlements by Guardians or Trustees MENTS,

LIQUIDATION

147 149 149 150 150 151 152 153 154

CONTRACTS,

by Berkeley Cox

BUSINESS

PAOS 137 137 137 138 138 138 139 142 145 145

INSURANCE

AND

OPTIONAL

157 158 162 163 165 170 170

SETTLE-

by John M. Huebner

Types of Business Organizations T h e Sole Proprietorship T h e Partnership T h e Corporation T h e Liquidation Agreement T h e Agreement to Sell and to Buy Valuation of the Business Interest and Determination of the Purchase Price Payment of Premiums Title to the Policies T h e Designation of the Beneficiary Dangers Inherent in the Practice of Naming as Beneficiaries

174 175 175 176 177 177 178

178 181 181 182

xiii

CONTENTS

PAGE

Persons of the Insured's Choice Suggested Procedure

TAXATION OF LIFE INSURANCE POLICY PROCEEDS, by

182 184

Bernard

G. Hildebrand Federal Income Tax Life Insurance Death Proceeds Life and Endowment Insurance Living Benefits Federal Estote Tax Federal Gift Tax State Taxation Income Tax Inheritance or Estate Tax Gift Tax Personal Property Taxes Conclusion PROGRAMMINO TO M E E T BENEFICIARY N E E D S , by John O . Todd Forecasting the Needs Getting the Facts Discovering and Clarifying the Problem Solving the Problem Options of Settlement Social Security Family Income Periods Demonstrating the Procedure Determining the Need Determining the Amount of Capital Needed Determining the Method of Acquiring the Capital The Mechanics of Converting the Capital to Income Providing for Contingent Beneficiaries Problems in Arranging Options The Effect of Taxes The Estate and/or Inheritance Tax The Gift Tax The Federal Income Tax The Insured as a Beneficiary of Life Insurance Significance of Guaranteed Incomes The Need for the Underwriter in Planning for Beneficiaries APPENDIX APPENDIX

A—Attitude of States Toward Assignment B—Assignment of Life Insurance Policy as Col-

lateral APPENDIX APPENDIX

curity INDEX

186 186 187 192 194 206 209 209 209 210 210 211 212

213 213 214 215 216 218 219 220 220 222 223 223 225 227 228 228 228 229 229 230 232 233

236 C—Summary of Cases D—Blank Life Insurance Company — Planned Se-

239

241 245

T H E S. S. H U E B N E R INSURANCE

FOUNDATION

FOR

EDUCATION

T h e S. S. Huebner Foundation for Insurance Education was created in 1940, under the sponsorship of a Cooperating Committee representing the life insurance institution, to aid in strengthening insurance education on the collegiate level. It functions along three principal lines: 1. Providing fellowships and scholarships to aid teachers in accredited colleges and universities of the United States and Canada, or persons who are contemplating a teaching career in such colleges and universities, to secure preparation at the graduate level for insurance teaching and research. 2. Building up and maintaining a research service center in insurance books and other source material which will be available through circulating privileges to teachers in accredited colleges and universities desirous of conducting research in insurance subjects. 3. Publishing research theses and other studies which constitute a distinct contribution directly or indirectly to insurance knowledge. T h e activities of the Foundation are under the direction of an Administrative Board consisting of five officers and faculty members of the University of Pennsylvania and two faculty members of other universities.

COOPERATING COMMITTEE Thomas I. Parkinson, Chairman Leroy A. Lincoln A. A. Rydgren

Representing T H E LIFE INSURANCE ASSOCIATION OF AMERICA Representing T H E AMERICAN LIFE CONVENTION

O. J. Arnold M. Albert Linton John A. Stevenson

Representing T H E I N S T I T U T E OF LIFE INSURANCE

ADMINISTRATIVE BOARD S. S. Huebner, Honorary Chairman Harry J. Loman, Chairman David McCahan, Executive Director Ralph H. Blanchard Paul H. Musser Edison L. Bowers Edwin B. Williams

SIGNIFICANCE OF THE BENEFICIARY By David McCahan, Ph.D., (C.L.U.)

When we start with the beneficiary in modern life insurance as the center of our thinking, the lines of thought move out in the different directions of an ever widening circle. This third party in a life insurance contract, included most times gratuitously and unselfishly, has given rise to a host of economic, social, psychological, legal, actuarial and financial implications of great magnitude. The very volume of outstanding life insurance reflects this beneficiary orientation. Only by emphasizing the potential needs of beneficiaries, by fostering a keen sense of responsibility on the part of family heads for the welfare of their dependents, by developing effective procedures for translating family love and affection into practical financial plans, and by using motivation techniques built largely upon beneficiary relationships, could the life insurance institution ever have attained its present stature in size and achievements. Contract provisions and company practices reflect the same orientation. Whether pertaining to the naming and changing of beneficiaries, the assignment of contractual rights, or the adaptation of optional provisions of settlement, refinements have been introduced and developed over the years designed to make life insurance a more effective instrument for safeguarding the beneficiary. Statutory enactments and court decisions show a like influence. Through laws such as those governing policy provisions, exempting life insurance cash values and proceeds from the insured's l

2

BENEFICIARY I N LIFE I N S U R A N C E

creditors, protecting beneficiaries against the claims of their own creditors, and freeing life insurance from death taxation, legislators have evidenced their concern for the beneficiary and their confidence in life insurance as a practical means for furthering the social welfare. Courts have evidenced similar beliefs in numerous decisions. T r e n d s in the directions mentioned have been accompanied by divers developments and problems in life insurance company operation and life underwriting practice. For life insurance companies, the function of liquidating proceeds for beneficiaries, and even for the insured himself, has been added to the indemnity and savings functions and greatly stressed. T h i s has lengthened considerably the period of time during which many contracts will be operative, has enhanced the significance of initial interest or mortality assumptions on which premiums, reserves and settlement benefits are computed, has raised varied legal, actuarial, financial and administrative problems of a complex character, and has increased the cost of service given to the public. For life underwriters, the functions of analyzing and appraising needs, of fitting policies and arranging settlement provisions to meet such needs, of coordinating life insurance with other estate plans, and of generally rendering a skilled type of personal guidance service has been added to that of motivating the prospective policyholder to recognize future as well as present obligations. Complicated programming and estate planning techniques have become commonplace. All these changes have brought with them a need for more extensive education and training, a career concept, and the acceptance of high professional standards. Woven through the web of trends which have stemmed from the beneficiary concept has been the philosophy that the strength of our civilization lies in the dignity and worth of its individual citizens and the individual members of their family units. And that in turn has strengthened the entire social fabric by inculcating faith in human beings and the American economy, by encouraging initiative and self-reliance, by stimulating prudence, thrift and foresight, and by pointing the way to a practical form of social-mindedness. T h e significance of the beneficiary in modern life insurance

SIGNIFICANCE OF T H E BENEFICIARY

3

has grown in the thought of the editor while this volume was taking shape. As the various phases thereof unfold, he hopes that the reader may experience a similar challenge to the imagination and a similar appreciation of the power of idealism based upon economic and social principles of demonstrated validity.

DESIGNATION OF THE BENEFICIARY* By James S. Burke, LL.B.f

are the respective interests of the insured and the beneficiary in the modern life insurance policy? Generally, they are clearly defined by the terms and provisions of the policy itself, which, of course, reflect the intentions of the person procuring the insurance, whether it be the insured himself, the beneficiary, or some third person. One might ask why, when a person insures his life in favor of another, it should be necessary for the contract to be so specific as to what he might do with a contract he has purchased by his sole act and with his own money. T o answer that question, as well as other questions concerning the nature and extent of the interest of the beneficiary in a life insurance policy, it is helpful to examine the origin and development of the life insurance contract in certain respects.

WHAT

INSURABLE I N T E R E S T OF BENEFICIARY Early in the history of life insurance, contracts commonly were made with persons other than the persons whose lives were insured. T h e insured, or the person whose life was the subject of the contract of insurance, served mainly as the vehicle to provide a third person with financial benefit in the event of the insured's • T h e purpose of this lecture is to discuss the fundamental principles involved in the beneficiary designation in a life insurance policy. Although there are three principal branches in the life insurance business—ordinary, industrial, and group—this discussion is confined to ordinary because the topics in this series more generally relate to ordinary, which comprises the far greatei portion of life insurance presently owned and presently sold, and because the interest of the beneficiary in industrial and group insurance has certain special characteristics. However, some of the generalities observed herein do apply to the beneficiary in industrial and group insurance. f Associate Manager, Ordinary Administration, Metropolitan Life Insurance Company. 4

DESIGNATION O F B E N E F I C I A R Y

5

death. In fact, the contract was made with such third person, who was described as the assured, and the insured had no rights under the contract at all. Marshall on Insurance, an English text, the American edition of which was published in 1805, describes the wagers that came to be made daily upon the duration of men's lives in the form of insurance, by persons who were neither connected with the parties nor in any manner interested in the duration of their lives. These evil practices led, in 1774, to the passage in England of an Act 1 regulating insurance on lives. It provided in part as follows: Whereas it hath been found by experience that the making assurances on lives, or other events, wherein the assured shall have no interest, hath introduced a mischievous kind of gaming; for remedy whereof be it enacted . . . That, from and after the passing of this Act, no insurance shall be made by any person or persons, bodies politic or corporate, on the life or lives of any person or persons, or on any other event or events whatsoever, wherein the person or persons for whose use, benefit, or on whose account such policy or policies shall be made, shall have no interest, or by way of gaming or wagering; and that every assurance contrary to the true intent and meaning hereof shall be null and void to all intents and purposes whatsoever. Early in the history of life insurance in the United States there was some conflict of opinion on the requirement of insurable interest. However, it soon became the public policy to prohibit the issuance of contracts of life insurance when procured by a person having no insurable interest in the life of the insured. What constitutes an insurable interest was described by the United States Supreme Court in 1882, in the case of Warnock v. Davis,2 in the following language. It is not easy to define with precision what will in all cases constitute an insurable interest, so as to take the contract out of the class of wager policies. It may be stated generally, however, to be such an interest, arising from the relation of the party obtaining the insurance, either as creditor of or surety for the assured, or from ties of blood or marriage to him, as will justify a reasonable expectation of advantage or benefit from the continuance of his life. It is not necessary that the expectation of advantage or benefit should be always capable of pecuniary estimation; for a parent has an insurable interest in the life of his child, and a child in the life of his parent, a husband in the life of his wife, ι 14 Geo. Ill, c. 48. « 104 U. S. 775.

6

BENEFICIARY IN LIFE INSURANCE

and a wife in the life of her husband. T h e natural affection in cases of this kind is considered as more powerful—as operating more efficaciously —to protect the life of the insured than any other consideration. But in all cases there must be a reasonable ground, founded upon the relations of the parties to each other, either pecuniary or of blood or affinity, to expect some benefit or advantage from the continuance of the life of the assured. Otherwise the contract is a mere wager, by which the party taking the policy is directly interested in the early death of the assured. Such policies have a tendency to create a desire for the event. They are, therefore, independently of any statute on the subject, condemned, as being against public policy.

For many years after this decision there was a great deal of doubt whether a policy, valid at its inception, should be payable to a beneficiary or assignee who, at the death of the insured, had no insurable interest. Such doubt was put at rest by Justice Holmes in 1911, in the case of Grigsby v. Russell,3 which held that a policy, once valid, is not voided by lack of insurable interest at death. That is generally the rule today except for a very few states where modified by statute or judicial decision. It was long ago recognized that a person has an insurable interest in his own life and therefore could contract for insurance of which he himself would be the absolute owner and that any beneficiary named by him would be but an incidental character. T h e interest of the beneficiary was one which came into being solely by the grace of the insured. Accordingly, there was no requirement that, in any such contract made by the insured, the beneficiary have an insurable interest in the life of the insured. That is generally the law today except in Texas, which, by the public policy of that State, requires every beneficiary to have an insurable interest, though the insured procured the policy and paid for it with his own funds. In the fairly recent case of Smith v. Coleman* the Supreme Court of Virginia, upon a rehearing, reversed itself to hold definitively that in a policy procured by the insured the beneficiary named by the insured is not required to have an insurable interest in his life to be entitled to the death benefits. Some states have fixed the meaning of insurable interest by express statute and have declared who may purchase life insur3 222 U. S. 149. * 32 S.E. (2) 704; 35 S.E. (2) 107.

DESIGNATION OF

BENEFICIARY

7

ance. Typical of such states is New York, the Insurance Law of which provides: Any person of lawful age may on his own initiative procure or effect a contract of insurance upon his own person for the benefit of any person, firm, association or corporation, but no person shall procure or cause to be procured, directly or by assignment or otherwise, any contract of insurance upon the person of another unless the benefits under such contract are payable to the person insured or his personal representatives, or to a person having, at the time when such contract is made, an insurable interest in the person insured. . . . If the beneficiary, assignee or other payee under any contract made in violation of this subsection shall receive from the insurer any benefits thereunder accruing upon the death, disablement or injury of the person insured, the person insured or his executor or administrator, as the case may be, may maintain an action to recover such benefits from the person so receiving them. T h e term, "insurable interest," as used in this section, shall mean: (a) In the case of persons related closely by blood or by law, a substantial interest engendered by love and affection; and (b) in the case of other persons, a lawful and substantial economic interest in having the life, health or bodily safety of the person insured continue, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury, as the case may be, of the person insured. R E V O C A B L E AND I R R E V O C A B L E BENEFICIARIES I N C L U D I N G R I G H T S R E T A I N E D AND R I G H T S GIVEN T h e early forms of contracts of life insurance in the United States had the general appearance of contracts made with the beneficiary. Even though the insured himself was the one who negotiated the policy, the application was made by the insured and the beneficiary and the contracts were so drawn that they were, in form as well as in legal effect, contracts with both the insured and the beneficiary. The Law of Life Insurance, written in 1871 by George Bliss, Jr., New York Counsellor at Law, recognized as an early American authority, had this to say about the interest of the beneficiary: We apprehend the general rule to be that a policy, and the money to become due under it, belong the moment it is issued to the person or persons named in it as the beneficiary or beneficiaries, and that there is no power in the person procuring the insurance by any act of his or

8

BENEFICIARY IN LIFE INSURANCE

hers, by deed or by will, to transfer to any other person the interest of the person named.

In 1888, Chief Justice Fuller, of the United States Supreme Court, in the case of Central Bank of Washington v. Hume,6 defined the interest of the beneficiary in a policy in substantially the same words, referring to Bliss. It was not until 1907 that policy contracts generally gained the appearance of contracts made with the insured. Until that time, policies issued by most of the insurance companies simply provided for payment to the beneficiary and contained no provisions whatever as to the right of the insured, even with the consent of the beneficiary, to make a change of beneficiary. For a few years prior to 1907, some of the larger companies had included in their policies a provision by which the insured could make a change of beneficiary without the consent of the beneficiary if he specifically reserved such right. Under the law as it then existed, this practice gave rise to some discussion as to whether such a provision was valid. Following the Armstrong Committee investigation in New York in 1905 and 1906, states began to adopt standard policy provision statutes. These statutes specified what provisions had to be included in life insurance policies and what provisions could not be included. On January 1, 1907, the standard forms of policy contract became statutory in New York, and until the rigidity of the law was somewhat relaxed several years later, companies doing business in New York had to copy their contracts verbatim from the law where they were written out in full. These standard forms provided for a change of beneficiary provision substantially as it appears in many policies issued today, and any doubts as to the validity of a reserved right to change the beneficiary then disappeared. In the modern life insurance policy, when the insured reserves the right to change the beneficiary, he is regarded as the owner of the policy. For some time after the validity of a reserved right to change the beneficiary had become well recognized, the generally accepted concept of the status of a revocable beneficiary was that he or she had a qualified or vested interest until it was divested by the actual exercise of the insured's right » 128 U.S. 195.

DESIGNATION OF BENEFICIARY

9

to revoke. Under that concept it was thought that the consent of the revocable beneficiary was necessary to the exercise of various policy provisions, for example, policy loans, cash values, and options on lapse. Of course, the insured could first revoke the interest of the beneficiary and then exercise such rights or privileges alone. During the last twenty years or so, however, decisions handed down in state after state have announced another and more rational rule. This modern rule, now prevailing in all except a few states, is that the interest in the policy of a revocable beneficiary is at best but a mere expectancy which is subject to every other interest created, or right or privilege exercised, by the insured alone. Only recently the Supreme Court of New Jersey, next to the court of last resort of that state, decided that the revocably designated beneficiary had no cause for complaint that the insured, in securing a policy loan and in assigning the policy to the insurer as security, had done so without the consent of such beneficiary. This decision by the New Jersey Court, in the case of David v. Metropolitan,9 is significant, because earlier pronouncements by courts of that state had left some doubt whether the insured could deal with the policy as his property without regard to the revocable beneficiary. A policy in which the beneficiary is irrevocably designated, that is where the right to change the beneficiary is not reserved to the insured, creates in such beneficiary a vested interest which the insured cannot defeat except with the consent of the beneficiary. This is unquestionably the general rule supported by the great weight of authority. Quoting with approval from Condon v. New York Life,1 the United States Circuit Court of Appeals, Seventh Circuit, in Morse v. Commissioner,8 declared: It is held by the great weight of authority that the interest of a designated beneficiary in an ordinary life policy vests upon the execution and delivery thereof, and, unless the same contains a provision authorizing a change of beneficiary without the consent thereof, the insured cannot make such change. And this applies to a policy to which there are attached the incidents of a loan value, cash surrender value, and automatic extensions by premiums paid. β 12 Life Cases 244. τ 183 Iowa 658; 166 N.W. 452. 8 100 F. (2) 593.

10

BENEFICIARY I N LIFE INSURANCE

Consequently, where the insured has designated the beneficiary without reserving the right to revoke, unless there is some provision in the policy specifically authorizing him to make policy loans, surrender the policy, or exercise other specific rights or privileges, he may do nothing with the contract, without the beneficiary's consent, which will in any way diminish or affect the irrevocable right of the beneficiary to receive, at the death of the insured, the full amount of insurance provided by the policy. T h a t an insured may contract for a policy in which he has not the right to change the beneficiary, but in which he specifically shall have certain rights, such as policy loans or the right to receive the cash value, has been upheld in Nielsen v. General American Life Co.9 In such a policy, even though the insured may be able to diminish the beneficiary's interest by policy loans or destroy it absolutely by surrender, nevertheless he cannot revoke that beneficiary's interest, such as it may be, and give it to another without the beneficiary's consent. As courts have observed, the terms and conditions of the policy are what control the rights of the insured and determine the interest of the beneficiary. However, in the majority of policies issued in the United States today, there are no specific conditions that would permit the insured to impair or destroy the interest of an irrevocably designated beneficiary. Once a beneficiary has been named in the policy, whether or not the right of revocation is reserved, the general rule is that nothing will terminate the interest of such beneficiary except a revocation by the insured if he has such right, the release or consent of the beneficiary if the insured does not have the right to change, or the death of the beneficiary before the insured. T h e interest of a named beneficiary is a personal one, not dependent on what relationship to the insured might have been described in the designation. For example, where a husband has designated his wife as beneficiary under a life insurance policy, designating her by name, the general rule is that divorce in itself and without special order of the court, where it has the power or authority to make such an order, does not terminate the interest of the beneficiary. This general rule prevails in cases where the insured has reserved the right to change the beneficiary but has β 89 F. (2) 90.

DESIGNATION OF BENEFICIARY

11

not exercised that right, as well as in cases where the right to revoke the wife's interest has not been reserved. There are a few exceptions to this rule in some states, although not many. In Texas and Kentucky the interest of a wife is automatically terminated by divorce whether she was revocably or irrevocably designated. In Michigan the wife's interest is automatically terminated by the divorce, whether she was revocably or irrevocably designated, unless the court decree specifies otherwise. In Missouri and Minnesota the insured husband may change the beneficiary, if he wishes to do so after divorce, even though his wife was named irrevocably. In New York, the injured party in a divorce action may apply to the court granting the final decree, or may bring an action in supplementary proceedings, for an order directing the insurance company to change the beneficiary, even one irrevocably designated. T h e virtual ownership of the policy by the beneficiary, as understood by the authorities and the courts in the early days, extended even to the beneficiary's estate in the event the beneficiary died before the insured. Along about the turn of the century it became general practice to include in policies procured by the insured a provision that the beneficiary's interest, whether revocable or irrevocable, shall revert to the insured if the beneficiary dies before the insured. This is the general practice today. In the absence of a new designation of beneficiary by the insured, the proceeds of the policy upon the death of the insured would be payable to the insured's estate. Of course, the insured may provide otherwise. In the original designation, for example, he may designate a contingent beneficiary to take the interest of the beneficiary in the event that the beneficiary should predecease him. However, if the insured dies before the beneficiary, the beneficiary's right to receive the proceeds becomes fixed, and, if the beneficiary dies before the proceeds are paid, unless some special provision has been included in the policy to cover such a contingency, the death benefit will not revert to the estate of the insured or pass to a contingent beneficiary, but will be payable to the estate of the beneficiary. But what happens if the insured and beneficiary die at about the same time, for example, in a common accident, and it is impossible to determine who died first?

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BENEFICIARY I N LIFE I N S U R A N C E UNIFORM SIMULTANEOUS DEATH A C T AND ITS E F F E C T

Prior to the enactment of the Uniform Simultaneous Death Act, adopted in many states within the past six or seven years, the general rule in this country was that where several persons perished in a common disaster, there was no presumption at all as to survivorship, notwithstanding differences in their age, sex, or physical strength. Under this general rule (the common law rule), where the insured and the beneficiary died and there was no evidence as to who died first, there were different results in the several states, depending, it appears, on whether the state viewed the interest of the beneficiary only as an expectancy, or as a vested interest subject to being divested. In the State of Maryland, for example, the Supreme Court held that, "Until it is shown that she died before her husband, the f u n d is payable to no one else, other than her representative, because it is only in the event of the death of the nominated beneficiary in the lifetime of the insured that others can possibly take." 10 T h e Supreme Court of Illinois, however, dissented from that view, saying that, "Such is not the commonly accepted view and is not the law of this State." 11 T h e Illinois court's reasoning was that the beneficiary's interest, during the lifetime of the insured, was an expectancy only; that the policy was under the control of the insured to such an extent that he could defeat the expectancy of the beneficiary; that the object of the insurance was to provide for the support of those dependent on him and that the burden of proof rested on the beneficiary's relations to show that the beneficiary actually became entitled to the proceeds by surviving the insured; and as they could not do that, the proceeds accrued to the estate of the insured. Twenty-seven states and Hawaii have now adopted the socalled Uniform Simultaneous Death Act. Concerning the objectives of the Act, one of its provisions reads that the Act "shall be so construed and interpreted as to effectuate its general purpose to make uniform the law in those states which enact it." T h e theory of the Act is that, in the absence of evidence to the 10 Comin v. Rogers, 73 Md. 406. H Middeke v. Bolder, 198 IU. 590.

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contrary, each person is presumed to be the survivor as to his own property. In respect to a policy of life insurance, the Act provides that where the insured and beneficiary have died, and there is no sufficient evidence that they died otherwise than simultaneously, the proceeds shall be distributed as if the insured had survived the beneficiary. There can be no questioning the wisdom of the Uniform Simultaneous Death Act. Considering the insured as the purchaser and owner of a policy on his life, it is only proper that the proceeds should be paid to the estate of the insured or to any designated contingent beneficiary, where there is insufficient evidence that the insured and beneficiary died otherwise than simultaneously. It is interesting to note that a few states in the West, influenced by the Roman or Civil law, do not follow the common law rule of no presumption of survivorship, nor have they as yet enacted the Uniform Simultaneous Death Act. Those states require by statute that in the absence of proof as to who survived, determination must be guided by the probabilities resulting from the strength, age, and difference of sex of the parties involved, according to certain fixed rules. Those rules are generally that: a male will have been supposed to have survived a female if both are between the ages of fifteen and sixty; if both persons were under fifteen, the older is presumed to have survived regardless of sex; if both were over sixty, the younger is presumed to have survived, regardless of sex; if one is under fifteen and the other over sixty, the younger is presumed to have survived, regardless of sex; if one is under fifteen or over sixty and the other is between those ages, the latter is presumed to have survived, regardless of sex. While the purpose of the Uniform Simultaneous Death Act, so far as life insurance is concerned, is only to clarify the situation where there is no proof of whether the insured or the beneficiary died first, it must be borne in mind that the Act has no application whatsoever where the beneficiary survives the insured and dies shortly thereafter. As already stated, in that situation the estate of the beneficiary is entitled to the proceeds of the policy unless some special provision has been included in the policy to cover that contingency. A number of such special provisions have been used in recent years. One such provision is a direction

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that the proceeds be payable to the beneficiary only if she is alive at the time of payment. Another such provision is that the beneficiary shall not be paid the death benefit unless she survives the insured by a specified time, generally a fixed number of days. These special provisions, in some instances, may accomplish a more desirable result than would be accomplished by mere reliance upon the Uniform Simultaneous Death Act, because cases of actual simultaneous death are very rare, whereas cases of a beneficiary surviving the insured and dying shortly thereafter are comparatively more numerous. When a policyholder asks for a so-called common disaster provision in a policy, it would seem obvious that he intends to cover not only the rare circumstances of simultaneous death, but also the possibility of death as a result of a common accident in which the beneficiary may survive the insured and die a short time later. PARTNERSHIPS, ASSOCIATIONS, CORPORATIONS, AND TRUSTEES AS BENEFICIARY It has been pointed out that a person who takes out a policy of insurance upon his own life may make it payable to any beneficiary, regardless of whether such beneficiary has an insurable interest in the life of the insured. Such beneficiary named by the insured may be a partnership, association, corporation, or trustee, as well as an individual. While life insurance policies for the benefit of business firms or corporations are more often procured by such firms or corporations and owned by them, or are assigned outright to them by the insured, there are cases in which the insured merely designates a partnership, association, or corporation as beneficiary. In those cases, the interest of such beneficiary is essentially no different from that of an individual beneficiary, the rights of the insured and beneficiary being dependent on whether the designation is made revocably or irrevocably. There might be some question as to what becomes of the interest of the partnership, association, or corporation that goes out of business, merges with another organization, or otherwise terminates its existence. If the interest of the beneficiary is revocable there is no problem if the insured designates a new beneficiary. If he does not do so, or if the beneficiary's interest is irrevocable, the problem arises as to who succeeds to

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the interest of the beneficiary, which is primarily a legal question. The provision in the policy that the interest of the beneficiary reverts to the insured if the beneficiary dies before the insured may cause complication, and generally to avoid this complication the designation of such a beneficiary is so framed that the interest of the beneficiary passes to its successors or assigns. Where a partnership is designated as beneficiary, it is very important that the designation clearly indicate that the partnership, as such, and not the individual partners, is the beneficiary; otherwise, in case of a change in the organization of the partnership, the insurance proceeds may not become payable to the intended beneficiary. The same general principles as to the nature and extent of the interest of the beneficiary apply where the beneficiary is a trustee. T h e designation of the trustee may be revocable or irrevocable, whichever is consistent with the terms of the trust. A "trustee" beneficiary designation generally is made when there is a separate written trust agreement giving authority to the trustee to hold and manage the proceeds of the policy when such trustee receives them from the insurance company at the death of the insured. T h e naming of a trustee beneficiary without any written trust agreement might be futile and might not accomplish the purpose the insured may have in mind. At the death of the insured, should the beneficiary receive the proceeds of the policy as trustee for another, without any written agreement prescribing the method of distribution of the funds so received, there would be nothing more than a bare trust in existence. In such cases, courts have held that there being nothing whatever to guide the trustee or the court as to the purpose or the manner of distribution of the trust estate, the only disposition the court can make is to order the payment of the trust funds to the presumed beneficiary or beneficiaries of the trust. For example, if an insured should designate as beneficiary of his policy "John Jones, as trustee for my son, William Smith" without any separate instrument of trust authorizing the trustee to hold the funds and directing him what to do with them, the trustee would have nothing to do but turn such funds over to the son after the death of the insured. If the son were a minor, or otherwise incompetent, payment made to the trustee beneficiary might be

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BENEFICIARY IN LIFE INSURANCE

upheld, but if someone else were appointed guardian for the minor or incompetent, considerable question might ensue as to who would be entitled to the funds. For these reasons many insurance companies will accept the designation of a trustee as beneficiary only if some written trust agreement is in existence. T H E MINOR AS BENEFICIARY The designation of a minor as beneficiary presents problems that ordinarily do not arise when an adult is designated. Suppose in the policy naming a minor as beneficiary the insured does not reserve the right of revocation. If the insured should thereafter wish to change the beneficiary, to assign the policy as collateral security for a loan, to make a policy loan, or surrender the policy for its cash value, he would be unable to do so, unless the policy specifically so provided, which, as has been previously pointed out, is not generally the case. Having given the minor a vested interest, there could be no divesting of that interest, or no impairment of it, without the minor's consent, which he lacks capacity to give. T h e intervention of the court might be necessary in having a guardian appointed who could duly act for the minor, and even then the court might be obliged, in its protection of the minor's property rights, to curtail the action the insured desired to take. Where a minor is named as beneficiary, there may also arise the question of how payment is to be accomplished in the event the policy becomes due and payable to such beneficiary before he has reached his majority. Insurers generally will not make payment of any substantial amount directly to minor beneficiaries, but will insist upon the appointment of a general guardian. The reason for this is self-evident, since a minor is not legally competent to receive payment, cannot give a binding receipt for it, and the insurer might possibly be required to pay a second time if there should be repudiation. Unfortunately, the appointment of a guardian involves expense to the minor beneficiary's estate. In a number of states there have been statutes passed authorizing waiver of guardianship and permitting payments due a minor to be made to another for the benefit of the minor, usually a parent or person standing in place of a parent; however, the amounts authorized are nominal, being

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less than five hundred dollars as a rule. In New York State it is provided by statute that any minor domiciled in New York who has attained the age of eighteen years shall be competent to receive and give full quittance for an amount, not exceeding two thousand dollars in any one year, paid by a life insurance company as benefits payable upon the death of the insured; not only does this statute permit payment where the total death benefit does not exceed two thousand dollars, but also where the proceeds are payable in instalments, either by the policy provisions or by a settlement agreement, not in excess of two thousand dollars per year. Pennsylvania has a singular statute providing that an insured, in designating a beneficiary in a life insurance policy, may appoint a guardian of the estate or interest of any beneficiary named in the policy who shall be a minor or otherwise incompetent, and further providing that payment by the insurance company to such guardian shall discharge the insurance company for such payment to the same effect as payment to an otherwise duly appointed and qualified guardian. FORM AND PROBLEMS OF "CLASS" DESIGNATIONS By a "class" is meant a group or collection of persons who possess somewhat the same or common characteristics; for example, children, grandchildren, heirs, brothers, sisters, or nephews. T h e designation of a class as the beneficiary of a policy is the naming of some such group as "children of the insured" without any identification of them by name. There is no legal question presented in the mere designation of a class as beneficiary. It is entirely proper, as a matter of law, to provide in a policy that the benefits shall be paid to any such cognizable class or group. Courts have repeatedly sustained the validity of class designations of beneficiaries. However, frequently courts have been called upon to determine the identity of the persons comprising the class. T h e term "heirs" has been held to include the children of the insured, illegitimate as well as legitimate, parents of the insured, and brothers and sisters of the insured. No class designation is entirely free of possible difficulties. Where the class is not clearly circumscribed, there may be a

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BENEFICIARY IN LIFE INSURANCE

great deal of difficulty in determining just what persons are properly entitled to receive the proceeds of the policy as members of that class. Even where the class is clearly circumscribed there may, after the insured's death, be difficulties encountered in the location and determination of the persons who comprise the class. Companies today are very careful in the filing of class designations and see to it that the class is described as precisely as possible. Generally, companies will not accept designations of a class, the relationship of which is too remote from the insured, or too vague of determination. It is preferable that the beneficiaries intended to receive the proceeds of a policy be designated by name. There is then no doubt as to the intention of the insured. After the death of the insured, when the insurance company pays to those beneficiaries, the company has no doubt that it has paid to all those entitled to receive. Even such a simple designation by the insured as "children born of the marriage of Mary Jones, my wife, with me" can present difficulty in the settlement of a claim. Certainly such a designation will delay prompt settlement as the company cannot pay the share of any one beneficiary until it has determined how many beneficiaries there are and consequently how much each is to receive. E F F E C T I N G C H A N G E OF BENEFICIARY Where the insured himself procures a policy on his life, the question is asked in that portion of the application in which he designates the beneficiary whether he wants to reserve the right to change the beneficiary, and the policy is written accordingly. Only where such right has been reserved can the insured, after the policy has become effective, substitute some other person as beneficiary for the one previously designated by him, and he may successively change the beneficiary as long as he continues to reserve the right to do so. T h e right to change the beneficiary, if reserved, is a matter of contract and cannot be denied the insured. Insurance companies, although prompt to act upon a change of beneficiary, must be concerned about the manner in which a change of beneficiary is made and must, therefore, provide in the policy the method by which such change may be accomplished. T h u s the procedure for changing the

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beneficiary is also a condition of the contract of insurance. Conformance with the requirements for changing the beneficiary is usually insisted upon and in the great majority of cases no difficulty is experienced either by the insured or by the company. Ordinarily the requirements for changing the beneficiary are simple. Notice of the change to the company is, of course, necessary. T h e reasons therefor are so obvious that they need not be mentioned and courts everywhere recognize the absolute need of notice of a change of beneficiary being brought home to the insurance company. Policy provisions of the various companies differ as to the manner in which the change shall be effected. Some provide merely for written notice to the company. Others require written notice to the company, accompanied by the policy for endorsement. The majority of insurance companies follow the endorsement procedure. There may be times when the insured desires to change the beneficiary but for one reason or another is unable to present the policy for endorsement. For example, the insured may be unable to produce the policy because it has been lost or because it is being withheld from him by someone not having any right to so withhold it. Courts have universally held that the requirements for changing the beneficiary are for the protection of the insurance company and that the company may waive them in a proper case. Time and space do not permit discussion of the refinements with respect to effecting in policies a change of beneficiary arising out of decisions of the courts, though it may be observed that, in general, where the insured has complied substantially with the requirements for changing the beneficiary, where the insured has done all that he could but for reasons beyond his control is unable, for example, to produce the policy, a change of beneficiary will nevertheless be deemed to have been accomplished as a matter of law. OWNERSHIP RIGHTS We have seen that where the insured designates a beneficiary revocably, the insured is the owner of the policy. Where the insured designates the beneficiary irrevocably, to all intents and purposes the insured and the beneficiary are joint owners

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BENEFICIARY IN LIFE INSURANCE

of the policy. In recent years there has been a vast increase in the procuring of life insurance by the beneficiary (the word "beneficiary" is here used in its broadest sense), caused by the expanded use of life insurance for business purposes and by changes in tax laws. Partners insure the lives of fellow partners, employers insure key men in their business, creditors sometimes insure debtors, wives insure husbands. In all these instances it is generally desired that the "beneficiary" own absolutely the policy procured on the life of the insured. T h e "beneficiary", generally described as the owner in such contracts, makes application for the policy and the insured, even though the latter joins in the application, acquires no right in the policy. Some companies have special forms of owner policies; others issue their regular forms of policies with endorsements attached thereto declaring that the beneficiary is the owner, anything in the policy to the contrary notwithstanding, and that the beneficiary shall have the right to exercise all rights which the insured would have. Even where a policy has been issued with the insured as owner, he may make the beneficiary the owner by transferring his rights to the beneficiary. T h e simplest form of such transfer is by an absolute assignment, but in recent years another procedure has been developed for transferring ownership which produces the same result. T h a t procedure consists of a written direction by the insured that all his rights, privileges, and options be vested in the beneficiary, and the policy generally is endorsed accordingly. These ownership policies, whether originally procured by the owner or later transferred to the owner by the insured, present one serious question which has not as yet been definitely determined. Of course, the owner may secure policy loans or surrender the policy for its cash value, and it seems to be generally agreed that such an owner may designate a beneficiary other than himself to receive the death benefit in the event of the death of the insured and can reserve the right to revoke that designation. Furthermore, there is no question that the owner may transfer his ownership by assignment or otherwise to another person, provided such transfer takes effect at the time it is made. Where ownership is established by a transfer from the insured, it also

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seems generally agreed that the insured when giving such ownership may nominate a successor to take ownership if the original owner should die before the insured. But there seems to be considerable disagreement as to whether an owner (once his ownership is acquired), either as the procurer of the original policy or by transfer from the insured, may himself designate any person to succeed to his ownership in case of his death before the insured, other than by proper disposition in his will. The cause of such disagreement is basically whether such a disposition, to take effect only at the death of the owner, would be in conflict with the statutes of wills as they exist in the various states. As a consequence, some companies will not recognize any disposition by an owner for the passing of his ownership of the policy to anyone other than the owner's estate, should the owner die before the insured. What disposition of the policy may then be made by the legal representatives of the owner depends entirely on the provisions of the deceased owner's will or of the laws of intestacy. Any attempt to discuss further this unsettled question is beyond the intended scope of this paper. That question in itself has been the sole subject of various papers and probably will be the subject of others before the question of law which it raises is definitely resolved.

ASSIGNMENTS OF LIFE INSURANCE POLICIES By Robert Dechert, LL.B.*

IN E A R L Y practices in America, before the right to change the beneficiary had been invented, there was little legal lore dealing with the subject of how a policy of insurance on the life of the insured was to be made payable to the proper person to receive the proceeds in case the policy matured. Life insurance policies in those days contained no cash surrender or cash loan provisions. T h e naming of the payee was a matter of the original contract, akin to the "third-party-beneficiary" under other forms of contract, and no special body of law had grown up around the subject.

CONCEPT OF A LIFE INSURANCE POLICY However, the use of the level premium plan of life insurance, causing the building up of large reserves for the purpose of keeping premiums from growing to ruinous size in later years when the risk of death was relatively greater, brought with it a corresponding emphasis upon the lifetime features of an unmatured life insurance policy. As these lifetime rights with respect to unmatured policies continued to be enlarged, the twofold nature of a modern life insurance policy began to emerge. T h e term policy of fire, burglary, or other property or casualty insurance stresses almost wholly the indemnity side of the contract. Who is the "assured" in whose favor such a contract runs? He is the person needing the indemnity protection, and as such the payee of the contract. There is customarily no process • Counsel of T h e Penn Mutual Life Insurance Company and member of the firm of Barnes, Dechert, Price, Smith Sc Clark, Philadelphia. 22

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provided to "change" such assured-payee of the property or casualty policy during the period for which premium has been paid. Assignment of such an insurance policy (as far as the right to indemnity is concerned) can validly be made only to one with an insurable interest based on a loss to be suffered if the event indemnified against should occur, and usually no such assignment can be made without the company's consent. If the need for the contract of indemnification ceases during the period for which premium has been paid, some part of the unearned premium will be repaid under most forms of property or casualty insurance; but the "assured" who is entitled to the indemnity payment is likewise the "owner" of such premium refund, except in those rare cases where he has executed a special document assigning the right to such cancellation refund, as in the cases where premiums on such a policy have been financed by a bank. Even then, the assignment of that right to the cancellation refund does not make the assignee of such right the "owner" of the policy as a whole, but merely of that particular right. Some early policies of life insurance on the lives of people now elderly are still in force; under them the concepts of the rights of the parties are still much like those under property or casualty policies. A man insured his life in the nineteenth century and named his wife as the "assured" to receive the specified indemnity in case he died. No provision for "change of beneficiary" by the insured was included, for indeed such a provision had not yet been invented. Now, in 1947, it is discovered that the wife died in 1897, leaving three children who are likewise now dead, with surviving issue of their own, of whom some are minors. T h e insured cannot bear to contemplate the estates to be opened and the guardianships to be established for the purpose of settling this single policy on which he has paid premiums all his life. He knows of the present practices as to "changing the beneficiary"; somehow this policy of which he believes himself the owner through long premium payments must be made to fit his present circumstances. This hypothetical case is cited to emphasize the fact that the dual nature of the modern life insurance policy is indeed a recent development. No true understanding of the problems of "Assign-

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ments of Life Insurance Policies" can b e gained unless t h e history of this progressive development is remembered. I m p o r t a n t as are t h e rights possessed today by the " o w n e r " of an u n m a t u r e d policy, they are nevertheless not the p r i m a r y purpose of the policy, which is providing a fund at maturity. T h e level p r e m i u m system, w i t h its necessity of b u i l d i n g u p ever-increasing reserves against older years, created the situation where it was essential, in the spirit of fairness and justice, to provide pre m a t u r i t y rights over the values resulting f r o m those reserves. T h e so-called "saving" element in a life insurance policy u n d e r the level p r e m i u m system is not in the first instance "saving" like t h a t in a savings bank, b u t is r a t h e r a "saving" of loss of protection t h r o u g h impossibly high p r e m i u m s in later years of life. However, the values in the reserves have in fact been "saved" by the policyholder as he goes along. T h o s e values lend great emphasis to the "life ownership" side of the d u a l n a t u r e of the m o d e r n life insurance policy. Before I proceed to the meat of this subject, I must pay t r i b u t e to the genius of the Anglo-Saxon law in a d a p t i n g its principles to the developing need of this new—and now gigantic—business of p r o v i d i n g a wholly private social security system. T h e law f o u n d a life insurance policy little different at first f r o m the policy of any other sort of insurance, except that a special f o r m of "third-party-beneficiary" doctrine was obviously a p p r o p r i a t e f o r it. T h e unilateral option in the policyholder (even when ailing in health) to continue the policy in force year after year u n t i l h e died and the growing values resulting f r o m the level p r e m i u m system soon forced recognition of need of developm e n t s in the law as to these special forms of contracts. As Lord Mansfield in the eighteenth century b r o u g h t into the English law the "law m e r c h a n t " to meet the commercial needs of the E n g l a n d of his day, so our American judges in particular have —largely by judicial process—moulded the law as to life insurance policies into a special series of rules, which in general fit the needs of the day. Sometimes by failing to realize the duality of the policy, a court will seem to fall by the wayside in the development of a fair a n d workable system of case law, b u t these occasions a p p e a r

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to be rare. T h e term "assured" from the early days seems to have dropped out of use. T h e person whose life measures the maturity of the policy is now known generally as the "insured". Theoretically, he himself cannot be the "assured" of the death proceeds, although he might be so considered if they are payable to his own estate. Of course it is possible that he may have no connection at all with the contract except that of furnishing its measuring rod, as in the case when a policy is taken out by his partner or wife or creditor. However, between those two extremes of the policy taken out by the insured and payable to his estate, and of the policy taken out and carried entirely by his partner or creditor, may exist a wide variety of possible sets of circumstances. Most of them furnish examples of the need for understanding fully the history and law relating to assignments of life insurance policies. ASSIGNMENT A N D C H A N G E OF BENEFICIARY C O M P A R E D Altogether too much emphasis seems to be laid in the discussion of this subject u p o n the name by which a document is called. As has been pointed out, the dual nature of the modern life insurance policy involves increasingly valuable life-time (prematurity) rights, and also the specified maturity values. T h e first question to consider under any life insurance policy is the location of both sets of rights at the inception of the policy. If the policy names the insured's son as the beneficiary of the death benefit, subject to the insured's expressed right to change the beneficiary by his own act alone, the right of the son to such death benefit is clearly subject to serious risk of destruction as long as the insured lives. But suppose in this situation the father (the insured) wishes to pass over to the son all rights under the policy. How does he do so? Obviously, an "absolute assignment" will accomplish this purpose, but there seems to be no necessity that any mystic set of words be used. Before the modern "absolute owner" form of life policies came into general use, some companies used an irrevocable designation of beneficiary as the means of creating a sole and complete ownership of a policy in someone other

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BENEFICIARY IN U F E INSURANCE

than the insured. Under the old practice of other companies, such a designation created a vested, single ownership of the proceeds (when due at maturity) in the beneficiary, but as to the life values and rights prior to maturity it created only a joint ownership in both the insured and the irrevocable beneficiary. It has been suggested that the magic term "change of beneficiary" and the word "assignment" (borrowed from other fields of law where the rights are less complex, or at least different) might be abandoned. Each policy issued today states clearly: a. Who is entitled to proceeds at maturity. b. Whether the right to proceeds is irrevocable or is subject to be changed. c. Who owns the various rights exercisable prior to maturity (including the right to change the beneficiary if the initial designation is not irrevocable). I

Under older policies one often must go through an interpretive process to determine the above facts, but most modern policies state the situation clearly. Having thus at the start a clear statement of the persons related to both sets of rights under life policies, why do not all companies insist that in every subsequent document affecting a change in any one of those rights, a new, clear statement be made as to the location of those rights thereafter? All too often the person who signs a document fails to realize its effect (or its lack of effect) upon rights other than the one specifically mentioned. For this reason there has grown up the somewhat confused situation as to the effect of an assignment upon a previous designation of beneficiary, when there has been no express change of beneficiary back to the insured's estate prior to the assignment, and no joinder in the assignment by the revocably-named beneficiary. T h e situation would be clear if every document affecting the title to any rights under a life policy was labeled "Change of Title" and stated clearly the intention to vest the various rights thereafter in the person or persons named, subject to any stated right to make further changes. T h e practice of many companies comes close to this, even though the documents have a way of carrying the mystic titles "Change of Beneficiary," "Assignment," and "Absolute Assignment."

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"ABSOLUTE" AND "COLLATERAL" ASSIGNMENTS An assignment of a life insurance policy may be of two sorts: a. "Absolute"—intended to make the assignee thereafter the owner of every right under the policy (both the right to proceeds at maturity and the bundle of pre-maturity rights). b. "Collateral"—intended merely as a security arrangement.

A constant source of trouble in life insurance practice has been the desire of lenders to receive a form of assignment called "Absolute" when in fact the arrangement is merely one of security calling for a "Collateral Assignment." This habit probably arose from the practice of lenders in calling for the signing of an unqualified stock power in blank when taking shares of stock as collateral, although such lenders rarely then went immediately to the step of causing such shares to be transferred to the lender's name at the inception of the loan, which is the general equivalent of the act of lodging with the life insurance company an apparently "absolute" and unqualified assignment of a life policy. Another serious source of trouble in the case of assignments which are intended to be collateral in substance (regardless of whether they are "Absolute" or "Collateral" in form) is the failure to state what, if any, pre-maturity rights such a collateral assignee is intended to have. T h e primary problem is to learn the intention of the parties, but all too often the parties fail to make their intentions plain. In order to obviate some of the confusion, and in recognition of the difficulty of overcoming the effect of the so-called "Absolute" stock power which is required in loans on stock collateral, we at the Company with which I am associated invented some years ago the title "Absolute Assignment as Collateral" for a form to be used instead of the true "Absolute Assignment" (which was designed for a permanent, nonsecurity transfer of title to a policy). T h e initial word "Absolute," coupled with the statement of rights in the assignee contained in the form, satisfied lenders who had been frightened away from use of the "Collateral Assignment" form by finding that under it some companies declined to deal with the assignee alone, but insisted in

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all instances on securing the joint signatures of assignor and assignee. The more recent "Bank Management Commission" form of assignment of the American Bankers Association (worked out jointly with a Committee of the Association of Life Insurance Counsel) is entitled "Assignment of Life Insurance Policy as Collateral." It is absolute in the sense that it gives to the assignee the right to exercise alone certain privileges which are essential to the protection of the lender, but the form is satisfactory in that it states clearly certain things necessary for the protection of the assignor-borrower. This form will be discussed later at greater length. NEED FOR CHANGE OF BENEFICIARY BEFORE AN ASSIGNMENT If all changes in title to any of the rights under a life insurance policy were made on a document like the proposed "Change of Title" referred to above, the problem suggested in the above heading would not exist, for then the document would state clearly the intention of the parties. Furthermore, the problem does not exist under those modern policies which spell out the situation by stating in effect: Whenever an assignment is executed by an owner of a policy who has the reserved right to change the beneficiary, the effect of such assignment shall be to destroy the rights of any named beneficiary in favor of the assignee.

However, even such policies leave certain problems when the assignment is in truth a collateral one, especially after the assignee has formally "released" his rights under the assignment. Vast numbers of policies now outstanding contain no such provision as that paraphrased in the preceding paragraph. One such policy may be payable to the insured's wife, subject to his reserved right to change the beneficiary. Let us consider two motives which may lead him to deal with the title to this policy: a. Suppose he deserts his wife and six small children, goes to live with another woman, assigns the policy to her without prior change of beneficiary, and dies. b. Suppose on the other hand the wife-beneficiary deserts the insured

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and their six small children and goes off with another man, whereupon the insured assigns the policy to a trustee for the children, and dies.

In both cases we have an assignment without prior change of beneficiary by an insured who has the right to change, b u t neglects to do so. It is obvious that in the first case the sympathy of the court might lead it to seize on the technicality of the failure to change the beneficiary as a reason for declaring the death proceeds payable to the deserted wife-beneficiary, whereas if the second case were the first to arise in the particular jurisdiction, the sympathy would of course swing in the opposite direction. Legal principles cannot safely be made to depend upon morals of parties in particular cases, although sometimes that is the result of o u r case system of legal developmént. However, the true criterion u n d e r the above set of facts is the intention of the assignor. T h e view in a substantial majority of states is that a person who executes an absolute assignment intends to give the assignee all rights, and thus the interest of the prior beneficiary is destroyed, even without a document bearing the formula " I change . . ," 1 It is of course true that any interest of the previous beneficiary may be destroyed by having her join in the assignment, just as effectively as by the insured's signing a "Change of Beneficiary," but I am assuming here that neither of such steps has been taken. I should perhaps also note the possibility in the minority states that such a joinder by a wife-beneficiary may be held to be an invalid act by her if the purpose is to give collateral for her husband's debts and if a married woman in such a jurisdiction cannot validly take such a step. 2 Bearing in mind the above difficulty, we at the Company with which I am associated initiated a number of years ago a procedure of which I have always been proud but which so far, I think, no other company has yet followed. T h e standard practice of life insurance companies where there is an outstanding designation of beneficiary subject to change 1 The attitudes of the several states are summarized in Appendix A, beginning on page 233. 2 Douglass v. Equitable Life Assurance Society, 150 La. 405, 90 So. 834 (1922).

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and a request for an assignment form is to prepare "A" and "B" papers. T h e "A" paper changes the beneficiary back to the insured's estate. (It is never held that the executors of the insured's own estate might be a designated beneficiary not superseded by a later assignment). T h e n comes the assignment in the "B" paper. If the assignment is on a collateral basis, there may also be a "C" paper, restoring the beneficiary arrangement which existed before the "A" paper was signed. T h e insured is apt to be confused by the storm of papers, wood pulp is used up, and there is always a risk that the wrong dates may be inserted or the documents put on the Home Office records of the Insurance Company in the wrong order. Our remedy was to simplify procedure and understanding, save paper, and insure all being in proper chronological order by commencing the document with this indented paragraph: If this instrument is executed by the insured alone or by the insured and not all the beneficiaries of record, and the right to do so is reserved to the insured alone, then I, the insured, hereby change the beneficiary under this policy and designate as beneficiary my executors or administrators.

T h e assignment follows, and then the signature. There would seem to be no risk that this will not be effective as both change of beneficiary (if the insured has the reserved right to make such a change) and assignment. In our form of "Absolute Assignment as Collateral" we followed this course one step further, and saved the "C" paper mentioned above as well as the "A" paper. T h a t form contained the following provision: 3. If this assignment is executed by the Insured alone or by the Insured and not all the beneficiaries of record, and if the right to change the beneficiary is reserved to the Insured, then I, the Insured, for the purpose of subjecting to this assignment the designation of beneficiary in force immediately preceding this assignment, (a) hereby change the beneficiary and designate as beneficiary of the policy at the time of this assignment my executors or administrators; and (b) reinstate, effective immediately after this assignment, the designation of beneficiary in force immediately preceding the change of beneficiary made by Paragraph (3a) above.

In this last mentioned provision we faced in the final step a difficult question arising at the time assignments are made. Let

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us suppose an insured has one hundred thousand dollars maturity value of life insurance which is payable to his wife and children under a program combining interest and instalment options, as described in a "Designation of Beneficiary" on file with the insurance company. If the insured assigns the insurance as collateral for an eighty-thousand dollar loan, the twenty thousand dollars remaining proceeds probably should not be made payable under the same settlement plan which was appropriate for the whole hundred thousand dollars. In such a case a subsequent "Designation of Beneficiary" would have to be filed after our "Absolute Assignment as Collateral" form, changing the beneficiary arrangement so as to make it appropriate for the reduced amount. However, we decided that this was the exceptional case rather than the rule. Most bank assignments are based on loans on the surrender value. If that is so, the spread between that value and the maturity value is usually large enough to make the original plan still desirable in spite of the assignment. Of course this question does not arise if the insured's desire, both before and after the assignment, is for the beneficiary to receive a lump sum settlement, for then the form covers the situation exactly. T h e important thing is to see that the attention of the insured is brought to the need of considering the possible effect of the collateral assignment on his previous beneficiary plan. INSURABLE I N T E R E S T REQUIRED OF ASSIGNEES OF LIFE INSURANCE POLICIES T h e subject of the requirement of insurable interest in assignees of life insurance policies has been involved in some unfortunate misunderstandings of basic principles. However, it should be noted in the first place that no one except the insurance company can raise the question of lack of insurable interest. An assignee who is not part of a scheme to defraud is not likely to find such a defense raised by a reputable life insurance company. Nevertheless it can be understood that a nondefrauding assignee without insurable interest will not rest in entire comfort merely on a belief in the unlikelihood of the question being raised by the insurance company. A third person may at some time attempt to present such a defense,

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and the insurance company, playing safe, may pay the proceeds into court, subjecting the assignee to the risk that a court may say that such action amounts to a raising of the question by the company itself. It must also be remembered that the doctrine of insurable interest arose first (in property insurance) to prevent the use of insurance as a cloak for mere gambling. When the doctrine of insurable interest was applied to life insurance, its purpose became the protection of society—and incidentally, or perhaps primarily, the insured himself—against the crime of murder. If I have an insurable interest in the life of another, it means that I stand to lose financially by his death and therefore need a contract of indemnification against such loss. In this one form of insurance, contrary to the situation in almost every form of insurance, the risk insured against is one which is certain at some time to become a fact. T h e certainty of happening has been referred to previously as being the cause of the increasing reserve to enable the premium to be held level in spite of the approach of the time of happening. Because of this increasing reserve factor, carrying with it various valuable pre maturity rights which are in addition to the fundamental indemnity-at-death feature, the law of insurable interest as to life insurance is different from that in other forms of insurance. Once I validly take out a policy of life insurance on the life of my partner, I may continue to carry it for my benefit even though our partnership ends, and I may collect when he dies although I then have no insurable interest in his life, and in fact gain financially by his death. 3 However, if I sell my house or my automobile, my right to collect insurance ends if later either is destroyed, even though I have kept up premium payments. A vital reason for the difference is the dual nature of the life policy already mentioned. Another is apparently the belief that insurance is less likely to lead a person of cupidity to commit murder than arson. 3 Re Syzmanski's Estate, 109 Pa. Super. 555, 167 Atl. 420 (1933) ; 2 Appleman, Insurance Law and Practice, Sec. 763; 2 Couch, Cyclopedia of Insurance Law, Sec. 415, Text 11 & 12.

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What, then, as to insurable interest required of assignees? The leading case is of course that of the United States Supreme Court—Grigsby v. Russell.* There Justice Holmes said: Life Insurance has become in our days o n e of the best recognized forms of investment and self-compelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property. . . . T o deny the right to sell . . . is to diminish appreciably the value of the contract in the owner's hands. . . .

The life insurance policy, because of ill-health of the insured, may possess an actual intrinsic value far above the cash surrender value based on mortality tables. At that very time, the circle of those possessing the greatest measure of insurable interest in the insured's life is apt to be in financial straits because of the insured's ill-health. The company is prohibited by the antidiscrimination statutes from paying him more than the stated value. How then is such an insured to realize the true value if he feels compelled to dispose of his policy? He can do so only if there is a free market for his policy, with the right to sell to those without insurable interest as well as those with such interest. This is in accord with the majority view in jurisdictions in the United States.5 T h e reasoning behind the view, so far as it belittles the risk of murder 6 resulting from assignments to those lacking insurable interest, resembles that relating to an insured buying insurance on his own life. When he does that, he may name as beneficiary whomever he pleases, regardless of insurable interest. The fact of his making his own selection is •»222 U.S. 149 (1911). Β T h e majority of states which support the rule that a policy valid at its inception may be assigned to one without insurable interest are: Arkansas, California, Connecticut, Georgia, Illinois, Indiana, Iowa, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Montana, Nebraska, New Hampshire, New Jersey, New York, North Carolina, North Dakota, Ohio, Oregon, Rhode Island, South Carolina, Tennessee, Vermont, Virginia, Wisconsin and District of Columbia. A complete list of the decisions in these states can be found in an article by Deane C. Davis in the Insurance Law Journal, No. 276, of January, 1946, pp. 2 ff. See also recent case of Wages v. Wages, 42 S.E. (2d) 481, 12 Life Cases, 463 Supreme Court of Georgia, April 17, 1947; 73 A.L.R. 1036; 2 Appleman, Insurance Law and Practice, Sec. 854; and 6 Couch, Cyclopedia of Insurance Law, Sec. 1458(e). β As stated in Clark v. Allen, 11 R.I. 439, 23 Am. Rep. 496, " T h e r e is in such a purchase, in our opinion, no immorality and no imminent peril to human life. We should have strong reasons before we hold that a man shall not dispose of his own."

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thought to lessen the risk of murder for profit. T h e same reasoning applies to the insured's own selection of the assignee, although in such a case it is true that the act is often induced by economic pressure in general; not, however, by pressure applied by the assignee. Pennsylvania is unfortunately a minority state on this point, in general requiring insurable interest in an assignee. No quarrel can be found with the application of the doctrine to the case of Werenzinski v. Prudential Insurance Company,1 for in that case the assignment might well be thought to have been so closely connected in time with the application for the policy by the insured as to bring into play the sound doctrine that such an assignee is in the same position as if he had himself applied for the insurance. In the Werenzinski case the insured was a penniless drifter, obviously without means to pay for the policy which he "bought." He transferred it to the benefactor who gave him room in the cellar when the policy was taken out and assigned. T h e suspicious circumstances of the insured being burned to death might well have influenced the court, even though it could not find as a fact that the policy had been bought with the intention at that time of transferring it to the householder. T h e situation in Pennsylvania8 and the other minority states9 is puzzling. Suppose a bank lends money on collateral, including a policy, and the loan goes into default. The bank wishes to foreclose its collateral, and puts the policy up at auction. The field of bidders is limited. T h e borrower is probably without funds. T h e bank almost certainly will have to buy in the policy itself. It can of course obtain the cash surrender value from the insurance company, but let us suppose that the health of the insured (the borrower) is impaired. If there is a deficiency in the loan 7 339 Pa. 83; 14 A. (2) 279 (1942). 8 T h e Pennsylvania rule mentioned above applies only where the assignee pays the premiums. If the insured pays them, the validity of the assignment is upheld. See Steen v. Lowrey, 85 Pa. Super. 365 (1925), and Lawrence v. Travelers, 6 F. Supp. 428 (D.C. E.D. Pa. 1934). See also opinion in Werenzinski Case. 9 T h e other minority states which deny or restrict an assignment to one without insurable interest are as follows: Alabama, Kansas, Kentucky, Missouri and Texas. For decisions in those states see Insurance Law Journal, No. 276, January 1946, pp. 13 ff.; 73 A.L.R. 1036: 2 Appleman, Insurance Law and Practice, Sec. 855; and 6 Couch, Cyclopedia of Insurance Law, Sec. 1458(e).

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after application of the proceeds of the foreclosure sale, the bank holding the purchased policy has insurable interest as a creditor, and can carry the insurance by continuing to pay premiums, if the amount of the insurance is not disproportionate to the balance still due. However, if the proceeds of the foreclosure sale paid the bank in full, the bank has a policy actually worth more than its cash value, but which it cannot carry in force without risk of losing at least part of the proceeds thereafter if the insurable interest doctrine is invoked against it. The result will be to stifle bidding at any foreclosure sale of life insurance policies held as collateral, to the detriment of both insured-borrower and bank-lender (or in some cases, an individual person as lender). Only the life insurance companies stand to profit financially, and they have no desire to profit from such circumstances. T h e ironical part of the situation is that only the insurance company can raise the insurable interest defense, and it has no desire to do so. Nevertheless, the fear that it might do so, under pressure of some adverse claim at maturity, destroys the free market for the insured's policy at the time of the insured's greatest need. In connection with this general subject of sales at foreclosure under assignments of life policies to banks, it should be noted that some banks have discovered that their forms of collateral note (not the form of assignment of the policies as collateral) are defective, in that the bank was not clearly given the right to pay premiums and to add the amounts thus paid to the principal of the loan, in case the borrower failed to pay such premiums. Under such circumstances banks have sometimes been forced to foreclose the policies to acquire title because of the risk that otherwise their act in paying premiums might be treated as outside the protection of the collateral assignment. It might be suggested that the Pennsylvania doctrine of requiring insurable interest in assignees might be limited to those who acquire title by assignment out of ordinary business channels. This would cover the Werenzinski situation, but would leave a free market at foreclosure sales or for the ailing insured who wanted to sell his policy for more than its cash surrender value to obtain money for treatment. However, there is no indication of any such differentiation being made. The remedy for

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the situation in the minority states like Pennsylvania seems to lie in corrective legislation, to bring the state into conformity with the rest of the country. F A I L U R E T O G I V E N O T I C E OF T H E A S S I G N M E N T T O T H E I N S U R A N C E COMPANY A life insurance policy is a nonnegotiable instrument. T o obtain full protection an assignee of a policy must give notice to the company of the fact of the assignment, even though no such requirement is actually stated in the policy. If a company pays to a later assignee or beneficiary of record in the absence of knowledge ór notice of the assignment, the company cannot be made to pay again, as, for example in cases where a fraudulent insured secured the issue of a duplicate policy for one sworn by him to have been "lost," after he had in fact assigned it to an assignee, who carelessly failed to notify the insurance company. 10 P R O G R E S S T H R O U G H USE OF A M E R I C A N B A N K E R S ASSOCIATION F O R M O F A S S I G N M E N T As I have already said, the Bank Management Commission of the American Bankers Association, following widespread investigation and discussion, approved a form of "Assignment of Life Insurance Policy as Collateral." 1 1 In the drafting of this it had the collaboration of representatives of the Association of Life Insurance Counsel. T h e ABA form operates as a satisfactory middle ground between the completely absolute type of form which theretofore was often demanded by bank lenders and the old type of collateral assignment form used by some life insurance companies, under which lenders often found themselves in difficulties because insurance companies would not permit any action to be taken without specific approval by the insured. Section Β of the form states clearly five specific rights which pass to the collateral assignee to be exercised by it alone. These of course include the right to the maturity proceeds, and likewise 10 Immel v. Travelers Ins. Co., 373 111. 256; 26 N.E. (2) 114 (1940); Patten v. Mutual Benefit Life Ins. Co., 192 S. C. 189; 6 S.E. (2) 26; 126 A.L.R. 91 (1939). 11 T h e text of the full form is printed as Appendix B, starting on page 236.

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include certain of the pre-maturity rights. 12 Section C of the ABA form states specifically three rights which are reserved to the assignor, with the express statement that this reservation does not impair the right of the assignee to surrender the policy or to exercise any of the other rights which were specifically given to him in Section B. Section D points out that the assignment is made and the policy is to be held as collateral security for all liabilities of any of those who signed the assignment. 13 Section E contains the promise of the assignee to pay over "to the persons entitled thereto under the terms of the Policy had this assignment not been executed" any sums left after the liabilities to the assignee are satisfied. It also contains a covenant by the assignee not to surrender the policy nor to borrow upon it except for the purpose of premium payment unless there has been a default in the obligations to the assignee or a failure to pay premiums when due, and in any event not until twenty days after the assignee shall have mailed to the assignor notice of his intention to exercise such right. Section F gives the insurance company freedom to recognize the assignee's claims as valid on their face and to accept the signature of the assignee alone for rights given to it. Section G relieves the assignee of the right to pay premiums and policy loan interest or principal but expressly states that if it pays any of such items the amounts so paid shall become "part of the liabilities hereby secured.," and as such become due immediately and draw interest at a rate not exceeding 6 per cent annually until paid. Sections H to K, inclusive, deal with other administrative details as to actions by the assignee, as to the superiority of the provisions of the assignment in case of conflict with any provisions of the note for which it is security, and as to the 12 Modern developments resulting from the inability of policyholders to obtain satisfactory forms of investment for their cash, with consequent use of cash to prepay life insurance premiums, have brought out the possible desirability of inserting into Section 4 (after the words "or apportioned thereto" and after the words "dividend deposits and additions") the words "and premiums now or hereafter prepaid or deposited." If it is designed to utilize the ABA form, where an owner of a policy assigns it as collateral for an obligation to a bank of a third person not in any way related to the owner, it is necessary to insert into Section D, after the words "or any of them," the additional words "or of ." However, this situation presumably is not the customary one involved in the assignment of a life insurance policy to a bank as collateral.

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declaration that the assignor has no bankruptcy proceedings pending against him and has not made an assignment for creditors. From the point of view of the lender of money, who is the prospective collateral assignee of an insurance policy, there are four matters as to which he must be satisfied before he accepts the assignment. These are as follows: 1. That all rights which he as assignee may ever wish to exercise are clearly included by the language of the assignment as being vested in him alone. 2. That all the persons who at the time of the assignment are owners of those rights have joined in executing the assignment (or have otherwise been satisfactorily eliminated fTom the group of owners of such rights). 3. That the assignee himself is such a person as is held to have an insurable interest sufficient to support the assignment as a valid one. 4. That there is no restriction in effect upon the assignability of the particular policy which is about to be assigned to him.

T h e old short form of absolute assignment, in spite of its sweeping language, was unsatisfactory in meeting the first one of these tests inasmuch as assignees who attempted to exercise specific rights under such a form often found that the insurance company was unwilling to recognize them as sole owners of the rights (in spite of the absolute quality of the language in the assignment) because there was no express mention of those particular rights being vested in the assignee. This situation arose because of the rule of law that, even though a transfer is on its face absolute in form, the assignor may always show that as between himself and the assignee the transfer was in fact for collateral purposes. T h e ABA form (and similar forms used by the insurance companies themselves) meets this situation by expressly listing the vital rights which are vested by the assignment in the assignee, to be exercised by his own signature alone.

RIGHTS OF CREDITORS IN LIFE INSURANCE I

By Howard C. Spencer, LL.B.*

T W O RACES OF MEN IT MAY seem a far cry from Charles Lamb's whimsical fantasy on " T h e Two Races of Men" 1 to the mundane subject of this study. But perhaps it isn't. There is a serious truth lurking behind the essayist's lighthearted bisection of mankind2 which has a bearing on the difficulties which beset the modern creditor who seeks to satisfy his claim out of his debtor's life insurance.3 A glance at the history of the debtor-creditor relationship, which in one form or another goes back pretty much to the beginnings of social life, may help to make this plain. T h e lot of the debtor in early society was not a happy one. Some measure of his wretchedness can be found in the probability that imprisonment for debt was in a sense an outgrowth of movements for relief of oppressed debtors who had been subject to the horrors of debt slavery and the barbaric customs under • General Counsel, Home Life Insurance Company. ι " T h e human species, according to the best theory I can form of it, is composed of two distinct races, the men who borrow, and the men who lend." —Charles Lamb " T h e Two Races of Men," in Essays of Elia. 2 A more prosaic statement by Max Radin is found in 5 Encyclopedia of the Social Sciences (1931) 32: "As a rule debt is not an isolated phenomenon in a particular society: there is a large class of persons who are constantly, almost permanently, in debt to a smaller class, although these classes in most cases do not constitute the entire communal group." 3 That these difficulties are very real should never be doubted. While this subject is traditionally discussed under the heading "rights of creditors," it is appropriate to wonder why. More often than not statutory and judicially created immunities result in the frustration of creditors who are rash enough to seek to establish such "rights." 39

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which a creditor might maim or kill his debtor or members of his debtor's family. T h e r e is little point in dwelling upon the excesses to which unfortunate debtors were formerly subjected even down to American colonial times. Most of us know about them in a general way. As was to be expected, however, debtors did not suffer these things willingly. There were revolts and reform movements of one kind and another. Gradually through the centuries the advantage has shifted from the creditor to the debtor until today some observers feel the pendulum may have swung too far. T h e trend in favor of the debtor has been particularly marked in American law to the distaste of some leading text writers on the subject. 4 When, however, one reflects upon how many more debtors there are than creditors this would seem an entirely normal development in a country where increasingly the emphasis has been placed on the welfare of the common man. If and when it becomes apparent that the movement has overrun its course to the detriment of the majority, corrective measures can confidently be anticipated. T h e means by which the advantage has been shifted from the creditor to the debtor are varied. Abolition long ago of debt slavery and, in much more recent times, of imprisonment for debt were major steps. T h e change in the concept of the bankruptcy law is another. At one time bankruptcy was a means of obtaining equality of distribution among creditors. Relief to debtors was incidental. Today in America the latter purpose is paramount. 6 But an important way of elevating the status of the debtor has been the creation of property which is exempt from the claims of creditors. T h e degree to which life insurance has become such property is, of course, the subject of the present inquiry. T h e concept of exempt property has been an expanding one. In the beginning it was confined largely to clothing which was being worn, bedding, and, to some extent, the necessary tools of * E.g. see 1 Glenn, Fraudulent Conveyances and Preferences (rev. 306. For a summary of Gray's violent objections to spendthrift trusts in his classic "Restraints on Alienation" (1st ed. 1883, 2nd ed. Griswold, Spendthrift Trusts (1936) Sees. 32 and 34-36. 5 See Levinthal, " T h e Early History of Bankruptcy Law," 66 U. Rev. 223, 224 (1918).

ed. 1940) expressed 1895) see of Pa. L.

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the debtor's trade.6 Household goods and farm livestock were early additions. T o the horse and buggy have been added in some places the automobile and trailer. T h e last exemption undoubtedly stems in part from the homestead exemption which has had a remarkable growth in American law. A "business homestead" is now possible in at least one state.7 T h e exemption principle has been extended to intangible property, soldiers' bonuses, pensions, workmen's compensation awards, railroad retirement benefits, seamen's wages, sickness and burial benefits of fraternal benefit societies, and other forms of life insurance. The application of the exemption principle to life insurance was a natural development. A primary purpose of exempt property was to save the debtor from extreme personal privation and to leave him the means for rehabilitation. But to many, mitigation of the suffering which would have otherwise been the fate of the debtor's family was an even more important purpose. And, of course, life insurance is uniquely associated with the idea of family protection. In fact, so long as the life insurance exemption is confined to the modest protection of the debtor's family, many creditors undoubtedly would voluntarily forego making claim against such life insurance. T h e situation which commonly arouses the ire of creditors is the one in which the debtor places substantial assets, in life insurance beyond his creditors' reach and then, after going through bankruptcy, uses the insurance to reestablish himself in business. It may be urged that the life insurance in such case is merely serving to accomplish the debtor's rehabilitation. But to many this is a doubtful argument. They assert that the justification for exempting the tools of a debtor's trade or his workmen's compensation payments is inapplicable. Nor are they too. willing to concede the right of the debtor's family to surrender β T h e scope of these exemption laws is somewhat amusingly illustrated in a section of the statutes of New Mexico (Sec. 21-501 (5) St. 1941). T h e section reads in part: ". . . one (1) gun or pistol, and the tools and implements of the debtor necessary for carrying on his trade or business. . . . " A careless reader might gain the impression that a gun was deemed essential for carrying on a trade in that state. But any superficial notion of the warlike disposition of New Mexican debtors would seem to be dissipated by a subsequent provision which specifies: "all articles, specimens, and cabinets of natural history or science, whether animal, vegetable or mineral, except such as may be intended for show or exhibition for money or pecuniary gain." ^ Vernon's Texas, S. 1936 Art. 3833.

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INSURANCE

t h e s e c u r i t y a f f o r d e d by t h e e x e m p t i o n s t a t u t e s f o r t h e sake o f g i v i n g t h e h e a d of t h e f a m i l y a n e w start i n life. T h e y m a i n t a i n t h a t if t h e rights of creditors are to be s u b o r d i n a t e d as a m a t t e r o f s o c i a l p o l i c y t o t h e security of t h e f a m i l y , t h a t p o l i c y s h o u l d n o t b e t o o easily subject t o d e f e a t at t h e w i l l of t h e f a m i l y . T h u s i t w o u l d s e e m t h a t t h e l i f e i n s u r a n c e b u s i n e s s is at least p o t e n t i a l l y i n v o l v e d i n t h e a g e - o l d s t r u g g l e b e t w e e n " t w o d i s t i n c t races, the men who borrow, and the men who lend." W i t h this i n m i n d , it was d e c i d e d to try i n this p a p e r : (1) t o o u t l i n e briefly, w i t h s o m e a t t e n t i o n t o h i s t o r i c a l s e q u e n c e , t h e p r i n c i p a l w a y s i n w h i c h creditors are c i r c u m s c r i b e d i n t h e i r a t t e m p t s t o e n f o r c e c o l l e c t i o n of t h e i r c l a i m s a g a i n s t l i f e insura n c e i n w h i c h t h e i r d e b t o r s h a v e s o m e interest, 8 (2) t o n o t e s o m e of t h e p r o b l e m s a n d , p e r h a p s , o n o c c a s i o n (3) t o a r o u s e c u r i o s i t y o v e r w h a t m a y b e s o u n d p u b l i c p o l i c y i n t h e necessary r e c o n c i l i a t i o n b e t w e e n t h e c o m p e t i n g interests of life i n s u r a n c e b e n e ficiaries a n d creditors. A s u r p r i s i n g a m o u n t has b e e n w r i t t e n o n this s u b j e c t . 9 M o s t of it, h o w e v e r , has b e e n f r a g m e n t a r y a n d a 8 Situations where the debtor has attempted to give the creditor an enforceable right in life insurance by assignment or otherwise are, for the most part, beyond the scope of this paper. 9 Special reference should be made to a series of law review articles by Isadore H. Cohen. They are: "Execution Process and Life Insurance," 39 Col. L. Rev. 139 (1939); "The Fraudulent Transfer of Life Insurance Policies," 88 U. of Pa. L. Rev. 771 (1940); "Creditors' Rights to Insurance Proceeds as Determined by Premium Payments," 40 Col. L. Rev. 975 (1940); " T h e Attachment of Life Insurance Policies," 26 Cor. L. Q. 213 (1941); "Exemption of Property Purchased with Exempt Funds," 27 Va. L. Rev. 573 (1941); " T h e Exemption of Life Insurance and the Conflict of Laws," 90 U. of Pa. L. Rev. 33 (1941); T h e Role of Life Insurance as an Asset in Bankruptcy: Part I, 28 Va. L. Rev. 211 (1941). T h e last article, published in December 1941, was "to be continued," but presumably the fate of war decreed otherwise. Mr. Cohen acknowledged that he was writing "with a bias for the creditor, against exemptions." Most of his readers will be inclined to view this as an understatement. One of the ablest expressions of the opposite point of view will be found in How New York State Protects Life Insurance and Annuities (3rd ed. 1946) bv Albert Hirst, Counsel, New York State Association of Life Underwriters and one of the best known authorities on this subject. But Mr. Hirst is obviously writing a brief on behalf of exemptions as they are provided by the New York law. Incidentally, whether or not it is intentional, his definition of what constitutes an "abuse" of the exemption principle points an accusing finger at the laws of a number of other states. Acknowledgment should be made to the valuable card catalog service of life insurance laws maintained by the Life Insurance Association of America, to the Legal Bulletin case service of the American Life Convention, and to the collection of laws on "creditors' rights" published in its Advanced Underwriting Service by T h e Insurance Research and Review Service, Inc. Last, but

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good deal of it has been composed in the heat of partisanship either for or against the principle of exempting life insurance from the claims of creditors. If the present study can claim no other virtue, it is hoped that it may be said of it that it has tried to maintain an objective balance on a controversial issue. STATUTORY P A T T E R N It is sometimes broadly stated that all exemptions of life insurance from creditors rest on a statutory foundation. While this may not be entirely correct, it is so near to the truth that it is a convenient working assumption. It seems appropriate, therefore, to commence with the statutes. An eminent authority on the subject of creditors' rights has observed: One of the most remarkable developments of statute law in the field of creditor's rights has been the rise of life insurance as a "homestead."10 He undoubtedly refers to the nature and extent of such laws rather than to their quality, which, in many instances, has been far from "remarkable." Some of the enactments are notably lacking in clarity. In extent, however, they fully justify the use of the adjective. The mass of legislation is greater than would likely be anticipated by anyone who has not had occasion to look into it. On first inspection, it is a bit difficult to perceive any pattern. T h e various provisions, appearing in unlike combinations and themselves differing somewhat in the ways in which they are expressed, do not seem readily capable of classification.11 But after several attempts a breakdown was devised that seems reasonably satisfactory. First, the various laws pertaining to particular types of insurance or to certain limited situations were grouped under the heading "Special Statutes." Then the remaining laws were classed as "General Statutes" and were subdivided in large certainly not least, the writer is indebted to his fellow lecturer in this series, Bernard G. Hildebrand, Esq., who has generously made available his extensive collection of statutes and cases, both reported and unreported, on the subject. Other sources are sufficiently indicated by specific footnotes. 10 Glenn, Fraudulent Conveyances and Preferences (Rev. ed. 1940) 317. 1 1 This diversity has been deplored. See Young "Bankruptcy and Exemption Statutes as Affecting Disposition of Life Insurance Proceeds," I Proc. Assn. of Life Ins. Counsel, XXIII (1918).

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part on the basis of origin. Occasionally the classes overlap and it is possible that some laws have been overlooked or improperly grouped, but on the whole it is believed that such a survey does reveal the presence of more common characteristics than is at first evident. The general statutes are discussed first. GENERAL STATUTES Married Women's Type (Restricted Exemption). A century ago women were legally incapable of owning separate estates. It may also have been true, odd as it now seems, that a wife had no insurable interest in the life of her husband. It has been suggested that the only way a wife or child could benefit from insurance was through policies payable to the husband's estate, subject of course to the claims of creditors.12 This was the background for the first married women's act passed in New York in 1840.13 In the years which have intervened, the disability of married women to hold separate property has been eliminated and the question of a wife's insurable interest has long ceased to be important; but the relatively incidental exemption clause has grown to striking proportions. This New York law of 1840, sometimes referred to as the "Verplanck Act," is generally believed to have been the first insurance exemption statute in America. One important feature of the law was that the exemption was restricted to insurance purchased by an annual premium of not over three hundred dollars. This was characteristic of the early married women's acts. Similar restricted laws were passed at an early date in other states.14 One rather odd development was the inclusion of a 12 Whitehead, v. New York Life Insurance Company, 102 N.Y. 143, 6 N.E. 267, 55 Am. Rep. 787 (1886). 13 This law (Laws of 1840, c. 80) read as follows: Sec. 1. It shall be lawful for any married women [sic], by herself, and in her name, or in the name of any third person, with his assent, as her trustee, to cause to be insured, for her sole use, the life of her husband for any definite period, or for the term of his natural life; and in case of her surviving her husband, the sum or nett [sic] amount of the insurance becoming due and payable, by the terms of the insurance, shall be payable to her, to and for her own use, free from the claims of the representatives of her husband, or of any of his creditors; but such exemption shall not apply where the amount of premium annually paid shall exceed three hundred dollars. Sec. 2. In case of the death of the wife, before the decease of her husband, the amount of the insurance may be made payable after her death to her children for their use, and to their guardian if under age. E.g., Connecticut (1850), New Hampshire (1850), Minnesota (1851).

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similar provision in the legislative charters of a number of companies.15 This restricted type of general statute has all but disappeared today.16 Married Women's Type (Unrestricted Exemption). Four years after the passage of the first New York statute, Massachusetts enacted a married women's act containing no premium restriction.17 This law seems to be the earliest example of the unrestricted type. There were also a number of early instances of unrestricted exemptions in legislative charters.18 Following the 1929 depression a number of states, when enacting "55-a" type statutes, of which more will be said later, amended their married women's acts to remove the premium restriction so that most of these laws which survive are now of the unrestricted type. There are today some nineteen states with unrestricted married women's laws.19 18 In Charters and By-Laws of Thirty-five Life Insurance Companies, published by A. J. Flitcraft in 1896, six of the charters had such provisions. T h e companies were: Mutual Benefit Life Insurance Company (N.J. 1845—$300); Connecticut Mutual Life Insurance Company (Conn. 1846—$100); National Life Insurance Company (Vt. 1850—by amendment, $200); Aetna Life Insurance Company (Conn. 1850—by amendment, $150); Northwestern Mutual Life Insurance Company (Wis. 1858, repealed in 1887—$300); Prudential Insurance Company of America (N.J. 1873—amount left blank; filled in in 1875 by amendment, $250). For 4 unrestricted companies out of the 35, see note 18. ie T h e South Carolina (1942 Code Sec. 7985) statute remains in the traditional pattern; so do the New York (Sec. 52 Domestic Relations Law) and Michigan (Sec. 12452 Comp. L. 1929) statutes. But in the latter two states there are more recent broader laws (New York Sec. 166 Insurance Law; Michigan Sec. 12451 Comp. L. Supp. 1933 amended Act 181 L. 1939); the Missouri law seems to have an extreme restriction in that apparently all of the premiums must have been paid from the married woman's funds (Revised Stat. 1939 Sec. 5847); in West Virginia if an annual premium exceeding $300 is paid in fraud of husband's creditors, an amount equal thereto enures to creditors (Code 1943 Sec. 4753); and in Wisconsin there is a limitation of $5,000. But this applies to wife's creditors; there is no limit with respect to husband's creditors. (Sec. 246.09 St. 1945). i t This law (Laws of 1844, c. 82) stated that any policy procured for the benefit of a married woman by any person on any life should "enure to her separate use and benefit and that of her children, if any, independently of her husband and of his creditors and representatives, and also independently of any other person effecting the same on her behalf." is i n the collection referred to in note 15, the instances were: Penn Mutual Life Insurance Company (Pa. 1847); Union Mutual Life Insurance Company (Me. 1848); Phoenix Mutual Life Insurance Company (Conn. 1851); and Travelers Insurance Company (Conn. 1866 by amendment). 19 Alabama (Sec. 624 Tit. 7 Code 1940); Arkansas (Sees. 7229, 7982, Dig. 1937); Connecticut (Sec. 5169 G.S. 1930); Delaware (R.C. 1935, Sec. 508); District of Columbia (Sec. 30-212 Code 1940); Indiana (Sec. 39-4210 Burns S.1933; added Sec. 155 c. 162 L. 1935); Kentucky (Sec. 297.140 R.S. 1942);

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While the original purpose of these laws was to emancipate married women, children were included as beneficiaries from the beginning and somewhat later dependent relatives were included in a number of laws.20 In one or two instances they have even been broadened to include a creditor as beneficiary.21 In at least one state,22 it is amusing to note that there is an "unmarried women's act" permitting a husbandless woman to insure the life of her father or brother and permitting her on survival "to receive the amount of the net insurance, in the same manner as in the cases of married women." Distribution Type. While the married women's type was the earliest kind of exemption statute, it was closely followed by another type which can conveniently be called the distribution type. The essential characteristic of these laws is that they provide in various ways that if an insured dies leaving insurance which is not payable to a named beneficiary it will pass to certain distributees, normally his widow and children, free from the creditors who have claims against his estate. Probably the earliest statute of this type was enacted in Maine in 1844.23 But Tennessee followed with a similar law a year or two later. 24 In addition to Maine and Tennessee there are six other states Maryland (Sec. 8 Art. 45 Ann.C. 1939); Massachusetts (Sec. 126 c. 175 G.L. 1932 and c. 42 L. 1933 c. 227 L. 1933); Minnesota (Sec. 61:15 St. 1941); New Hampshire (Sec. 1 c. 327 R.L. 1942); New Jersey (Sec. 17:34-26 R.S. 1937); North Carolina (Sec. 58-205 G.S. 1943); Ohio (Sec. 9397 G. Code); Oklahoma (Sec. 212 Tit. 36 St. 1941); Pennsylvania (Sec. 517 Tit. 40 Purdon's St. 1930); Tennessee (Sec. 8457 Code 1932); Vermont (Sec. 3088 P.L. 1933); Washington (Sec. 7230-1 Rem.R.S. 1931 amended c. 179 L. 1939). There is also a constitutional provision in North Carolina (Art. 10 Sec. 7 Const, amended c. 262 L. 1931). 20 E.g., District of Columbia, Illinois, Maryland. 21 E.g., Indiana. 22 Missouri Revised St. 1939 Sec. 5849. 23 Laws of 1844, c. 114. T h e law, which is somewhat long, is quoted in Young, "Rights of Beneficiaries, Next of Kin, Creditors, and Others to Life Insurance Policies and the Proceeds Thereof Under the Statutes of Maine," I Proc. of Assn. of Life Ins. Counsel, XVIII (1917). This law is somewhat obscurely worded but judging by its modern counterpart (Sec. 21 c. 156 R.S. 1944) the proceeds of the policy less premiums paid within three years of death, with interest, descend without being subject to creditors' claims. 24 Laws of 1845-6, c. 216. T h e modern Tennessee statute (Sec. 8456 Code 1932) which apparently is little changed from the original laws reads, "Any life insurance effected by a husband on his own life shall, in case of his death, enure to the benefit of his widow and children; and the money thence arising shall be divided between them according to the statute of distribution, without being in any manner subject to the debts of the husband."

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that now have statutes of this nature. They are Florida, Iowa, Kansas, Mississippi, North Dakota, and South Dakota. 25 As a general rule this kind of law operates against creditors of the insured only. The Iowa and South Dakota statutes are exceptions to this statement. In the case of the Iowa act a widow is protected from her own creditors on debts contracted before insured's death to the extent of fifteen thousand dollars, and in the case of the South Dakota act, both widow and children gain protection from all creditors up to five thousand dollars. Procedural Type. A somewhat later type of law is now in seventeen jurisdictions. T h e common characteristic of these laws is that they are enacted, not as a part of the insurance law, but as a part of the general exemptions from execution which are frequently found in civil practice or procedure codes. Because of the fact that they are general exemption statutes they usually provide immunity from all creditors, including creditors of the beneficiaries. In this respect they are much broader than the married women's acts or the distribution type or the "55-a" type. On the other hand, they are generally restricted in the amount which they protect. A common pattern found in several western states exempts all kinds of benefits "in any manner growing out of any life insurance" if the annual premiums do not exceed five hundred dollars. 26 Arizona and Minnesota have statutes of similar pattern but are restricted in their application to benefits payable to a wife or child of the insured not exceeding ten thousand dollars.27 A South Dakota law protects proceeds up to five thousand dollars going to widow, husband, or minor child. 28 Maryland has a seemingly broad general exemption which is in fact 25 Florida, Sec. 222.13 St. 1941; Iowa, Sec. 511.37 Code 1946; Kansas, Sec 40-258 G.S. Supp. 1945 (limited to policies of $1,000 or less); Mississippi, Sec. 309 Code 1942 (except for premiums paid on policy by one other than insured and for expenses of last illness and funeral); North Dakota, Sec. 26-1018 R.C. 1943; and South Dakota: Sec. 31.1509 Code 1939. 26 California (Sec. 690.19 Code Civ. Proc. 1941); Idaho (Sec. 8-204 Code 1932 amended c. 104-L. 1937); Montana (Sec. 9428 R.C. 1935); Nevada (Sec. 8844 Comp. Laws 1941); Utah (Sec. 104-37 Code 1943). In this group California and Nevada provide if premiums exceed $500 exemption shall equal proportion which $500 bears to premiums paid. Idaho restricts the exemption to residents and a premium of $250, and Montana restricts the exemption to judgment debtors who are married or are heads of families. 27 Sec. 24-601 Code 1939 and Sec. 550.37 St. 1941, respectively. 28 Sec. 51.1805 Code 1939.

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quite limited. 29 The New Mexico Code does not limit the amount exempted but confines the protection to the debts of the deceased.30 Mississippi31 has a rather curious combination of statutes and Texas 32 and Delaware33 have procedural limitations protecting cash values. Vermont provides that life insurance of five hundred dollars or less in hands of company which is due or payable is not subject to "trustee process."34 The District of Columbia has recently included ". . . insurance, annuities, or pension or retirement payments, not otherwise exempted, not to exceed $100 each month . . ." in its general property exemption law.35 Florida and North Dakota also have statutes protecting cash values from creditors of insured. 36 55-a Type. Unquestionably the best known exemption statute is former Section 55-a of the Insurance Law of New York. This law is important not only because it was in force in New York from the time of its enactment in 192737 on through the depres2» Sec. 8 Art. 83, Ann. Code 1939 exempts from execution ". . . all money payable in the nature of insurance . . . except on judgments for breach of promise to marry or for seduction." But this section is limited by the Maryland Constitution (Art. 3 Sec. 44) to $500. 30 Sec. 21-505 St. 1941. But see note 47. 31 Sec. 308 Code 1942 exempts all proceeds up to $10,000 payable to anyone from creditors of insured "even though such person paid the premium," while Sec. 309 exempts proceeds up to $5,000 from creditors of insured if policy payable to estate of insured "except premiums paid on the policy by anyone other than the insured for debts due for expenses of last illness and for burial." T h e protection of the latter section, which is in effect also a distribution type, is cut down proportionately if the legatees or heirs receive benefits from other insurance. 32 Art. 3832a, Vernon's Texas S. 1936, protects from all creditors beneficial interest of members of insured's family in cash value of any policy in force more than two years. 33 Sec. 4608 R.C. 1935 provides ". . . but insurance companies shall not be liable to attachment, except only as to moneys due in consequence of the happening of the risk provided for in the policy of insurance. . . ." Seemingly this would protect cash values from attachment. 34 Sec. 1754 P.L. 1933. 35 Sec. 15-403 D.C. Code 1940 P.L. 505 c. 610 Laws of 1944. This exemption is restricted to those supporting families and living or working in District. Non-heads of families have a somewhat lower exemption. 36 Sec. 222.14 St. 1941 and Sec. 26-1017 R.C. 1943, respectively. 37 Laws of 1927, c. 468. T h e text of the law read, "If a policy of insurance, whether heretofore or hereafter issued, is effected by any person on his own life or on another life, in favor of a person other than himself, or, except in cases of transfer with intent to defraud creditors, if a policy of life insurance is assigned or in any way made payable to any such person, the lawful beneficiary or assignee thereof, other than the insured or the person so effecting such insurance, or his executors or administrators, shall be entitled to its proceeds and avails against the creditors and representa·

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sion years, but because it was copied almost literally in a number of other states38 and undoubtedly influenced the course of legislation elsewhere. Section 55-a was passed because of the inadequacy of the protection afforded by the New York married women's act39 and goes back in part for its inspiration to the first Massachusetts law of 1844.40 Because of its unique importance it seems worthwhile to list the points covered by Section 55-a: (1) It applies to policies effected by insured in favor of any other person; (2) it applies to tives of the insured and of the person effecting the same, whether or not the right to change the beneficiary is reserved or permitted, and whether or not the policy is made payable to the person whose life is insured if the beneficiary or assignee shall predecease such person; provided, that, subject to the statute of limitations, the amount of any premiums for said insurance paid with intent to defraud creditors, with interest thereon, shall enure to their benefit from the proceeds of the policy; but the company issuing the policy shall be discharged of all liability thereon by payment of its proceeds in accordance with its terms, unless before such payment the company shall have written notice, by or in behalf of a creditor, of a claim to recover for transfer made or premiums paid with intent to defraud creditors, with specification of the amount claimed." 88 w i t h i n seven years from the date of its passage Hobert S. Weaver, then Attorney for the Association of Life Insurance Presidents, listed the following states: Alabama (1932) (now Sec. 624 Tit. 7 Code 1940); Arkansas (1931) (now Sec. 7981 Dig. 1937); Colorado (1929) now Sec. 40 c. 87 St. 1935 amended c. 178 L. 1937); Delaware (1931) (now Sec. 504 R.C. 1935); District of Columbia (1934) (now Sec. 35-716 Code 1940); Georgia (1933) (now Sec. 56-905 Code 1933); Maine (1929) (now Sec. 137 c. 56 R.S. 1944); New Hampshire (1931) (now Sees. 2 and 3 c. 327 R.L. 1942) (except for assignees); North Carolina (1931) (now Sec. 58-206 G.S. 1943); Rhode Island (1931) (now Sec. 13 c. 153 G.L. 1938); West Virginia (1929) (now Sec. 3359 Code 1943); and Wisconsin (1931) (now Sec. 272.18 (19) St. 1945). See Weaver: "Protection of Life Insurance Policy Proceeds from Creditors' Claims by Legislation and Decisions since 1929," VI Proc. of Assn. of Life Ins. Counsel, 149, 152 (1934). 89 In brief recently submitted in Kindleberger v. Lincoln National Bank, 155 F (2) 281 (1946), prepared in part by Albert Hirst who also had a hand in drafting Sec. 55-a, three reasons were given for enactment of Sec. 55-a: (1) Under Domestic Relations Law Sec. 52 wife-beneficiary occupied position inferior to every other beneficiary, (2) Under Cohen v. Samuels, 245 U.S. 50 (1917), the trustee was entitled to policies where the right to change the beneficiary was reserved, (3) creditors could create a nuisance by seizing the right of insured's estate to receive death benefits if the beneficiary predeceased insured. Laws 1844, c. 82. T h e first section of that law is the married women's law which has already been quoted (see note 17). T h e second section read as follows: "Sec. 2. Where a policy of insurance is effected by any person on the life of another, expressed therein to be for the benefit of such other, or his representatives, or for that of a third person, the party for whose benefit such benefit is made shall be entitled thereto as against the creditors and representatives of the person so effecting the same."

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BENEFICIARY IN LIFE INSURANCE

policies eSected by another in favor of any other person; (3) it applies to policies issued before or after the passage of the law; (4) it applies to policies assigned or made payable to another after issue except in cases of transfer with intent to defraud creditors; (5) it applies to "proceeds and avails" of the policy without any limitation based on amount of premiums or face amount; (6) it expressly declares that the beneficiary or assignee shall be entitled to such proceeds and avails against the creditors and representatives of the insured or person effecting the same if such beneficiary or assignee is not the insured or effector; (7) it expressly declares that the presence of the right to revoke the beneficiary is immaterial; (8) it expressly declares that a reversionary interest in the insured is immaterial; (9) it expressly declares that the amount of any premiums paid with intent to defraud creditors, with interest, shall enure to creditors' benefit from the proceeds of the policy; (10) it expressly declares that such right of defrauded creditors is subject to the statute of limitations; and (11) it expressly declares that the company shall be discharged by paying the proceeds in accordance with the policy terms unless it shall have written notice of a claim of definite amount based on fraud. Looking at the statute from a reverse point of view, it did not: (1) protect the effector, whether or not he was the insured, as a beneficiary; (2) protect anyone against creditors of a beneficiary; (3) include annuities or disability insurance within its scope. In addition to the states that adopted Section 55-a within a few years of its enactment in New York, three 41 others have more recently passed a similar law, and presently there are some fourteen 42 other jurisdictions having statutes of a broadly equivalent nature. « W a s h i n g t o n (Sec. 7230-1 Rem. R.S. 1931 amended c. 179 L. 1939). Virginia (Sec. 4219-b Code 1942 added c. 304 L. 1946). T h e Virginia law is particularly interesting. That state has been somewhat slow to enact such statutes and this 1946 law is restricted to the protection of "householder or heads of families"; and where the effector has the right to change the beneficiary or assignee the total insurance exemption is limited to $10,000, prorated between policies where there is more than one. Michigan (Sec. 12451 Comp. L. Supp. 1933 amended Act 181 L. 1939). This law provides that proof of the existence of a debt at the time a transfer is made is prima facie proof of fraud as to that debt. 42 Some of these statutes antedate Sec. 55-a. In this class seem to be Connecticut (now Sec. 1568-c G.S. Supp. 1935); Kentucky (now Sec. 297.150 R.S.

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In 1939 in the revision of the Insurance Law in New York Section 55-a was repealed and Section 166 was enacted. 43 On the surface, this Section may seem like a new law. In fact it is the old law with a few changes plus a consolidation of a number of special statutes. All exemption statutes in New York have now been grouped in this section except for the spendthrift statutes and the welfare statutes. Some important additional life insurance features of Section 166 were: (1) a wife investing her own funds in insurance on the life of her husband is now protected, to an unlimited amount from her own creditors; (2) the fraud necessary to enable creditors to recover is "actual intent to hinder, delay or defraud creditors, as such actual intent is defined by article ten of the debtor and creditor law"; (3) the language was clarified at various points, particularly to leave no doubt that it was an exemption statute as that term is used in the Bankruptcy Act. Comprehensive Type. As a final type of general statute the Louisiana Law stands almost alone. 44 It very broadly exempts "the proceeds, avails and dividends of all life insurance" from "all liability for any debt." 45 Broader language than this can scarcely be conceived unless it be in the New Mexico statutes on the subject. The New Mexico laws include, in addition to the procedural type provision which has already been mentioned, 40 a sweeping exemption of all types of insurance benefit from all 1942); Massachusetts (now Sec. 125 c. 175 G.L. 1932 a m e n d e d c. 42 L . 1933); M i n n e s o t a (now Sec. 61.14 St. 1941); New Jersey (now Sec. 17:34-28 R.S. 1937); O k l a h o m a (now Sec. 211 T i t l e 36 St. 1941); O r e g o n (now Sec. 101-514 C o m p . L. 1940); T e n n e s s e e (now Sec. 8458 C o d e 1932); V e r m o n t (now Sec. 7013 P.L. 1933); a n d W y o m i n g (now Sec. 57-236 R.S. 1931). A few s u c h statutes h a v e been e n a c t e d since Sec. 55-a. I n Illinois a n o l d e r m a r r i e d w o m e n ' s act was t r a n s f o r m e d in t h e 1937 Code to a b r o a d e r law (Sec. 238 S.B. 270 L. 1937). M a r y l a n d e n a c t e d a r a t h e r b r o a d law in 1945 (Laws of 1945, c. 864 a d d i n g A r t . 48 A to A n n o t a t e d Code of 1939). Nevada e n a c t e d a s o m e w h a t similar law in 1941 (Sec. 3656.83 C o m p . L. S u p p . 1941). S o m e of t h e f o r e g o i n g laws a r e s o m e w h a t n a r r o w e r in scope t h a n Sec. 55-a. Some a r e slightly b r o a d e r . P e r h a p s t h e Pennsylvania law (Sec. 517 T i t . 40 P u r d o n ' s St. 1930), w h i c h has been classified as a m a r r i e d w o m e n ' s act (see n o t e 19), s h o u l d in fact be listed here. 43 Laws of 1939, c. 882. 44 Sec. 4105 G.S. 1939. « T h e s a m e status is given to h e a l t h a n d accident, a n n u i t y , a n d e n d o w m e n t c o n t r a c t s by Laws of 1944, Act. 221. 46 See n o t e 30.

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types of creditors. 47 Kansas, Nebraska, Arkansas and perhaps Georgia also have broad statutes. 48 SPECIAL STATUTES Fraternal, Assessment, etc. Type. As would be expected, the relatively small benefits paid in the various forms which have sometimes been classified as "workingman's" insurance have been quite generally protected by exemption statutes. 49 Probably because the benefits of this type are normally rather small, oftentimes amounting to little more than burial insurance and therefore offering relatively scant opportunity to deprive creditors of substantial sums, little objection has been raised to this class of exemptions. It is, of course, quite easy to identify the statutes which go to make up this class. Most types of company in this group, however, are disappearing, 50 probably in part because of the growing popularity of group insurance. A possible exception to this statement is fraternal insurance. Exemption statutes applying to fraternal benefit societies are widespread. Perhaps, in part owing to the uniform fraternal benefit code, there is a fair degree of uniformity throughout the country with respect to the nature of the exemption laws.51 It may be noted in passing, however, 47 Sec. 21-503 St. 1941. 48 Kansas: Sec. 40-414 G.S. 1935; this statute protects against creditors of assured of effector and of beneficiaries. Nebraska: Sec. 44-371 R.S. 1943; this statute protects against creditors of insured and of beneficiary (if related to the insured by blood or marriage). Arkansas: Act 102 L. 1933 (Sec. 7988 Dig. 1937); this was an emergency statute declaring a complete moratorium on insurance moneys, but see discussion of the law under portion of this paper which takes u p problem of constitutionality. Georgia: Sec. 56-903 Code 1933; this is an old provision going back apparently to the Code of 1863 and provides when insured directs payment and company assents "no other person may defeat the same." Its meaning is not clear. 48 At least two-thirds of the states have such statutes. 60 E.g. In New York stipulated premium companies and employees' mutual benefit associations are no longer permitted, and cooperative life and accident insurance companies have practically disappeared. All at one time had separate exemption statutes in that state. 61 T h e exemption provision of the Code (New York Conference Bill, 1912) reads as follows: "Section 21. (Benefit not Attachable.) No money or other benefit, charity or relief or aid to be paid, provided or rendered by any such society shall be liable to attachment, garnishment or other process, or be seized, taken, appropriated or applied by any legal or equitable process or operation of law to pay any debt or liability of a member or beneficiary, or any other person who may have a right thereunder, either before or after payment."

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that when New York revised its law in 193952 all special type provisions, including the fraternal benefit section, were merged with the general statute. In the process, the comprehensive protection from creditors of the beneficiary which has been an outstanding characteristic of these laws was omitted. In addition to the laws of general application there were perhaps a fair number of cases when the exemption provision was included in a legislative charter. 63 Group Type. T h e same considerations that prompted the protection of benefits in the case of assessment and fraternal insurance were applicable in the early days of group insurance. Some eleven states84 now have a special statute applying to group proceeds. Protection against the beneficiaries' creditors is practically universal in these laws. It is interesting to speculate about the future of this class of exemption. Will the increased amounts for which group insurance is issued (twenty-thousand-dollar policies are no longer uncommon) and the increasing use of permanent insurance in place of term insurance have any bearing on the terms of these statutes? Of course, on the whole, there is less opportunity to place assets out of reach of creditors in the case of group insurance, and employees as a class are of less consequence to creditors than business men (to whom insurance is largely unavailable). But the spendthrift aspects must be taken into account and it remains to be seen what, if any, influence the trend in group insurance will have on the nature of the group exemption statutes. It is interesting to note that in the last revision of the New York Law in 1939 when the various scattered exemptions were gathered together in Section 166, the special protection for group beneficiaries was dropped and the same provisions which apply to ordinary insurance were extended to group policies. Disability Income Type. Disability income is normally payable 82 Laws of 1939, c. 882. 53 E.g., N.Y. Laws of 1879, c. 189. 5* California (Sec. 10213 Ins. Code 1937 amended c. 947 L. 1943). Colorado (Sec. 167 c. 87 St. 1935), District of Columbia Sec. 35-718 Code 1940), Indiana (Sec. 39-4223 Burns' S. 1933 added Sec. 168 c. 162 L. 1935), Iowa (Sec. 509.13 Code 1946), Massachusetts (G.L. 1932, c. 175 Sec. 135), North Carolina (Sec 58-213 GS. 1943), New York Sec. 166 Insurance Law), Ohio (Sec. 9426-4 G. Code), Pennsylvania (Purdon's St. T i t . 40 Sec. 534), Virginia (Sec. 4258 j Code 1942).

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to the insured and therefore would not be protected from his creditors under the typical general statute. It is, however, particularly appropriate that at least some modest protection be afforded such payments for the same reason that workmen's compensation awards are exempted from the claims of the injured man's creditors. It was, therefore, not surprising that New York added a new provision, 55 Section 55-b, in 1934, dealing with disability payments. That section barred all debts incurred before the disability and all of those incurred after it except those arising for necessaries. In the 1939 revision a ceiling of four hundred dollars per month was placed on the exemption so far as debts incurred after the disability were concerned. Lump sum payments for dismemberment were also brought within the protection of the statute. A number of other states have enacted special statutes on this subject. T h e District of Columbia law excepts necessaries.56 Massachusetts exempts income up to thirty-five dollars weekly except for necessaries purchased after commencement of disability, 57 and Wisconsin exempts income up to one hundred fifty dollars per month. 58 Arkansas exempts benefits payable to residents. 59 A number of other states have special statutes. 60 Of course in a few states the general statute is sufficiently broad to cover disability payments. This is notably true of Louisana and is probably true of most procedural type statutes. In some other states the general statute by its language includes such payments. 61 Annuity Type. Annuities provide a rather complicated subject matter in that in some respects they resemble life insurance 65 Laws of 1934, c. 626. 56 Sec. 35-717 Code 1940. 67 Sec. 110-A c. 175 G.L. 1932 added c. 401 L. 1938. 68 Sec. 272.18 (25) St. 1945. 69 Sec. 7988 Dig. 1937. eo California (Sec. 690.20 Code Civ. Prac. 1941), Florida (Sec. 222.18 St. 1941), Michigan (Sec. 14578 Comp. L. 1929 amended Act 225 L. 1939), Minnesota (Sec. 550.39 St. 1941), Mississippi (Sec. 307 (c) Code 1942), New Jersey (Sec. 17:18-12 R.S. 1937), Pennsylvania (Purdon's St. (1930) Tit. 40 Sec. 766 added Act. 98 L. 1933), Tennessee (Sec. 9429 (I) Code 1932 added c. 287 L. 1937), Texas (Art. 5068a Vernon's Texas S. 1936), Virginia (Sec. 4219 Code 1942), Washington (Rem. R.S. Sec. 569-1). 81 Colorado, Georgia. Iowa, Maine, Nebraska, and New Mexico.

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(e.g., cash value of deferred annuity) and in other respects they resemble disability insurance (e.g., income payments to persons with impaired earning power). T o a large extent the need for minimum protection against creditors is equally as urgent as in the case of disability income. Again, therefore, it is not surprising that a year after the passage of the disability income section, New York passed Section 55-c, entitled: "Rights of creditors and beneficiaries under annuity contracts."62 This section applied to two types of cases; first, where a person purchased an annuity for the benefit of himself, and second, where he purchased it for the benefit of another. In the first instance, the benefits other than periodic payments were exempt. Such payments were subject to garnishment (ordinarily 10 per cent of income) and the surplus of such payments over the amount needed for the purchaser's education and support were subject to claims of his creditors. In the second instance the benefits other than periodic payments were likewise exempt and such payments were free from the purchaser's creditors and might be free from the beneficiaries' creditors if the company and the purchaser so agreed. These provisions were somewhat modified by the 1939 amendment consolidating all exemptions in one section. 63 62 Laws of 1935, c. 490. 63 T h a t part of Sec. 166 of the Insurance Law now applying to annuities reads as follows: T h e benefits, rights, privileges and options which, under any annuity contract heretofore or hereafter issued are due or prospectively due the annuitant, who paid the consideration for the annuity contract, shall not be subject to execution nor shall the annuitant be compelled to exercise any such rights, powers or options contained in said annuity contract, nor shall creditors be allowed to interfere with or terminate the contract, except (a) as provided in subsection four and except (b) that the total exemption of benefits presently due and payable to any annuitant periodically or at stated times under all annuity contracts under which he is an annuitant, shall not at any time exceed four hundred dollars per month for the length of time represented by such installments, and that such periodic payment shall be subject to garnishee execution to the same extent as are wages and salaries, pursuant to the provisions as to such executions contained in the civil practice act; and (c) that if the total benefits presently due and payable to any annuitant under all annuity contracts under which he is an annuitant, shall at any time exceed payment at the rate of four hundred dollars per month, then under the provisions of the civil practice act, the court may order such annuitant to pay to a judgment creditor or apply on the judgment, in installments, such portion of such excess benefits, as to the court may appear just and proper, after due regard for the reasonable requirements of the judgment debtor and his family, if dependent upon him, as well as any

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Some other states have special laws on this subject. A Pennsylvania law antedating the New York laws exempts income up to one hundred dollars per month from the purchaser's creditors.84 The general statutes of Louisiana and New Mexico accomplish the same result. And in three states annuities are expressly included in the spendthrift statutes. 65 Where the annuity is purchased for another, the general statutes of a number of states protect the annuitant from the claims of creditors of the purchaser both with respect to cash values and proceeds. 66 Spendthrift Type. The protection of beneficiaries from the claims of their own creditors is easily one of the most contropayments required to be made by the annuitant to other creditors under prior court orders. T h e benefits, rights, privileges or options accruing under such contract to a beneficiary or assignee shall not be transferable nor subject to commutation, and if the benefits are payable periodically or at stated times, the same exemptions and exceptions contained herein for the annuitant, shall apply with respect to such beneficiary or assignee. An annuity contract within the meaning of this section shall be any obligation to pay certain sums at stated times, during life or lives, or for a specified term or terms, issued for a valuable consideration, regardless of whether or not such sums are payable to one or more persons, jointly or otherwise, but does not include payments under a life insurance policy at stated times during life or lives, or for a specified term or terms. T h e explanation of this somewhat involved provision contained in How New York State Protects Life Insurance and Annuities, (3rd ed. 1946) 20 (see note 9) is as follows: (1) Annuities being provisions for old age, the section provides that no annuitant shall be compelled to exercise any "rights, powers or options" contained in his annuity contract. In other words, an annuitant cannot be compelled to destroy a deferred annuity. This exemption does not apply to cases of fraud (see Chapter XII). (2) Annuities amounting to $400 per month or less are subject to what is known as garnishee execution. Under such an execution, a judgment creditor may seize 10% of the moneys, as they become due. (S) Annuities amounting to more than $400 per month are subject to garnishee execution as just stated and, in addition, a judgment creditor may institute a proceeding under the Civil Practice Act, asking the Judge to determine how much of the excess over $400 per month the annuitant needs for his own support and that of his family "if dependent upon him"; the Court may direct that any amount not so required be paid to the judgment creditor. (4) Where a person buys an annuity for the benefit of another, the beneficiary finds himself in exactly the same position as if he himself had paid for it; what we stated above under (1), (2) and (3) applies to such an annuity. 64 Purdon's St. 1930 Tit. 40 Sec. 515 amended Act. 337 L. 1935. 65 Alabama, Colorado, and Connecticut. ββ Georgia, Illinois, Maryland, Maine, Michigan, Nebraska, Ohio, Nevada, and Tennessee.

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versial problems in this whole field. T h e special statutes relating to fraternals, group, disability income, and annuities, particularly the latter two classes, all involve this problem to some extent, and some of the general statutes touch upon it, but the question comes up in what is probably its most acute form in the case of life insurance proceeds which are being held by the company under some form of deferred settlement. The historical solution to this question is quite different from the other forms of life insurance exemption. During the latter half of the last century a bitter controversy raged over the question of whether the settlor of a trust could specify that the interest of the beneficiary in the trust was to be exempt from the claims of the beneficiary's creditors. Such a trust came to be known as a "spendthrift trust." These were ultimately held valid in some American states without a statute; in other jurisdictions special statutes were passed; and in a few other states such trusts have never been valid. 67 When it became desirable to exempt insurance funds from beneficiaries' creditors, the analogy with the spendthrift trust was too obvious to overlook. T h e trouble was, however, that the insurance company-beneficiary relationship was not a trust. Few companies had trust powers and those that did have were not prepared to segregate funds, accept discretionary powers, and otherwise conform to the normal trust pattern. For a time considerable confusion ensued. 68 But gradually the states passed special statutes explicitly applicable to life insurance proceeds. T h e first statute of this type seems to have been adopted in New York. In 1911 Section 15 of the Personal Property Law, β7 The authoritative text on this subject is Griswold, Spendthrift Trusts (1936). β8 Some idea of the complexities of attempting to adopt the spendthrift trust concept to the nontrust relationship can be gained from reading Horton, Power of an Insured to Control the Proceeds of His Policies (1926). See also Davis, "Spendthrift Trusts in Life Insurance Policies," (1925) 5 B. U. L. Rev. 91; Pierson, "Recent Legislation Preserving Insurance Proceeds for Beneficiaries," (1930) 16 A. B. A. J. 23; Peterson, "Protection of Proceeds of Instalment Settlement Contracts against Claims of Creditors of the Beneficiary," (1923), II Proc. Assn. Life Ins. Counsel, 221; Van Hecke, "Insurance Trusts—The Insurer as Trustee," (1928) 7 N.C. L. Rev. 21.

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which had concerned the subject of trusts, was amended to include insurance proceeds. 69 T h i s new form of exemption statute proved popular and is now present in approximately half the states. 70 In a few cases the laws apply by their terms only to domestic companies. 71 In a few instances the statute seems to be confined to trusts, the words "or other agreement" being omitted. 72 In some statutes it is stated that the company need not segregate its funds. 73 But in general there is a marked resemblance among the statutes of this category. 74 In fact, in a number of cases two or more states employ identical language. T h e outstanding characteristic of these spendthrift statutes is the permissive nature of the exemption. T o be operative the company and someone else (in some cases the beneficiary is expressly excluded) must agree on the exemption. Such a requirement would seem to exclude from this category one or two statutes in which the exemption is put in force by operation of law. T h i s is, of course, accomplished by general statutes such as 69 T h e following language was used: ". . . Provided, however, that w h e n the proceeds of a life insurance policy, becoming a claim by the death of t h e insured, are left with the insurance company u n d e r a trust or other agreement, the benefits accruing thereunder after the death of the insured shall n o t be transferable, nor subject to a commutation or incumbrance, nor to legal process except in an action to recover for necessaries, if t h e parties to the trust or other agreement so agree." 70 Alabama (Sec. 4 T i t . 28 Code 1940), California (Sees. 10132 and 10171 Ins. Code 1937), Colorado (Sec. 64 c. 87 St. 1935), Connecticut (Sec. 4193 G.S. 1930 amended Sec. 856 h G.S. Supp. 1945), Delaware (Sec. 505 R.C. 1935), District of Columbia (Sec. 35-720 Code 1940), Illinois (Sec. 241 Code 1943), I n d i a n a (Sec. 39-4215 Burns' S.1933 added Sec. 160 c. 162 L. 1935), Iowa (Sec. 508.32 Code 1946), Kansas (Sec. 40-414a Gen. St. 1935), Massachusetts (Sec. 119 A c. 175 G.L. 1932), Michigan (Sec. 12426-2a Comp. L. 1929), Minnesota (Sec. 61.31 & 61.33 St. 1941), Mississippi (Sec. 5682 Code 1942), Nebraska (Sec. 44-370 R.S. 1943), New York (Sec. 15 Personal Property Law), O h i o (Sec. 9398-1 G. Code), Oregon (Sec. 101-517 Comp. L. 1940), Pennsylvania (Purdon's St. 1930 T i t . 40 Sec. 514), R h o d e Island (Sec. 14 c. 153 G.L. 1938), T e x a s (Art. 5068a Vernon's Texas St. 1936), Vermont (Sec. 7014 P.L. 1933), Virginia (Sec. 4219a Code 1942) 5100,000 limit, Wisconsin (Sec. 206.39 St. 1945), Wyoming (c. 115 L. 1937). 71 E.g., Delaware, Indiana, Iowa, Oregon. 72 E.g. Illinois, Iowa, Mississippi, Oregon. In Iowa and Oregon the Commissioner must approve the form of "trust." 73 E.g., District of Columbia, Illinois, Indiana, Massachusetts, Mississippi, Ohio, Pennsylvania, Wisconsin, Wyoming. Ή However, apparently no state other than New York excepts necessaries in its s p e n d t h r i f t statute. Some states do refer to necessaries in their disability exemption statutes.

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the Louisiana Law.75 But reference here is rather to a statute such as the Nebraska Law which stipulates that a policy may be payable in instalments and that if the beneficiary is other than the party procuring the policy, he shall have no right to commute the amount due, encumber or dispose of it, or to anticipate any benefits.76 There has been one rather interesting development in New York with regard to insurance spendthrift provisions. The New York law for many years had authorized the court to direct the disbursement of funds from a trust accumulating income for a minor when the minor had insufficient means for support or education. But the Court of Appeals had held by a divided court that this did not apply to insurance proceeds being retained under a deferred settlement. 77 Therefore, on the recommendation of the Law Revision Commission in 1945, the Legislature amended Section 17 of the Personal Property Law to permit the court to order the payment. 78 76 See notes 44 and 45. 7β Sec. 44-370 R.S. 1943. 77 In re Nires, 290 N.Y. 78, 48 N.E. (2) 268 (1943) motion denied 290 N.Y. 745. 49 N.E. (2) 1010. 78 T h e amendment added the following: "2. When a person, for whose benefit the proceeds of a life insurance policy issued or delivered in this state, or issued for delivery in this state, are being retained under an agreement by the insurer to credit interest thereon, shall be destitute of other sufficient means of support or education, the supreme court, at special term, may, on the application of such person or his guardian or committee, cause a suitable sum to be taken from the interest credited or agreed to be credited, to be applied for the support or education of such person." T h e Act also contained the following: " T h e judicial power conferred by section one of this act shall exist with respect to (a) all policies of insurance which become effective subsequent to the effective date of this act; (b) all policies of insurance which have become effective prior to the effective date of this act, provided the insured on such effective date of this act has or thereafter during his life acquires an unqualified power to change the beneficiary and mode of payment of the proceeds of such policy; (c) all agreements made subsequent to the effective date of this act between either the insured or the beneficiary of a life insurance policy and the insurer with respect to the mode of payment of the proceeds of such policy." T h e Law Revision Commission stated by way of explanation of this law at the time of its enactment: "It is designed to remedy the defect in the present law revealed in Nires v. Equitable Life Assurance Society of United States, 290 N.Y. 78 (1943). T h e amendment enables the destitute beneficiary of life insurance proceeds retained by an insurer for future distribution, to obtain for his support or education the interest periodically credited to such proceeds, if the Supreme Court shall so direct. It embodies a rule similar to that now applicable to trusts."

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This law, of course, affects at most only a limited number of deferred settlements but it does mark something of a change in thinking on the subject of insurance deferred settlements. It will be interesting in the years to come to see whether other states follow this lead. Welfare Type. In recent years a number of states,79 particularly those having heavily populated industrial areas, have passed laws concerning life insurance owned by recipients of one form or another of public relief. As an illustration, two years after the passage of Section 55-a of the Insurance Law, New York80 enacted a law providing that if a person who had received public assistance died leaving life insurance payable to his estate, the public welfare official should be entitled to a preferred claim for the cost of such assistance. It is further stipulated, however, that such claim may be waived if the insured leaves a widow or minor children who are liable to become public charges. Another New York law provides that ownership of life insurance shall not preclude granting old age assistance but permits the officials to require "whenever practicable" the assignment of the life insurance. 81 In a number of states minimum amounts of life insurance are established which are to be exempt from the claims of public officials for recoupment. 82 79 California (Sec. 2163 Wei. and Inst. Code 1937 amended c. 358 L. 1943), Colorado (Sec. 28 (5) c. 119 St. 1935 added c. 201 L. 1937 amended c. 148 L. 1943), Connecticut (Sec. 610e G.S. Supp. 1939 amended Sec. 296f G.S. Supp. 1941), Illinois (Sec. 15b c. 107 S-H. St. 1935 amended S.B. 455 L. 1943), Iowa (Sec. 249.23 Code 1946), Maryland (Sec. 10 Art. 70 A Ann.C. 1939), Massachusetts (Sec. 5 c. 118A G.L. 1932 added c. 436 L. 1936 amended c. 729 L. 1941), Michigan (Sec. 27 Act. 280 L. 1939 amended Act. 225 L. 1945), New Jersey (Sec. 44:1-95 R.S. 1937) (c. 119 L. 1940), New York (see notes 80 and 81), Ohio (Sec. 1359-7b G. Code), Rhode Island (Sec. 2 c. 1154 L. 1942) (c. 1505 L. 1944), Utah (Sec. 76 A-3-5 Code 1943), Washington (Sec. 9998-7a Rem. R.S. 1931 added Sec. 3 c. 25 L. 1939), West Virginia (Sec. 626 (79) Code 1943), Wisconsin (Laws of 1937 Special Session c. 7). so Laws of 1929, c. 565 (Sec. 129 Public Welfare Law, now Sec. 105 Social Welfare Law). 81 Sec. 223 Social Welfare Law. 82 E.g. Connecticut $500 (Sec. 610-e G.S. Supp. 1939 amended Sec. 296f G.S. Supp. 1941); California—policy in effect 5 years with maturity value not exceeding $1,000 (Sec. 2163 Wei. & Inst. Code 1937, amended c. 358 L. 1943); Illinois $500 (Sec. 15-b c. 107 Smith-Hurd St. 1935 amended S.B. 455 L. 1943).

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T H E F I R S T H U N D R E D YEARS I N N E W Y O R K T h e foregoing survey of exemption statutes by types m u s t necessarily fail to give any real concept of the trend in any particular jurisdiction. A complete examination of all of t h e statutes in all of the states would, of course, be a task of herculean proportions. B u t it does seem worthwhile to a t t e m p t t o list chronologically the successive enactments of at least one state. Perhaps in this m a n n e r some idea can be gained of the cycles t h r o u g h which these laws have developed. New York is chosen for this purpose since t h e statutory o u t p u t there has been considerable a n d in some respects i m p o r t a n t to the growth of t h e law elsewhere, although, o n this score, it should be pointed o u t that N e w York has borrowed as well as lent in the process of developing its statutory policy. Covering a period of a little more t h a n a century there have been a b o u t thirty separate enactments. Some of them, to b e sure, represent m i n o r a m e n d m e n t s or recodifications without change of existing laws. O n the o t h e r h a n d , there are probably a fair n u m b e r of exemption provisions in special acts of incorporation which a r e not included in the list. It has n o t been f o u n d practical to make any systematic search for them. Laws of 1840, Ch. 80: General—Married Women's Act—Original This appears to have been the original exemption statute in America. 83 Laws of 1858, Ch. 187: General—Married Women's Act—Amendment Restricts the three-hundred-dollar premium limitation to premiums paid out of husband's property. Laws of 1862, Ch. 70: General—Married Women's Act—Amendment Broadens class of children covered. Laws of 1866, Ch. 656: General—Married Women's Act—Amendment Act enlarged to cover endowments. Laws of 1870, Ch. 277: General—Married Women's Act—Amendment Exemption language clarified. Laws of 1873, Ch. 821: General—Married Women's Act—Amendment Provided for assignment with formalities approximating those required in deeds and wills. Laws of 1879, Ch. 189: Special-Fraternals-Original An act to incorporate the Grand Lodge of the Empire Order of Mutual Aid of the State of New York. The Lodge was authorized to hold and disburse a beneficiary fund and the act provided that 88 The text is quoted in note 13.

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payments from the f u n d : "shall not be liable to be seized, taken or a p p r o p r i a t e d by any legal or equitable process to pay any d e b t or liability of said deceased member." Another instance in the same year is Ch. 496 incorporating the Supreme Council of the Catholic M u t u a l Benefit Association. O n the other h a n d when the Society of Members of the New York Stock Exchange for M u t u a l Relief in the City and County and State of New York was incorporated by Laws of 1872, Ch. 395, no similar exemption was included! Laws of 1879, Ch. 248: General—Married Women's Act—Amendment Broadened assignability. T h o s e who feel that the New York courts went o u t of their way to protect married women by holding their interests were inalienable will be amused by the title of this act, " A n Act for the Relief of Policyholders in Life Insurance Companies." Laws of 1883, Ch. 175: Special—Assessment Companies—Original General law governing incorporation a n d regulation of assessment companies a n d exempting benefits f r o m debts of members. Laws of 1889, Ch. 520: Special-Fraternals-Original Same type of law for fraternals. Laws of 1892, Ch. 690: Special—Assessment Companies and Fraternals— Amendment Codification of Insurance Law, Sec. 212 related to assessment companies, Sec. 238 related to fraternals. Laws of 1896, Ch. 272: General—Married Women's Act—Amendment Married W o m e n ' s Act with some changes of phraseology became Sec. 22 of Domestic Relations Law. Laws of 1897, Ch. 345: Special—Assessment Companies—Amendment Slight a m e n d m e n t of Sec. 212 Insurance Law. Laws of 1897, Ch. 503: Special—Fraternals—Amendment Slight a m e n d m e n t of Sec. 238 Insurance Law (does not affect exemption provision). Laws of 1898, Ch. 85: Special—Stipulated Premium Companies—Original Added Sec. 317 to Insurance Law. Laws of 1900, Ch. 641: Special—Fraternals—Amendment Slight a m e n d m e n t of Sec. 238, Insurance Law. Laws of 1909, Ch. 19: General—Married Women's Act—Recodification Sec. 22 changed to Sec. 52 Domestic Relations Law. Laws of 1909, Ch. 33: Special—Assessment Companies and Fraternals— Recodification Continues Sees. 212 and 238 Insurance Law. Laws of 1911, Ch. 198: Special—Fraternals—Amendment Sec. 238 changed to Sec. 240 Insurance Law. Laws of 1911, Ch. 327: Special-Spendthrift—Original A m e n d m e n t to Sec. 15 Personal Property Law. Laws of 1918, Ch. 192: Special—Group Insurance—Original Added Sec. 101-d to Insurance Law.

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Laws of 1924, Ch. 548: Special—Employee's Mutual Benefit AssociationOriginal Adds Sec. 226 to Insurance Law. Laws of 1927, Ch. 468: General-"55-a"-Original Adds famous Sec. 55-a to Insurance Law. Laws of 1929, Ch. 565: Special-Welfare-Original Adds Sec. 129 to Public Welfare Law providing for making claim on insurance payable to estate for relief granted. Also permits official to waive right where widow or minor child is in need. Laws of 1934, Ch. 626: Special—Disability Income—Original Adds Sec. 55-b to Insurance Law exempting disability benefits. Laws of 1935, Ch. 490: Special—Annuities—Original Adds Sec. 55-c to Insurance Law exempting annuity benefits. Laws of 1936, Ch. 693: Special—Welfare-Original Adds Sec. 124-q to Public Welfare Law, permitting old age assistance officials to require when practical that insurance be assigned in return for support. Laws of 1939, Ch. 882: General—"55-a"—Amendment Adds Sec. 166 to Insurance Law revising and combining Insurance Law sections 55-a, 55-b, 55-c, 101-d, 212, and 240. 84 Laws of 1940, Ch. 619: Special—Welfare—Amendment Re-enacts in substance Sec. 129 of Public Welfare Law as Sec. 105 Social Welfare Law and Sec. 124-q of Public Welfare Law as Sec. 223 of Social Welfare Law. Laws of 1944, Ch. 688: Special—Welfare—Amendment Amendment to Sec. 105 Social Welfare Law modifying maximum funeral cost. Laws of 1945, Ch. 828: Special—Spendthrift-Original Amends Sec. 17 Personal Property Law to permit court to order, in certain cases, interest payments from proceeds being accumulated by insurance company. FEDERAL STATUTES Veterans' Payments. L i f e insurance exemption laws, by a n d large, h a v e been confined to the states. T h e r e is one prominent exception to this statement. A federal statute relating to payments to veterans broadly exempts such payments from the claims 84 Sees. 317 and 226 had already been repealed because the types of companies to which they were applicable were no longer permitted in New York. Sec. 200 of the Insurance Law provides that the pension rights of an employee in a retirement plan organized under the Insurance Law shall be subject to Sec. 166, which concludes as follows: " T h e provisions of this section applicable to any insurance policy or annuity contract shall likewise apply to group insurance policies or annuity contracts, to the certificates or contracts of fraternal benefit societies, and to the policies or contracts of cooperative life and accident insurance companies." Query: Does the exemption apply to policies of savings bank life insurance issued pursuant to authorization contained in the Banking Law?

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of creditors of both the veteran and beneficiaries. 85 Included within the scope of this law are both National Service Life Insurance and earlier forms of Government life insurance. Bankruptcy. When the first Bankruptcy Act was passed in 1800 no mention was made of life insurance for the obvious reason that there was very little in existence. Probably the same reason explains the absence of any provisions in the 1841 act and, to a lesser degree, the 1867 act. By that time a number of state exemption laws had been passed, but the volume of litigation under them was not large. It has been pointed out, however, that by the time the act of 1898 was being considered there were about a dozen decisions under the act of 1867.8e The act of 1898, which in substance is still in force, contained two very important provisions: Section 68T and Section 70 a. 88 The 1938 Amendments, commonly known as the "Chandler Act," added another clause to Section 6 89 and inserted the word 85 U.S. Code T i t l e 58 Sec. 454-a. 86 Cohen: " T h e Role of Life I n s u r a n c e As an Asset in Bankruptcy: P a r t I , " 28 Va. L. Rev. 211, 217 (1941). An interesting account of t h e legislative history of this p a r t of t h e law is here given. 87 Sec. 6 reads as follows: " T h i s act shall not affect t h e allowance to b a n k r u p t s of the exemptions which are prescribed by the State laws in force a t the time of the filing of the petition in the State wherein they have h a d their domicile for the six m o n t h s or the greater p o r t i o n thereof immediately preceding the filing of the petition." 88 Sec. 70-a reads in p a r t as follows: " T h e trustee of t h e estate of a b a n k r u p t . . . shall . . . be vested by operation of law w i t h t h e title of t h e b a n k r u p t , as of t h e d a t e h e was a d j u d g e d a b a n k r u p t , except in so f a r as it is property which is e x e m p t to all . . . (3) powers which he m i g h t have exercised for his own benefit b u t n o t those which h e m i g h t have exercised for some other person; (4) p r o p e r t y transferred by h i m in f r a u d of his creditors; (5) p r o p e r t y which prior to t h e filing of t h e petition he could by any means have transferred or which m i g h t have been levied u p o n a n d sold u n d e r judicial process against h i m : Provided, T h a t when any bankr u p t shall have any insurance policy which has a cash surrender value payable to himself, his estate, or personal representatives, h e may, w i t h i n thirty days a f t e r the cash surrender value has been ascertained and stated to t h e trustee by the company issuing the same, pay or secure to the trustee the s u m so ascertained a n d stated a n d c o n t i n u e to hold, own a n d carry such policy free f r o m the claims of the creditors p a r t i c i p a t i n g in t h e distribution of his estate u n d e r the b a n k r u p t c y proceedings, otherwise the policy shall pass to the trustee as assets. . . ." 89 "Provided, however, that no such allowance shall be m a d e out of t h e property which a b a n k r u p t transferred or concealed a n d which is avoided u n d e r this title for the benefit of the estate, except t h a t , where the voided transfer was m a d e by way of security only a n d t h e p r o p e r t y recovered is in excess of the a m o u n t secured thereby, such allowance may be m a d e o u t of such excess." E x e m p t i o n s prescribed by t h e laws of t h e United States were also added to those which are recognized in b a n k r u p t c y .

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65

"solely" in (3) of Section 70 a. 90 There was also a further insertion in the proviso after (5),91 as well as a number of other changes which are not of particular importance here. 90 So that the clause read: "(3) powers which he might have exercised for his own benefit, but not those which he might have exercised solely for some other person." 91 So that it now reads: "Provided, T h a t when any bankrupt, who is a natural person shall have any insurance policy," etc.

RIGHTS OF CREDITORS IN LIFE INSURANCE II By Howard C. Spencer, LL.B.

CASE LAW I N T E R P R E T A T I O N S THE statutory foundation, to which earlier reference has been made, supports a considerable body of case law. While law suits cost money they are sometimes inevitable. T h e meaning of a statute may not be clear. Its application to unforeseen circumstances may be in doubt. T h e facts may be in dispute. Or it may simply be that the contending claimants are equally determined. Whatever the cause may be, some familiarity with the resulting decisions is indispensable to any adequate understanding of the subject. It was a little difficult to decide just what cases belonged to the subject of this paper. In general, cases where a creditor has been named as beneficiary or assignee have been excluded, unless this action has been taken in derogation of the rights of others. Noncreditor phases of the statutes for the most part have been disregarded. Otherwise, an effort has been made, within the time available, to assemble and note the more significant cases.1 OF M A T T E R S R E L A T I N G P R I N C I P A L L Y TO THE STATUTE Problems

of

Constitutionality

Scope of Exemptions. T h e most searching question of constitutionality, of course, concerns the scope of these exemption laws which in some cases is very broad. Almost a quarter of a century 1 A summary of cases is included as Appendix C. See page 239. 66

RIGHTS OF

CREDITORS

67

ago Mr. Parkinson, in c o m m e n t i n g o n the trend toward greater exemptions, i n d i c a t e d a d o u b t over their constitutionality. 2 I n a few instances courts seem to have shared this v i e w a l t h o u g h perhaps o n more l i m i t e d grounds. A S o u t h D a k o t a court in 1896 held 3 a very broad statute 4 to b e i n v i o l a t i o n of the state constitution. Ironically e n o u g h the violated provision was designed to protect debtors from oppression by their creditors. 5 A n O h i o court in 1902 held a fraternal benefit association provision invalid o n the g r o u n d that it v i o l a t e d the state constitutional p r o h i b i t i o n against discrimination.« A n u m ber of early cases, however, h e l d somewhat similar laws constitutional. 7 I n more recent times a federal court h e l d 8 a typical married women's statute i n v i o l a t i o n of a South Carolina constitutional provision designed for the benefit of debtors. Still more recently the Supreme Court of that state had an opportunity to confirm or reject the federal court's interpretation, 9 b u t the court sidestepped the issue i n a m a n n e r consistent with the h i g h r e p u t a t i o n of southern chivalry. 1 0 2 "In other words, is there not a limit to the legislative right to declare that a man's assets, even though they be invested in an insurance policy, and irrespective of his control over their ultimate destination, shall not be available to his creditors."—Thomas I. Parkinson, "Statutes Exempting Life Insurance Proceeds from Creditors," IX Am. Bar. Assrt. J. 113 (1923). 3 Skinner v. Holt, 9 S.D. 427, 69 N.W. 595 (1896). * The statute (Laws 1890, c. 51 Sec. 21) read as follows: "A policy of insurance on the life of an individual, in the absence of an agreement or an assignment to the contrary, shall inure to the separate use of the husband or wife and children of said individual, independently of his or her creditors; and an endowment policy, payable to the assured on attaining a certain age, shall be exempt from liabilities from any of his or her debts." 5 The Constitutional provision in question stated: "The right of the debtor to enjoy the comforts and necessaries of life shall be recognized by wholesome laws; exempting from forced sale a homestead, the value of which shall be limited and defined by law, to all heads of families, and a reasonable amount of personal property, the kind and value of which to be fixed by general laws." The court's holding was that the law in question was neither "wholesome" nor "reasonable." A somewhat similar holding in Minnesota two years earlier, How v. How, 59 Minn. 415, 61 N.W. 456 (1894), had subsequently been modified, 61 Minn. 217, 63 N.W. 627 (1895), followed in First National Bank v. How, 65 Minn. 187, 67 N.W. 994 (1896). β Williams v. Donough, 65 Ohio St. 499, 63 N.E. 84 (1902). τ For a collection of the cases see note to "Constitutionality of Statute Exempting Proceeds of Life or Benefit Insurance," 1 A. L. R. 757 (1919). 8 In re Cunningham, 15 F. (2) 700 (D.C.S.C. 1926). » Wilson v. Mut. Benefit L. Inc. Co., 182 S.C. 131, 188 S.E. 803 (S.C. 1936). io The trustee in bankruptcy sought the cash value of a policy and the

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BENEFICIARY IN LIFE INSURANCE

Even though Florida has a constitutional provision much like that of South Dakota and South Carolina, it has been held that it is not exclusive in its nature 11 and thus constitutes no limitation on the very broad exemption statutes of that state.12 Application to Preëxisting Debts. Although it is evident from the foregoing discussion that the courts have not seriously limited the general scope of the exemption laws, there is one aspect which they have stressed again and again. Such statutes must not be applied retroactively to debts in existence before the passage of the law. Going back to the South Dakota case for a moment: Shortly after the lower court decision, the South Dakota legislature amended its law. T o anyone who knows lawyers and legislatures, and reads the new statute, must come a suspicion that the amendment was designed to meet the pending litigation. 13 But the court had no difficulty declaring such amendment as ineffective on the wife had taken refuge behind the statute. T h e lower court had decided for the wife, and the trustee had appealed on two grounds. But the court observed that the trustee in his brief had limited his appeal to o n e question; namely, the validity of the exemption statute. And since the court felt t h a t the statute was not to be interpreted as applicable to cash value cases, it concluded its opinion as follows: "Although this statute was pleaded as a defense by the respondent Lila Brownlee Fretwell, a n d j u d g m e n t was awarded her u p o n the theory that the statute applied, yet this court, having construed the statute as not being applicable to the facts of this case, does not feel called upon to pass on the constitutionality thereof, and therefore the a p p e a l is dismissed." T h u s , presumably, the wife retained the policy awarded h e r by the lower court on the basis of t h e statute which the u p p e r court held was inapplicable, and the issue of constitutionality was p u t off. 11 Cooper v. Taylor, 54 F. (2) 1055 (C.C.A. Fla. 1932). 12 A somewhat similar question came u p in N o r t h Carolina when the court held that a constitutional provision (Art. 10 Sec. 7) exempting death proceeds precluded any statutory exemption of cash values— Whiting v. Squires 6 F. (2) 100 (C.C.A. N.C. 1925), cert, denied 269 U.S. 587 (1926). A constitutional a m e n d m e n t broadening the exemption was adopted in 1932 after the passage of a "55-a" statute in 1931. 13 T h e amended law, Laws of 1895, c. 89 Sec. 1, read as follows: " T h e avails of any policy or policies of insurance heretofore or hereafter issued u p o n the life of any person, and payable u p o n the death of such person to the order, assigns, estate executors or administrators of the insured, a n d not assigned to any other person, shall, if the insured in such policy at the time of death reside or resided in this state and leave or left surviving a widow or husband or any minor child, to an a m o u n t not exceeding in the aggregate the sum of five thousand dollars, inure to the separate use of such widow or h u s b a n d or m i n o r child or children or both, as the case may be, independently of the creditors of such deceased, a n d to such a m o u n t shall not in any action or proceeding legal or equitable be subject to the payment of any debt of such decedent."

RIGHTS OF CREDITORS

69

basis that it was an impairment of the obligation of contract and was prohibited by both state and federal constitutions.14 There are many cases on this point. Perhaps the best known is W. B. Worthen Co. v. Thomas,15 Therein the Supreme Court of the United States declared an Arkansas statute broadly exempting all life insurance from all debts, passed during the banking crisis of the 'thirties but not confined to the duration of the emergency, to be invalid so far as preëxisting debts were concerned.16 In order to avoid this well established doctrine of unconstitutionality, it is customary for courts where possible to construe these statutes as not applying to preëxisting debts. Such cases will be briefly touched upon next. Problems of Meaning Application to Preëxisting Debts. There have been a fair number of cases holding that exemption statutes which were silent on the question were not intended to be applicable to debts in existence at the time of the passage of the law.17 As an offshoot of this issue it has been questioned whether a preëxisting creditor is barred by a statute so far as policies taken out after its passage are concerned. This was one time thought possible and, 18 in fact, it has been so held,19 but probably the better view is to the contrary.20 Another subsidiary question is: What is a preëxisting debt for purposes of such statutes? As between the date of a mortgage and the date of a deficiency judgment on 1* Skinner v. Holt, 9 S.D. 427, 69 N.W. 595 (1896). i® 292 U.S. 426 (1934); see annotation to this case in "Debtor's Exemption Statutes as Impairing Obligations of Existing Contracts," 93 A. L. R. 177 (1934). ie Act 102 L. 1933; see note 48 in preceding chapter. 17 E.g. Addiss v. Selig, 264 N.Y. 274, 190 Ν .E. 490 (1934), 92 A. L. R. 1384. In re Heilbron's Est., 14 Wash. 536, 45 P. 153 (1896); Weil ν. Marquis, 256 Pa. 608, 101 Α. 70 (1917). For a discussion of the Pennsylvania statutes on this point see In re Lang, 20 F. (2) 236, 238 (D.C. Pa. 1927); Fearn v. Ward, 65 Ala. 33 (1880). i s See Weaver, "Protection of Life Insurance Policy Proceeds from Creditors' Claims by Legislation and Decisions Since 1929," VI Proc. Assn. of L. Ins. Counsel 149, 154 (1934). 1» Cecilian Operating Corp. v. Berkwit, 151 Misc. 814, 272 N.Y. S. 291 (1934). In re Beach, 8 F. Supp. 910 (D. C. Mass. 1934). In re RosenbergOldstein Co., 236 F. 812 (D.C. La. 1916) (policy in existence but had no cash value until after passage of act). 20 in re Gordon 90 F. (2) 583 (C.C.A. N.Y. 1937).

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BENEFICIARY IN L I F E INSURANCE

such mortgage, the former seems sounder. 21 Also, in the case of a judgment based upon a sale induced by false representations, the date of the sale, not the judgment, is controlling. 22 On the other hand, when a creditor accepted a note in discharge of an obligation, he became a creditor as of the date of the note so far as his rights under an insurance exemption statute were concerned. 23 Distributive Aspects. Many of the exemption statutes have some distributive aspect; that is, they determine to whom life insurance will be payable if not otherwise disposed of, and the exclusion of creditors was perhaps originally incidental to that purpose. There are probably at least two reasons for this. One is historical; the earliest married women's acts had a strong distributive flavor.24 T h e second is constitutional; in some states having constitutional debtor clauses, it is safer to have a distributive statute. 25 Some of the distributive aspects of these statutes are of interest to creditors. It is hard to draw a definite line between exemption and distribution. In a state where policies payable to the insured's estate go to specified distributees, can the insured provide in his will for payments to creditors out of his insurance? T h e answer is "yes" in Louisiana if there are no forced heirs. T h e Louisiana case 28 so deciding quotes as authority Iowa and Tennessee cases.27 But 21 In re Crayton, 56 F (2) 282 (D.C. N.Y. 1932) (date of deficiency judgment) was disapproved In re Jeroloman, 6 F. Supp. 430 (D.C. N.Y. 1934). 22 Fidelity Coal Co. v. Diamond, 310 111. App. 387, 34 N.E. (2) 123 (1941). 23 Rosenberg v. Robbins, 289 Mass. 402, 194 N.E. 291 (1935). 24 In fact, what seems to be the earliest reported decision on the New York Married Women's Act (L. 1840 c. 80) was a distribution case. Within a month after the passage of the Act a married woman procured a $5,000 policy on the life of her husband for a term of five years. In the succeeding year she and her husband and daughter sailed for Europe on the steamship President "and have never since been heard of." It was decided in Moehring v. Mitchell, 1 Barb. c. 264 (N.Y. 1846) that her husband's personal representative was entitled to the proceeds. 25 In Anderson v. Northern and Dakota Trust Co., 65 N.D. 721, 261 N.W. 759 (1935), the court in deciding that, when a policy payable to an estate makes no contrary disposition, the proceeds will go to the heirs and not the residuary legatees, stated that a contrary holding would make the statute purely one of exemption and might imperil its constitutionality in view of earlier North Dakota opinions (See note 5). 2β Michiels v. Succession of Gladden, 190 La. 917, 183 So. 217 (1938). 27 Miller v. Miller 200 la. 1070, 205 N.W. 870 (1925); see annotation of this case in 43 A. L. R. 573 (1926); Davidson Realty Co. v. Caldwell 204 Io.

RIGHTS OF CREDITORS

71

a later Iowa case points out that a mere formal request by the testator that his debts be paid will not accomplish the trick. 28 It must be clear that he intends that the insurance be used to pay such debts. And in Tennessee, on the basis of a recent case,29 there is reason to believe that unless he was aware of the case, the average individual would not make his language strong enough to comply with the rule it sets up. On the other hand, in Tennessee if insurance payable to insured's estate is bequeathed to nonstatutory distributees, creditors come first.30 Getting back to Louisiana, creditors cannot claim insurance payable to the estate in the absence of a direction by insured even if the statutory distributees do not claim the insurance or there are no such distributees. 31 Under the distribution statute in Maine, it was held that insured could dispose of his life insurance by will except for three years' premiums and interest. 32 The typical western statutes earlier referred to in these lectures as "procedural" have a strong distributive cast. In Nevada an insured cannot will proceeds payable to his estate 83 and neither the Nevada 34 nor Idaho 38 courts have any power to refuse to set aside exempt property no matter how meritorious the creditor's claim. Apparently by statute there is now some discretion in the California courts on this point. 36 Under the Mississippi law certain types of debt (expenses of last illness and burial) may be collected from the insurance payable to the estate. It has been held, however, that such preferred expenses must be paid from general assets if there are any, even if this deprives the rest of the creditors from any share 606, 215 N.W. 615 (1927); Union Trust Co. v. Cox, 108 Tenn. 316, 67 S.W. 814 (1902). 28 in re Grilk, 210 Io. 587, 231 N.W. 327 (1930). 29 Adams v. Gairaway, 179 Tenn. 93, 162 S.W. (2) 1086 (1942). 30 Sparkman-Thompson Inc. v. Chandler, 162 Tenn. 614, 39 S.W. (2) 741 (1931). 31 Succession of Erwin, 169 La. 877, 126 So. 223 (1930). 32 Berman v. Beaudry, 118 Me. 248, 107 A. 708 (1919). 33 In re Lavendol's Est., 46 Nev. 181, 209 P. 237 (1922). 3 4 In re MacDonnell's Est., 56 Nev. 346, 53 P. (2) 625 (1936), confirmed on rehearing 56 Nev. 504, 55 P. (2) 834 (1936); see also In re Foster's Est., 47 Nev. 297, 220 P. 734 (1923). 35 Letup v. Lemp, 32 Ida. 397, 184 P. 222 (1919). 3β The court in the MacDonnell case (note 34) expressed the hope that the Nevada law would be amended as the California statute had been. (Calif. Probate Code Sec. 660).

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BENEFICIARY IN LIFE I N S U R A N C E

in the estate. 37 On the other hand, in Mississippi the law provides that policies payable to the estate will go to distributees free from the claims of creditors only up to five thousand dollars. In one case the distributees claimed that the insured by naming them in his will had made them beneficiaries under the policies. 38 T h e court rejected this argument and, dividing the five thousand dollars ratably among the distributees, permitted each to take so much of the exemption as he or she had not received as a named beneficiary of other policies on testator's life. But in South Dakota creditors were unsuccessful in cutting down the distributive share of a widow in insurance payable to the estate on the basis that she was named as beneficiary in other policies. 39 It is frequently said that the "55-a" type statute is a pure exemption statute with no distributive aspects, but in the recent highly publicized Kindleberger case the court in effect interpreted the statute as one of distribution. 4 0 Since this is a highly mischievous construction which can serve no useful purpose, it seems likely that an effort will be made to amend the section in the District of Columbia and perhaps elsewhere. 37 Delta Ins. & Realty Co. v. Benjamin, 122 Miss. 275, 84 So. 226 (1920). See also Wells, " W h e n Should a Life Insurance Company, Under the Statute Laws of the State of Mississippi, on the Death of the Insured Pay t h e Proceeds of a Life Policy, Payable to t h e Insured's Executor, Administrator or Assigns, to such Executor, Administrator or Assigns?" I Proc. of L. Ins. Counsel XLVIII. 38 Magee v. Bank of Hattiesburg, 134 Miss. 126, 98 So. 541 (1924). 39 In re Jacobs Est., 68 S.D. 513, 4 N.W. (2) 809 (1942). M Kindleberger v. Lincoln National Bank, 155 F. (2) 281 (App. D.C. 1946); see critical comment in 32 Va. L. Rev. 1040 (1946) a n d 59 Hary. L. Rev. 988 (1946). T h e critical portion of the statute is: " W h e n a policy . . . is effected by any person . . . the lawful beneficiary . . . other than the insured or the person so effecting such insurance, or his executors or administrators, shall be entitled to its proceeds . . . against the creditors and representatives of t h e insured . . . whether or not the right to change the beneficiary is reserved . . . and whether or not the policy is m a d e payable to t h e person whose life is insured if the beneficiary . . . shall predecease such person . . ." T h e court's construction was that "his" refers to the beneficiary r a t h e r than to the effector-insured. Perhaps as a m a t t e r of grammar and a p a r t from the history of "55-a" type statutes, the language is capable of this construction which makes "55-a" a special type of distribution statute, although, of course, a very odd type which, needless to say, was never intended. Both the court and the law review editors proceeded on the assumption that the question had never been passed u p o n except for the brief reference of t h e surrogate in In re Ciarniak's Est., 140 Misc. 754, 251 N.Y. S. 536 (1931). T h i s may be true b u t surely many courts must have had the chance. For example, the Arkansas court had an o p p o r t u n i t y to apply such a doctrine h a d it chosen to in Lee v. Potter, 193 Ark. 401, 100 S.W. (2) 252 (1937).

RIGHTS OF CREDITORS

73

Interrelationships Between Statutes. In some instances states make new exemption laws without repealing existing statutes. Surprisingly little question has arisen on this score.41 When, however, New York enacted Sec. 55-a of the Insurance Law in 1927 without repealing Sec. 52 of the Domestic Relations Laws, its married women's act containing a five-hundred-dollar annual premium restriction, a serious question was presented over the status of the latter law. After rather extended litigation, it was settled by the state's highest court 42 that such portion of the old law as was inconsistent with the new was repealed by implication. 43 But it has been made clear that creditors who have acquired rights in excess of annual premiums which have been paid while the old law was in force do not lose such rights by reason of such repeal by implication. 44 Scope of Exemptions. T h e concept of exempt property to be effective requires a time dimension and some degree of flexibility with regard to the physical nature of the object exempted. Obviously, no degree of exemption would be worth while if it were confined to some one instant of time and it would be of very limited usefulness if restricted to the original form of the thing exempted. It is equally obvious, however, that to overextend the exemption is to run the risk of giving "the beneficiary of an insurance policy a letter of marque to go out and commit acts of piracy on the high seas of trade and commerce."45 With respect to the physical extent of the exemption, it has been stated that the courts have almost universally extended the exemption to cover the bank account into which the exempt 41 In Alabama when a "55-a" type law was added to a married women's act, the court suggested that the result was "rather involved."—Lone v. First Nat. Bank, 228 Ala. 258, 153 So. 189,194 (1934). 42 Chatham Phenix Nat. Bk. v. Crosney, 251 N.Y. 189, 167 N.E. 217 (1929) rev. 224 App. Div. 58, 229 N.Y. S. 140 (1st Dept. 1928). 43 Presumably the same result has been accomplished in Michigan where a broader statute seems to have been passed without repeal of the old restricted married women's act (see note 16 of preceding chapter). 44 Holmes v. John Hancock Mut. L. Ins. Co., 288 N.Y. 106, 41 N.E. (2) 909 (1942). 48 Reiff v. Armour & Co., 79 Wash. 48, 139 P. 633 (1914). The statute broadly exempted insurance proceeds from all debts. The debtor-beneficiary had used the proceeds to purchase real estate and then had engaged in business and failed. The lower court had held that the real estate, representing the exempt proceeds, was not subject to the debts. The upper court gave force to its quoted conviction by holding that the proceeds were exempt only from debts existing at the time such proceeds became available.

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proceeds have been deposited. 46 T o do otherwise would very largely nullify the purpose of the law. But judicial agreement ends at this point and undoubtedly the degree to which the court inclines toward or away from the principle of exemption largely determines the amount of physical change which the exemption is permitted to survive. 47 With respect to the element of time, an important problem is whether the exemption will be permitted to survive beyond the lifetime of the one originally protected. One line of cases holds that this may not be done, 4 8 but there are decisions continuing the protection to, in substance, those who are named under the intestacy laws. 49 Another question which may come up when a statute exempts only a limited amount of insurance proceeds is: Which part is exempt? 50 These are, of course, not problems which are unique to insurance. They also come up in the case of pensions and other forms of exempt property. Problems

of Choice—Which

Law Governs

What?

This title has been chosen deliberately for its slightly vague connotations. A more orthodox heading would be "Problems of Cohen, "Exemption of Property Purchased with Exempt Funds," 27 Va. L. Rev. 573,584 (1941). H e suggests that the best judicial statement for the extension may be the one f o u n d in Holmes v. Marshall, 145 Calif. 777, 79 P. 534 (1905). See "Deposit of Exempt Funds as Affecting Debtor's Exemption," 67 A. L. R. 1203 (1930). 4? E.g., real estate purchased with proceed held exempt in Booth v. Martin, 158 Iowa 434, 139 N.W. 888 (1913); held not exempt in Bank of Brimson v. Graham, 335 Mo. 1196, 76 S.W. (2) 376 (1934). 48 Matter of Estate of Tellier, 210 Iowa 20, 230 N.W. 545 (1930); Estate of Crosby, 2 Cal. (2) 470, 41 P. (2) 928 (Calif. 1935). In Walker v. Queenes, 174 T e n n . 129, 124 S.W. (2) 236 (1939), a war risk policy was payable in instalments to the insured's father. On the father's death, the commuted value was paid to insured's estate and then paid over to the father's estate where the father's creditors sought to claim it. 38 U.S.C. Sec. 454-a broadly exempts payment "either before or after receipt by the beneficiary," b u t it was held by the u p p e r court that father's estate took commuted value as a distributee u n d e r Tennessee law rather than as beneficiary and that in consequence the exemption no longer applied. 49 E.g., Coleman v. McGrew, 71 Neb. 801, 99 N.W. 663 (1904); Sovereign Camp W.O.W. v. Snider, 227 Ala. 126, 148 So. 831 (1933). so A California case, California U.S. Bond & Mtg. Corp. v. Grodzins, 139 Cal. App. 240, 34 P. (2) 192 (1934), seems to require an original specification of the exempt portion, while an Iowa case, Booth v. Propp, 214 Iowa 208, 242 N.W. 60 (1932) is much more liberal, permitting a widow to apply the entire exemption on an unexpended balance.

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RIGHTS OF CREDITORS

Conflict of Laws." But even this would scarcely be adequate since a court has recently chosen to phrase the problem in terms of "comity." 51 Anyone who is familiar with the general principles of conflict of laws will appreciate the unstable base upon which this brief survey must be predicated. The general uncertainties of the subject seem to be multiplied when applied to the life insurance field52 and so far as the immediate question of exemption statutes is concerned there appear to be practically no fixed principles. 83 The reason for this state of affairs is not hard to find. Insureds take out insurance, appoint beneficiaries, contract debts, move from job to job, and live out their lives either solvently or otherwise with very little regard for state lines. Choice-of-law problems are relatively insignificant with respect to many of our activities because the span of time involved is relatively short. But in the case of life insurance contracts, which are commonly measurable in terms of decades rather than years, the chances for involvement with the laws of many states are relatively great. One annotator on the subject believes that of the several laws of possible application, either the law of the jurisdiction, (1) where the insurance contract was made, or (2) where the insured was domiciled, is more logical than, (3) where suit is brought, or (4) where the contract is to be performed, or (5) where the beneficiary resides.54 A spokesman for creditors is less sanguine. Pretty much all he can see is consistent defeat for the hapless creditor. The only practical hope he feels is some type of federal intervention. 55 While there is a great deal of confusion on this subject, it seems to be generally agreed that the outstanding illustration of t h a t confusion is the case of United

States Mortgage

and

Trust

51 Tate v. Hain, 181 Va. 402, 25 S.E. (2) 321 (1943), critically reviewed on this point and others in a note: "Exemption of Life Insurance by Comity," 30 Va. L. Rev. 185 (1943). 62 This is the impression to be gained from Carnahan's exhaustive study, Conflict of Laws and Life Insurance Contracts (1942). 03 Mr. Carnahan (note 52) does not even devote a separate classification to the topic. 64 "Conflict of Laws as Regards Rights of Creditors in Respect of Proceeds of Life Insurance," 79 A. L. R. 809 (1932). 55 Cohen, "The Exemption of Life Insurance and the Conflict of Laws," 90 U. of Pa. L. Rev. 33, 61 (1941).

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BENEFICIARY IN LIFE I N S U R A N C E

Company v. Ruggles.5β Perhaps the facts and history of this case may serve to illustrate the difficulties of this subject: T h e insured, while living in Ohio, insured his life with Wisconsin and Connecticut insurers. Some of the policies were made payable to his wife, the others to his estate. Insured and his wife finally moved to New York but insured continued to pay premiums to general agents of the companies in Ohio. While a resident of New York, he changed the policies payable to his estate to his wife. He did this by mailing the policies to Ohio where the general agent forwarded them to Wisconsin. Under Connecticut law the insured could pay five hundred dollars in annual premiums regardless of conditions and the premiums paid to the Connecticut company did not exceed the amount. Wisconsin law permitted such payments up to one hundred and fifty dollars. Excess payments in fraud of creditors could be recovered from the proceeds. T h e Ohio law provided creditors could reclaim only premiums paid in fraud of creditors. T h e New York law then enabled an insured to pay up to five hundred dollars in annual premiums for his wife, regardless of his condition, but all insurance purchased with excess premiums inured to his creditors' benefit. At the time of death, the insured was solvent and his creditors sued in New York under the New York law. T h e story of the litigation as summarized by the spokesman just referred to is an absorbing one. 57 O n the first trial, the court dismissed the complaint. T h e Appellate Division on appeal granted a new trial by a three-to-two vote on the basis that the creditors had a right to follow the excess premiums over five hundred dollars paid after insured moved to New York. At this point the case was the subject of widely varying opinions expressed in five law review notes. 58 On the new trial the court granted judgment for the creditors for a proportion of the proceeds, determined by the ratio of the amount of premiums over 56 258 N.Y. 32, 179 N.E. 250 (1932). 57 Cohen, "The Exemption of Life Insurance 90 U. of P. L. Rev. 33, 49-53 (1941). 58 42 Harv. L. Rev. 575 (1929); 38 Yale L. ]. 481 (1929); 9 B. U. L. Rev. 40; and 6 N.Y.U. L. (note 57) points out that the law review writers, were divided three to two.

and the Conflict

of Laws,"

681 (1929); 14 Corn. L. Q. Rev. 304 (1929). Mr. Cohen like the Appellate Division,

R I G H T S OF CREDITORS

77

five hundred dollars annually paid in New York to the total premiums paid on the policies. On the second appeal to the Appellate Division, there were some different judges. Four judges voted for reversal, one for affirmance. Even the majority was badly split on its reasoning. Finally the case was taken to the Court of Appeals where the reversal against the creditors was finally unanimously affirmed. It will be observed that the Ruggles case involves an alleged fraudulent transfer; to wit, payment of premiums in New York in excess of the statutory amount and that the practical result is to hold that the New York law does not govern an act occurring in the state. A contrary result is not unusual. 59 For whatever it may be worth it is possible to make a distinction between fraudulent transfer cases and direct application of the exemption statutes. There is a vague generalization that exemption statutes are of local concern, applicable sometimes only to residents 60 or to contracts made within the jurisdiction. 61 This theory, however, has been very badly shattered in connection with the spendthrift cases, probably in part because courts have felt the necessity for extending the protection of Section 15 of the New York Personal Property Law to states without similar statutory sanction for the use of spendthrift clauses which have become very common. In one recent case the court applied the New York law in Michigan on the basis that the policy specifically referred to the New York law and introduced a "contractual" element. 62 Still more recently, however, the New York law has been "extended" to Virginia without the aid even of a 5» Red River Nat. Bk. v. DeBerry, 47 Tex. Civ. App. 96, 105 S.W. 998 (1907) (law of jurisdiction where payments made, and policy taken out govern); Lanning v. Parker, 84 N.J. Eq. 429, 94 A. 64 (1915) (same); G. P. Farmer Coal if Supply Co. v. Albright, 90 N.J. Eq. 132, 106 A. 545 (1919) (same); Cross v. Armstrong, 44 Ohio St. 613, 10 N.E. 160 (1887) (same); Jackson v. Tallmadge 246 N.Y. 133, 158 N.E. 48 (1927) (law of jurisdiction where proceeds transferred, not where policy taken out, governs). βο See Note: "Right of Non-resident Debtor to Benefit of Local Exemption Law," L. R. A. 1915 A. 396. Tennessee exemptions apparently apply only to residents, but in White v. Bickford, 146 Tenn. 608, 244 S.W. 49 (1922), although certain exemptions were denied a nonresident child he was given the protection of the insurance statute on the ground that it was a "distribution" statute rather than an exemption law. The Iowa statute has been extended to nonresidents.—SiarA v. Stark, 203 Io. 1261, 213 N.W. 235 (1927). βι In Equitable L. Assur. Soc. v. McRee, 75 Fla. 257, 78 So. 22 (1918), the local law was not applied to a contract made elsewhere. 62 Annis v. Pilkewitz, 287 Mich. 68, 282 N.W. 905 (1938).

78

B E N E F I C I A R Y IN L I F E I N S U R A N C E

"contractual" reference.* 3 A commentator on this last case, in the course of deploring the importation 64 of a New York exemption into Virginia, observed: As a means of putting money beyond the reach of creditors, life insurance has reached a stature that is equalled only by the spendthrift trust.65 T h e r e is, of course, much truth in this observation. T h e prin cipal difference of opinion arises over the conclusion to be drawn from it. OF M A T T E R S R E L A T I N G P R I N C I P A L L Y THE CREDITOR

TO

The Premium Payer as Creditor Payer Without an Interest. By way of preliminary note it is perhaps well to state that although it not infrequently becomes important to know who has paid premiums on a policy, no life insurance company to the writer's knowledge makes, or could practically make for that matter, a record showing the identity of premium payers. When the issue becomes important, the proof must generally be sought elsewhere than in the company records. Although the status of the premium payer here under discussion is that of creditor, it is often a special kind of "creditor" looked upon with suspicion and disfavor by other creditors and, perhaps, to some extent even by the companies. T h i s is true because a premium payer who seeks the role of creditor generally attempts to assert some kind of equitable lien on the policy proceeds which is apt to operate preferentially against other creditors and which is often disruptive of company claim procedure. It is often asserted that one without an interest who volunteers to pay a premium merely makes a gift which cannot serve as a 63 Tate v. Hain, 181 Va. 402, 25 S.E. (2) 321 (1943). T h e insured living in North Carolina took out a policy with a New York company and named his daughter as beneficiary, electing an instalment option with the usual spendthrift clause. T h e daughter moved to Virginia, and after her father's death assigned her interest in the proceeds and later became bankrupt. Virginia had no spendthrift statute but the court held that the proceeds were governed by New York law and that neither the bank nor trustee took any present interest. 64 Virginia passed its own spendthrift statute in 1944 (Laws of 1944, c. 371). It is limited to $100,000. 65 "Exemption of Life Insurance by Comity," 30 Va. L. Rev. 185 (1943).

RIGHTS OF CREDITORS

79

basis for any lien. 66 This may be true. But it is relatively unimportant, for the critical question merely becomes: What constitutes an interest? The uncertain nature of this question is illustrated by the following sequence. In 1939 a New York insurance broker who had advanced premiums on policies payable to named beneficiaries sought to establish a lien and was defeated on the basis of the New York exemption statute. 67 In 1940 a law review writer referring to this case intimated that the same result might have been accomplished irrespective of the exemption statute on the basis that the payer was a mere volunteer. 68 In 1941 the broker again brought suit, this time on policies payable to the insured's estate, which was insolvent. The court, noting the lack of protection of the exemption statute as contrasted with the earlier case, granted an equitable lien.69 Payer With an Interest. A beneficiary whose rights in the policy are legally vested of course has an interest, but has little need for it since such a payer will normally succeed to the entire proceeds.70 T h e case of the ordinary beneficiary is more difficult. In many instances probably no reimbursement is contemplated. 71 If, however, the equities are strong in the payer's favor the court will be apt to find some contractual or other element on which to base an interest. 72 When the payer has some definite status, such as collateral assignee,73 the right to a lien seems quite clear. M Proctor v. MacClaskey, 278 Mass. 238, 179 N.E. 600 (1932). βτ Brandt v. Godfrey, 172 Misc. 768, 16 N.Y. S. (2) 51 (1939). 68 Cohen, "Creditors' Rights to Insurance Proceeds as Determined by Premium Payments," 40 Col. L. Rev. 975, 1000 (1940). β» Brandt v. Godfrey, 177 Misc. 982, 32 N.Y. S. (2) 400 (1941); aff. 264 App. Div. 757, 35 N.Y. S. (2) 713 (1st Dept. 1942); leave to appeal denied 264 App. Div. 838, 35 N.Y. S. (2) 764 (1st Dept. 1942). 70 A rare exception to this rule occurred in Geisler v. Mut. Benefit H. ir A. Assn., 159 Kan. 452, 155 P. (2) 435 (1945), where an employer-beneficiary was denied recovery on the ground of a lack of insurable interest. 71 E.g., Eklund v. Eklund, 173 P. (2) 50 (Calif. 1946). 72 Massachusetts Linotyping Corp. v. Fielding, 312 Mass. 147, 43 N.E. (2) 521 (1942); Metropolitan L. Ins. Co. v. Haack, 50 F. Supp. 55 (D. C. La. 1943); Cronan v. Metropolitan L. Ins. Co., 50 R.I. 323, 147 A. 618 (1929); Yarnick v. Metropolitan L. Ins. Co., 156 Kan. 16, 131 P. (2) 881 (1942). 73 Fidelity Union Trust Co. v. Guaranty Trust Co., 135 N.J. Eq. 222, 37 A. (2) 853 (1944). For an odd case where the creditor-assignee unsuccessfully sought recovery of premiums from the insurer, see Watson v. Massachusetts Mut. L. Ins. Co., 78 App. D.C. 248, 140 F. (2) 673 (1943).

80

B E N E F I C I A R Y IN LIFE The Federal

INSURANCE

Tax Collector as

Creditor

In General. State exemption statutes are ineffective against tax claims asserted under federal laws by federal authorities. 74 It would be contrary to a sound constitutional relationship between state and federal governments to permit each state to decide on what conditions the Federal Government should enforce its taxes. T h e temptation to state legislatures to "encircle" federal tax policies might in some instance prove too strong. 75 Federal tax claims can be divided into two groups: those which can be collected out of property which is the subject of the tax, and those which must be enforced against other property belonging to the taxpayer. T h e former group, which includes estate and gift tax claims, is omitted from this paper since it is considered elsewhere in this volume. 76 T h e latter group is largely made up of income tax claims. T h e Internal Revenue Code, which governs the collection of income taxes, authorizes two types of procedure: summary distraint 7 7 and a somewhat involved form of civil action. 7 8 So far as life insurance is concerned there are a number of different situations. Insured's Interest in Cash Value. As might be expected, the authorities have had trouble in reaching cash values. It was held some time ago that the insured's interest in a policy where he had the right to the cash value was distrainable. 7 9 And it was One possible exception might occur if the Government chose to obtain an ordinary money judgment. Rule 69 of the Federal Rules of Civil Procedure requires the Government to conform to whatever collection procedures are available under state law in the absence of a special federal statute. Under a former law the Government was held bound by a state exemption statute under such circurastances.-FinA v. O'Neil, 106 U.S. 272 (1882). τ5 Perhaps Congress might adopt as its own the diverse pattern of state exemption laws as it has done in the Bankruptcy Act (U.S. C. Tit. 11 Sec. 24, Bankruptcy Act Sec. 6). But it has wisely chosen instead to prescribe a uniform list of exemptions (U.S. C. Tit. 26, Sec. 3691). These exemptions could, but do not, include life insurance in any form or amount. 7β Currently the principles governing collection of estate taxes against life insurance are in an interesting formative stage. T h e reader is fortunate in being able to turn to Mr. Hildebrand's authoritative exposition of the subject on pages 194 to 206. T7 The basic authority to distrain is contained in U.S. C. Tit. 26, Sec. 3690. Third persons in possession of taxpayer's property mav be required to surrender it (U.S. C. Tit. 26 Sec. 3710). T8 U.S. C. Tit. 26 Sec. 3678. 1» Cannon v. Nicholas, 80 F. (2) 934 (C. C. A. Colo. 1935), and Kyle v. McGuirk, 82 F. (2) 212 (C. C. A. Pa. 1936).

RIGHTS OF CREDITORS

81

subsequently intimated that the Collector might proceed directly against the insurer.80 But this intimation was later repudiated in the First, Second and Third Circuits.81 Their decisions left the Government no alternative so far as the insurer was concerned but to proceed by the longer route of the civil action. This the Government has done successfully.82 Insured's Interest in Death Proceeds. While the Federal Government properly is not bound by state exemption laws unless it chooses to be, under generally recognized principles it is affected by changes in property rights which occur pursuant to state law. Thus, even though the Government may have secured a valid lien on an insured's interest, such lien will cease when on death the insured's interest in the policy expires and a beneficiary becomes owner of the proceeds.83 But if in any case insured's interest has not irrevocably ceased, as, for example, if it can be shown that there has been a transfer in fraud of creditors for which a remedy exists under applicable state law, the Government can follow the proceeds into the hands of a transferee.84 Furthermore if the proceeds are payable to the 80 Columbian National L. Ins. Co. v. Welsh, 15 F. Supp. 777 (D.C. Mass. 1936); aft. on somewhat different grounds, 88 F. (2) 333 (C. C. A. Mass. 1937). 81 US. v. Mass. Mut. L. Ins. Co., 127 F. (2) 880 (C. C. A. Mass. 1942); accord. US. v. Aetna L. Ins. Co., 46 F. Supp. 30 (D. C. Conn. 1942); US. v. Metropolitan L. Ins. Co., 130 F. (2) 149 (C. C. A. N.Y. 1942); and US. v. Penn Mut. L. Ins. Co., 130 F. (2) 495 (C. C. A. Pa. 1942), respectively. T h e reasoning of the First and T h i r d Circuits was that the insurer's obligation to pay does not accrue until the insured elects to take the cash value. T h e Second Circuit argued that satisfaction of an intangible obligation, such as payment of a debt, does not amount to a surrender under the statute. For comment on these cases see, "Distraint on a Delinquent Taxpayer's Life Insurance Policy From the Insurers," 52 Yale L. J. 928 (1943). 82 US. v. Prudential Ins. Co. of Am., 54 F. Supp. 664 (D .C. Pa. 1944); see also US. v. Trout, 46 F. Supp 484 (D. C. Calif. 1942) and U.S. v. Ison, et al, 67 F. Supp. 40 (D. C. N.Y. 1946). 83 US. v. Steele, 26 A. F. T . R . 1186 (D. C. N.Y. 1939). In this case the Government had filed only a notice of lien. Would the decision have been the same if the customary notices of lien and levy had been filed and a warrant of distraint issued? Or suppose that the Government had instituted a foreclosure action joining all parties? At what point along the line does the Government acquire an interest which will modify the normal course of substantive rights proceeding in accordance with state law? It would seem on theory that the rule of the Steele case would be applicable at least so long as the death occurred before a decision had been reached in a foreclosure action. But until the matter has been judicially clarified most companies will doubtless feel it necessary to delay payment in border line cases pending the payment of the taxes or the securing of some form of release of lien from the tax authorities. 84 Pearlman v. Commissioner, 153 F. (2) 560 (C. C. A. 3rd 1946), aff. 4 T . C. 34 (1944).

82

BENEFICIARY IN LIFE INSURANCE

estate a state exemption statute of the procedural type will not serve to protect beneficiaries. 86 Beneficiary's Interest in One Sum Death Proceeds. The operation of law which deprives the Government of its lien on the death of the insured creates an interest in a one sum beneficiary which would seem to be subject to seizure by the Federal Government if it has a tax claim against such beneficiary and files a notice of lien with the company before the claim has been paid. 86 While the writer has come across no case, on principle it seems clear that state exemption statutes can have no greater efficacy here than in the case against the insured. Beneficiaries' Interest in Deferred Settlement Proceeds. If proceeds are payable on a deferred basis and are held under a spendthrift clause, it is not as clear on principle as the one sum case but it seems quite evident from spendthrift trust decisions that the normally formidable insurance spendthrift clause will prove no barrier to the collection of federal taxes.87 If this results in injustice, it is up to Congress rather than state legislatures to impose any needed restraints. The

Welfare

Official

as

Creditor

T h e numerous welfare statutes have not produced any great number of cases. T h e constitutionality of a New York law establishing a claim on insurance payable to the estate of the insured 85 Kieferdorf v. Commissioner, 142 F. (2) 723 (C. C. A. 9th 1911), aff. 1 T . C. 772 (1943). 86 O n the same reasoning a o n e sum p a y m e n t on a m a t u r e d endowment contract or a m a t u r e d disability income benefit would a p p e a r to be collectible from the company on a tax claim against the o n e w h o is entitled to such payment. 87 In the leading case of Matter of Rosenberg, 269 N.Y. 247, 199 N.E. 206 (1935) 105 A. L. R. 1238, rev. 243 A p p . Div. 687, 277 N.Y. S. 938 (1935) which aff. 153 Misc. 46, 274 N.Y. S. 482 (1934), cert, denied 298 U.S. 669 (1936), the New York Court of Appeals p e r m i t t e d the Federal G o v e r n m e n t to assert its lien on all of the income n o t subject to a prior 10% g a r n i s h m e n t in a Surrogate's Court proceeding despite t h e s p e n d t h r i f t protection of Sec. 15 of the Personal Property Law (which also applies to life insurance). Apparently t h e Government could not proceed by distraint a n d if it h a d brought an action it would have been b o u n d by federal s t a t u t e to enforce its judgment only in m a n n e r provided for by state statute. T w o o u t of seven judges dissented. For c o m m e n t on the case in the lower court see 48 Harv. L. Rev. 1441 (1935). I n Mercantile Co. v. Hofferbert, 58 F. Supp. 701 (D. C. Md. 1944) the Rosenberg case is followed a n d t h e cases a r e collected a n d reviewed. T h e one contrary decision therein noted to be on a p p e a l was later reversed in U.S. v. Dallas National Bank, 152 F. (2) 582 (C. C. A. T e x . 1946).

R I G H T S OF CREDITORS

83

has been affirmed. 88 In one case the court recognized the "equitable" claim of one who had been paying premiums on an industrial policy, known to the company's representative, even though the insurer had already paid the welfare authorities under the statute. 89 But seven years later the same court distinguished this case on facts which do not seem from the opinions to be too different. 90 And a welfare claim was given precedence over insured's judgment creditor. 91 In an interesting case under a statutory proceeding for distraint, the court compared the welfare officials with a trustee in bankruptcy, or a Collector of Internal Revenue, and declared that the official stood in the shoes of the insured and must comply with the policy terms before being entitled to the cash surrender value. 92 The Wife as Creditor Occasionally the wife of the insured appears as creditor. Sometimes she has sought an equitable lien for premiums paid on policies where she is no longer named as beneficiary. 93 Sometimes her claim is based on alimony 94 or other obligations. 95 T h e possibility of developing a similarity between the "marital rights" doctrine and the creditor's status sò far as life insurance is con88 Smyth v. City of New York, 156 Misc. 400, 282 N.Y. S. 136 (1935), aff. on this ground but reversed on other grounds, 247 App. Div. 27, 286 N.Y. S. 293 (1st Dept. 1936). 89 Zahn v. Metropolitan L. Ins. Co., 250 App. Div. 231, 294 N.Y. S. 17 (2nd Dept. 1937). »0 Donlan v. Metropolitan L. Ins. Co., 268 App. Div. 1000, 52 N.Y. S. (2) 10 (2nd Dept. 1944). It is not clear from the opinion who had paid the premiums. Recently a premium payer has again succeeded over welfare authorities to the extent of premiums paid.—Sapowitch v. Zajac, 270 App. Div. 980, 62 N.Y. S. (2) 535 (4th Dept. 1946); see also Middlesex County Welfare Board v. Motolinsky, 134 N.J. Eq. 323, 35 A. (2) 463 (1944). 91 In re Ciappei's Est., 159 Misc. 438, 287 N.Y. S. 988 (Surra. 1936). »2 Hodson v. Metropolitan L. Ins. Co., 34 N.Y. S. (2) 922 (Mun. Ct. 1942). 93 Mut. L. Ins. Co. v. Gervasini, 178 Misc. 121, 33 N.Y. S. (2) 278 (1942), aff. 265 App. Div. 847, 38 N.Y. S. (2) 362 (1st Dept. 1942). 94 Franklin v. Franklin, 176 Misc. 612, 28 N.Y. S. (2) 195 (1941), aff. 262 App. Div. 991, 30 N.Y. S. (2) 811 (1st Dept. 1941); Foulks v. Foulks, 49 Ohio App. 291, 197 N I . 201 (1934); Schlaefer v. Schlaefer, 71 App. D.C. 350, 112 F. (2) 177 (1940); see, "Enforcement of Claim for Alimony against Exemptions," 11 A. L. R. 123 (1921), supplemented in 106 A. L. R. 669 (1937) and 130 A. L. R. 1028 (1941). 95 Pauling v. Pauling, 65 F. Supp. 814 (D. C. Minn. 1946), aff. 159 F. (2) 531 (C. C. A. Minn. 1947).

84

BENEFICIARY IN LIFE INSURANCE

cerned has been noted. 96 However, what is perhaps as odd a case as any occurred in New York.97 There a wife secured a judgment against her husband and sought through a receiver to obtain possession of a policy in which she was named as beneficiary. N o right was reserved in her husband to change the designation. Her application was successful with respect to some other policies payable to her husband's estate but was denied with respect to the policy in which she was named beneficiary on the ground that the exemption statute made the application improper regardless of the fact that the applying creditor and beneficiary were one and the same person. A seemingly more satisfactory result on similar facts was reached in Ohio, 98 although possibly the cases can be "reconciled" on the basis that in Ohio the wife had obtained a divorce. The

Insurer

as

Creditor

Occasionally the insurer turns up in the role of creditor. Most frequently some form of set-off is sought. This has been granted 99 and also denied. 100 Where the set-off is contemplated by the terms of the policy, its allowance seems particularly appropriate. 101 On the other hand, denial of an insurer's attempt to 96 Cohen, "The Fraudulent Transfer of Life Insurance Policies," 88 U. of Pa. L. Rev. 771, 801-802 (1940). In Gaines v. Gaines, 30 Ky. L. Rep. 710, 99 S.W. 600 (1907), the court protected the wife's interest against a named beneficiary but in Farley v. First National Bank, 250 Ky. 150, 61 S.W. (2) 1059 (1933), one judge dissenting, the court seemingly abandoned its earlier position. Cohen prefers the earlier case. T h e Pennsylvania court refused to permit a wife who had a support order to retain certain policies which she had seized and in which she was named as beneficiary.—Geary v. Geary, 338 Pa. 385, 12 A. (2) 23 (1940). »•¡Abraham v. Abraham, 155 Misc. 574, 278 N.Y. S. 863 (City Ct. 1935). »8 Hoffman v. Weiland, 64 Ohio App. 467 29 N-E. (2) 33 (1940); the appellate court reversed a holding of the lower court comparable to the Abraham case. 99 Smith v. Unity Industrial L. Ins. Co., 13 So. (2) 129 (La. 1943); Wolfley v. Wooteny, 220 Mo. App. 668, 293 S.W. 73 (1927). 100 Bouchard & Sons v. Nashville Protestant Hospital, 177 Tenn. 151, 146 S.W. (2) 956 (Tenn. 1941); Jefferson Standard L. Ins. Co. v. Rankin, 39 Ga. App. 373, 147 S.E. 157 (1929); Atlantic L. Ins. Co. v. Ring, 167 Va. 121, 187 S.E. 449 (1936); Wilkes v. Equitable L. Assur. Soc. of U.S., 289 N.Y. 63, 43 N.E. (2) 812 (1942). 101 Federal L. Ins. Co. v. Kemp, 257 Fed. 265 (C. C. A. Ind. 1919). But the courts have had trouble with these cases where the insured pays part of the premium in cash and agrees to pay the rest if needed and the insurer attempts to offset the unpaid part against the cash value. T h e Indiana Supreme Court followed the Kemp case in Federal L. Ins. Co. v. Sayre, 128 N.E. 850 (Ind. 1920), then withdrew its opinion and distinguished the case under considera-

R I G H T S OF C R E D I T O R S

85

enforce a claim against the proceeds of a policy in another company seems equally understandable. 102 It is interesting to note that the Federal Government as an insurer was unable to set off a fine imposed by a district court against a beneficiary under a war risk policy. 103 The Necessaries Creditor A few statutes permit creditors who have furnished "necessaries" to reach insurance proceeds, particularly disability income and deferred settlements which are otherwise protected from creditors. This qualification would seem to merit more widespread adoption, even though it necessarily introduces some element of uncertainty over what constitutes "necessaries." In general the courts have rather closely confined the word to its basic meaning of food, clothing, and shelter, not even extending it to include notes, the proceeds of which are used to purchase such items.104 T h e term has been interpreted, however, to include alimony. 105 OF M A T T E R S R E L A T I N G PRINCIPALLY TO THE DEBTOR The Insolvent Debtor In General. A note writer almost twenty-five years ago remarked that exemption laws were generally clear but that a study of decisions on the question of life insurance effected by a failing debtor in favor of his wife or children "shows a chaotic condition of the law."10® Without conceding the entire accuracy of the first observation, it is safe to accept the second as true, tion from the Kemp case on the basis that the "premium bond" in the Sayre case was not a true obligation of the insured.—195 Ind. 7, 142 N.E. 223 (1924). In Federal L. Ins. Co. v. Harding, 152 N.E. 844 (Ind. App. 1926) the court felt that the facts were more like the Kemp case than the Sayre case but the Supreme Court disagreed-201 Ind. 704, 166 N.E. 926 (1929). 102 Ponder v. Jefferson Standard L. Ins. Co., 194 Ark. 829, 109 S.W. (2) 946 (Ark. 1937). 103 McElhany v. U.S., 101 Ct. CI. 286 (1944). 104 Abrams v. Parker, 41 N.Y. S. (2) 434 (Sup. 1943). 105 Franklin v. Franklin, 176 Misc. 612, 28 N.Y. S. (2) 195 (1941); aff. 262 App. Div. 991, 30 N.Y. S. (2) 81 (1st Dept. 1941). ιοβ Note: "Rights of Creditors of an Insured Insolvent against His Wife and Children as Beneficiaries of a Life Policy," 23 Col. L. Rev. 771 (1923).

86

BENEFICIARY IN LIFE I N S U R A N C E

both as of then and now. 107 It is hard to compress an adequate statement on this subject within the brief space available for it. At the outset it should be recognized that there are compelling social reasons why an individual should be permitted to make some provision for his family largely irrespective of his financial condition. Some of the trouble has come from the fact that legislatures have been slow to face the issue and the courts have felt the necessity for improvising—not always with the most satisfactory results. T h e best known instance of this is Central Bank v. Hume108 in which the Supreme Court of the United States announced the doctrine that an insolvent might devote a moderate amount to insurance for the benefit of his wife and children, at least if there was no fraudulent intent. An annotator stated in 1924 that this view represented the weight of authority 109 and it probably still correctly describes the results which are being reached. In general it perhaps can be said that there have been three stages, of which the Hume doctrine of "reasonable" amount marked the first. Second came the period of restricted married women's acts when the insolvent could, with relative safety, pay up to the statutory amount of annual premiums. T h i r d and finally, the typical "55-a" approach has been to prohibit transfers in fraud of creditors. O n the surface the most restrictive of the three, this can turn out to be the most liberal, depending on the test used to establish fraud and on the measure of damage. Fraudulent Transfers. In dealing with fraudulent transfers, there are four questions that must be answered: a. b. c. d.

What constitutes fraud? What constitutes a transfer? What is the measure of damage? When does the statute of limitations commence to run?

T h e problem of what constitutes fraud has long been a puzzling one. T h e difficulty is one of determining intent, which is 107 Cohen stated in 1940: "There is no other subject where the problem is so elemental, the solutions so varied, the court so adept in the creation of diverse concepts."—Cohen, "The Fraudulent Transfer of Life Insurance Policies," 88 V. of Pa. L. Rev. 771, 773 (1940). 108 128 U.S. 195 (1888). Mr. Williston criticized this case for its lack of statutory foundation. Williston, "Can An Insolvent Debtor Insure His Life for the Benefit of His Wife?" 25 Am. L. Rev. 185 (1891). 109 Note: "Right of Insolvent to Insure Life for Benefit of Relatives," 31 A. L. R. 51 (1923) supplemented by 34 A. L. R. 838 (1924).

R I G H T S OF C R E D I T O R S

87

a wholly subjective matter. Because of the impossibility of knowing or of proving what goes on in the mind of another there was a tendency at common law to adopt the rule which became incorporated in the Uniform Fraudulent Conveyance Act; namely, that a transfer while insolvent was conclusively presumed to be fraudulent regardless of the debtor's subjective state if made without a fair consideration. This, of course, greatly assisted in the determination of what was or was not a fraudulent conveyance. It is, however, equally obvious that such a conclusive presumption might work a substantial hardship with regard to life insurance, particularly where the exemption statute specifically excepted all transfers made in fraud of creditors. Frequently, insureds may be in genuine doubt over their solvency or, in fact, may not even suspect the possibility of being insolvent. T h e current New York statute has attempted to avoid the harshness of the conclusive presumption of fraud based merely on the fact of insolvency by invoking another definition of fraud from the Uniform Fraudulent Conveyance Act; namely, "actual intent to hinder, delay or defraud creditors." 110 Purely as a matter of reason this definition of fraud is much fairer to the parties than the conclusive presumption based on insolvency because it accords with the fact. But those who represent creditors again point to the practical impossibility of proving a state of mind. 111 T h e public verdict on this issue will be eventually ascertainable from the number of states which follow the lead of New York in this matter. 112 Of course, a conceded transfer would not be fraudulent if it involved only property which was absolutely exempt and which could never be subject to the claims of creditors.113 With regard to what constitutes a transfer, the clearest form is where an insured names a beneficiary for or makes an assignn o Sec. 166 Insurance Law (Laws of 1939, C. 882). m Mr. Cohen is vehement on this point; see note 107. 112 Not necessarily by statute. For example in Doethlaff v. Penn Mut. L. Ins. Co., 117 F. (2) 582 (C. C. A. Ohio 1941), the court, while giving lip service to the doctrine of the Hume case, in fact describes the issue in terms of what constitutes "intent to delay, hinder and defraud" creditors. 113 Prudential Ins. Co. of Am. v. Beck, 39 Cal. App. (2) 355, 103 P. (2) 241 (1940). A long dissenting opinion in this case in effect queries the soundness of the assumption that the exemption is absolute in fraudulent transfer cases. See also In re Rubin, 29 F. Supp. 416 (D. C. N.Y., 1939).

88

BENEFICIARY IN LIFE

INSURANCE

m e n t of a n e x i s t i n g p o l i c y h i t h e r t o p a y a b l e to h i s transfers w e r e e x c e p t e d i n t h e Hume case a n d i n c o u r t s f o l l o w i n g t h e d o c t r i n e of t h e Hume case d o t o transfers of e x i s t i n g i n s u r a n c e . 1 1 4 Cases h o l d i n g trary are g e n e r a l l y based o n s t a t u t e s . 1 1 5

estate. S u c h general the n o t a p p l y it to t h e c o n -

F r o m t h e p o i n t of v i e w of logic, p a y m e n t of p r e m i u m s is as m u c h a transfer of p r o p e r t y as a s s i g n m e n t of a n i n t e r e s t i n a p o l i c y b u t h i s t o r i c a l l y t h e d o c t r i n e of t h e Hume case w a s int e n d e d t o a p p l y t o p o l i c i e s o r i g i n a l l y t a k e n o u t for w i v e s a n d c h i l d r e n . T h e P e n n s y l v a n i a courts w e r e p a r t i c u l a r l y o u t s p o k e n i n t h e i r d e f e n s e of this p r i n c i p l e , a n d i n o n e case t h e c o u r t p o i n t e d o u t "in s u c h cases t h e p o l i c y w o u l d b e at n o t i m e t h e p r o p e r t y of t h e i n s u r e d , a n d h e n c e n o q u e s t i o n of f r a u d i n its transfer c o u l d arise, as t o his creditors." 1 1 6 N o t all courts h a v e s h a r e d this v i e w . 1 1 7 If, h o w e v e r , p r e m i u m s are p a i d w i t h s t o l e n f u n d s , t h e c r e d i t o r has i n g e n e r a l b e e n p e r m i t t e d to recover e v e n t h o u g h there w a s an e x e m p t i o n s t a t u t e w h i c h w o u l d n o r m a l l y p r e v e n t it. 1 1 8 114 For a collection of cases on this point see Note: "Validity as against Creditors of Change of Beneficiary of Insurance Policy from Estate to Individual," 6 A. L. R. 1173 (1920), supplemented by 106 A. L. R. 596 (1937). Perhaps this difference accounts for the tendency of some courts to apply general exemption statutes of the "55-a" type only to policies "originally payable" to third parties; e.g., Matter of Greenberg, unofficially reported in 49 A. L. C. Legal Bull. 146 (D. C. N.Y. 1943), and McCarthy v. Griffen, 299 Mass. 309 12 N.E. (2) 837 (Mass. 1938). l i s In Massachusetts transfers of existing insurance to a wife are protected under a married women's id—Bailey v. Wood, 202 Mass. 549, 89 N.E. 147 (1909)—but not transfers to anyone else, even a son— York v. Flaherty, 210 Mass. 35, 96 N.E. 53 (1911). Such transfers are also protected in Kentucky, Farley v. First Nat. Bank, 250 Ky. 150, 61 S.W. (2) 1059 (1933); in North Carolina, Pearsall v. Bloodworth, 194 N.C. 628, 140 S.E. 303 (1927); and in New Jersey, Borg. v. McCroskery, 120 N. J. Eq. 80, 184 A. 187 (1936); see also Cole v. M arpie, 98 111. 58 (1880). n e McCutcheon's Appeal, 99 Pa. 133, 137 (1881). Other examples of this doctrine are Ross v. Minnesota Mut. L. Ins. Co., 154 Minn. 186, 191 N.W. 428 (1923), 21 Mich. L. Rev. 937 (1923), 2 Wis. L. Rev. 316 (1923); and Bennett v. Rosborough, 155 Ga. 265, 116 S.E. 788 (1923), 33 Yale L. J. 207 (1923). 117 E.g. Merchants' and Miners' Transportation Co. v. Borland, 53 N.J. Eq. 282, 31 A. 272 (1895) ; Lehman v. Gunn, 124 Ala. 213, 27 So. 475 (1900); Exchange state Bank v. Poindexter, 137 Kan. 101, 19 P. (2) 705 (1933) . 118 E.g., Tolman v. Crowell, 288 Mass. 397, 193 N.E. 60 (1934); Holmes v. Gilman, 138 N.Y. 369, 34 N.E. 205 (1893); Jansen v. Tyler, 151 Ore. 268, 49 P. (2) 372 (1935); Bennett v. Rosborough (note 116), is one of the few cases holding to the contrary. See "Right With Respect to Proceeds of Life Insurance of One Whose Funds Have Been Wrongfully Used to Pay Premiums," 38 A. L. R. 930 (1925).

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As a matter of theory, it may be argued that if an insolvent insured who has the right to revoke the designation of a beneficiary fails to do so, the passage of the proceeds on death constitutes a transfer in fraud of creditors. This has been argued, but unsuccessfully.119 Repayment of an outstanding loan would seem to amount to a transfer and it has been so treated.120 A somewhat related problem arises where the transaction involves a withdrawal of funds which are under the protection of an exemption statute. The result depends upon the nature of the exemption and probably upon whether the court feels the insured is in reality using the funds for his own purposes.121 This brings us to our third question: Granted that a transfer has been made and that it is fraudulent, what is the proper measure of damage? The answers have varied all the way from nothing to the entire proceeds.122 Where the transfer consists merely of a payment of premiums while insolvent, a strong argument can be made that the damages l i e Weil v. Marquis, 256 Pa. 608, 101 A. 70 (1917); Irving Bank v. Alexander, 280 Pa. 466, 124 A. 634 (1924); North British ύ· Mercantile Ins. Co. v. Ingals, 109 Cal. App. 147, 292 P. 678 (1930); Colgate v. Guaranty Trust Co. 159 Misc. 664, 288 N.Y. S. 463 (1936). 120 in re Hirsch, 4 F. Supp. 708 (D. C. N.Y. 1933). But a contrary result was reached in In re Yaeger, 21 F. Supp. 324 (D. C. N.Y. 1937), on the basis that the Hirsch case involved a policy loan which was in the nature of an advancement while the Yaeger case involved a bank loan for which the policy was pledged as collateral. A contrary result was also reached in In re Silansky, 21 F. Supp. 41 (D. C. Pa. 1937), on the ground that the Pennsylvania exemption statute, contrary to the New York law, does not restrict exemption of policy to those not procured by fraud. 121 In Schwartz v. Holzman, 69 F. (2) 814 (C. C. A. N.Y. 1934), where the check was drawn jointly to the insured and the beneficiary, the court ruled against the trustee in bankruptcy who sought to claim the funds. A contrary ruling was made in Butler v. Rand, 11 F. Supp. 343 (D. C. N.Y. 1935), where the check was payable to the insured alone. 122 One practical aspect is whether the question of damages is being considered before or after maturity. One early case, Del Valle v. Hyland, 76 H u n . 493, 27 N.Y. S. 1059 (1st Dept. 1894), was cited by Mr. Cohen for the proposition that creditors may recover nothing before maturity if policies have no substantial cash equity. He deprecates this result and suggests in " T h e Fraudulent Transfer of Life Insurance Policies," 88 U. of Pa. L. Rev. 771, 773 (1940), that since even the cash value may not truly measure the value of a policy, creditors should be permitted to carry the policy along on some equitable basis. This was virtually the result in Reynolds v. Aetna L. Ins. Co., 160 N.Y. 635, 55 N.E. 305 (1899). Under a Missouri statute it has been held that an action brought before death is premature—Kansas City Mo. v. Halvorson, 352 Mo. 1027, 180 S.W. (2) 710 (1944).

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should not exceed a return of premiums with interest. T h i s rule is expressed in "55-a" type statutes 123 and in some others. Where the transfer consists of a transfer of the debtor's interest in the policy, the cash value of the interest transferred is one obvious solution. 124 Naturally, creditors are not satisfied with such a rule and even courts holding to such solution are apt to admit the possibility of exception where the insured may be approaching death or some other exceptional fact is present. 125 Many courts, however, habitually award the proceeds rather than the cash value where the entire interest was transferred fraudulently and death of the insured has matured the policy. 126 Another possible measure of damage is the proportion of the insurance proceeds which are attributable to the property fraudulently transferred. 127 Finally, there is the question of when the statute of limitations commences to run. If it be conceded that there has been a transfer in fraud of creditors, how promptly must they move to seek relief? T h e r e are three likely times from which the applicable statute of limitations may commence to run, (1) the date of transfer, (2) the date of discovery of the fraud, or (3) the date of death of the insured. As between actual fraud and constructive fraud—that is, merely fraud presumed from insolvency at the time of transfer—the second time is the more appropriate for actual fraud and the first for constructive fraud. T h e cases, however, largely divide on whether the statute commences to run as of the date of payment of the premium or the date of death. 128 123 See note 37 of preceding chapter. 124 White v. Pacific Mut. L. Ins. Co., 150 Va. 849, 143 S.E. 340 (1928); Union Central L. Ins. Co. v. Flicher, 101 F. (2) 857 (C. C. A. Calif. 1939); Equitable L. Assur. Soc. v. Hitchcock, 270 Mich. 72, 258 N.W. 214 (1935), 33 Mich. L. Rev. 1108 (1935); First Wisconsin Nat. Bank of Milwaukee v. Roehling, 224 Wis. 316, 269 N.W. 677 (1936), rehearing same result 224 Wis. 329, 272 N.W. 664 (1937). 125 Navassa Guano Co. v. Cockfield, 253 F. 883 (C. C. A. S.C. 1918); Bryson v. Manhart, 11 Cal. App. (2) 691, 54 P. (2) 778 (1936). 126 Continental National Bank v. Moore, 83 App. Div. 419, 82 N.Y. S. 302 (1st Dept. 1903); Gould v. Fleitmann, 188 App. Div. 759, 176 N.Y. S. 631 (1st Dept. 1919), afl. 230 N.Y. 569, 130 N.E. 897 (1920); Love v. First Nat. Bank of Birmingham, 228 Ala. 258, 153 So. 189 (1934). 127 See Jansen v. Tyler, 151 Ore. 268, 49 P. (2) 372 (1935). 128 The typical "55-a" statute limits the recovery of premiums paid in fraud of creditors by the phrase "subject to the statute of limitations." Some courts have held that this means that the statute does not commence to run until

RIGHTS OF CREDITORS The Bankrupt

91

Debtor

Relation Between State and Federal Statutes. While a large share of the cases on the rights of creditors in life insurance are in the bankruptcy courts, many of them turn on interpretations of state exemption statutes. These are considered in other parts of this paper. T h i s section will be confined to questions peculiar to bankruptcy. 129 T h e question of primary importance is the degree to which state exemption statutes will be recognized in bankruptcy. It will be recalled that Section 6 of the Bankruptcy Act provides that the Act shall not affect the allowance of state law exemptions to bankrupts. Insurance is not mentioned as such in this section. T h e proviso in Section 70a, however, stipulates that a bankrupt may free from the bankruptcy insurance policies payable to himself by paying to the trustee an amount equal to their cash values. It was originally thought that the proviso was intended to override Section 6 so far as policies payable to insured's estate were concerned. 130 But it was finally determined otherwise by the Supreme Court. 1 3 1 In other words the proviso does not affect policies exempt under state law. They are completely excluded from the bankruptcy and are not available to creditors in any degree. If policies are not so exempt they will at least enjoy the partial exemption furnished by the proviso. Occasionally a bankruptcy proceeding may involve some creditors whose claims arose before the passage of a state exemption statute and other creditors whose claims came into existence after death of the insured-Forfe v. Flaherty, 210 Mass. 35, 96 N.E. 53 (1911); John Weenink & Sons Co. v. Blahd, 73 Ohio App. 67, 54 N.E. (2) 426 (1943). Other courts interpret the phrase to mean that the statute starts to run when the premium is paid.-Parfcs v. Parks, 288 Ky. 350, 156 S.W. (2) 90 (1941); Lanning v. Parker, 84 N.J. Eq. 429, 94 A. 64 (1915); Greenberg v. Goodman, 128 N.J. Eq. 149, 15 A. (2) 633 (1940); Purvin v. Grey, 270 App. Div. 152, 59 N.Y. S. (2) 176 (1st Dept. 1945). One of the problems of the latter interpretation is what the creditors may do during the lifetime of the debtor if the statute is running against them. T h e court in the Purvin case on this point refers to the Greenberg case and to Stokes v. Amerman, 121 N.Y. 337, 24 N.E. 819 (1890), in which it was indicated that a creditor could invoke the aid of equity to preserve rights in premium payments pending the death of the insured. 129 For a collection of cases see "Life Insurance As Assets Under Bankruptcy Act," 68 A. L. R. 1215 (1930), supplemented by 103 A. L. R. 239 (1936). 130 Matter of Lange, 91 Fed. 361 (D. C. Io. 1899); Matter of Scheid, 104 Fed. 870 (C. C. A. Calif. 1900). 131 Holden v. Stratton, 198 U.S. 202 (1905).

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such passage. The state statute will under such circumstances, of course, exempt the life insurance only with respect to the latter claims.132 The trustee in such instances will be required to proceed separately on behalf of such creditors as are not barred by the state law.133 Disposition of Policies not Exempt under State Law. Having determined that a policy is not exempt under state law, the bankruptcy court is still faced with the problem of what to do with it under the federal statute. T h e proviso is phrased in terms of policies having a "cash surrender value." This expression gave some trouble. What about policies having no such value? The Supreme Court held they did not pass to the trustee. 134 Where there was a "loan value" 135 or where the company customarily purchased its policies for a given value,130 the proviso was held to apply to such amounts. Where the equity of the bankrupt was less than the cash value because of a loan, the former was construed to be the amount payable under the proviso.137 The time aspects of bankruptcy sometimes become particularly important in the case of life insurance. The Act vests title in the trustee as of the date of adjudication, but only to the property held by the bankrupt as of the time of filing of the petition. The Supreme Court held that a trustee had no interest in a policy on the life of a bankrupt who committed suicide between the time of filing his petition and the date of adjudication. 138 One major interpretation became necessary as the years went by. At the time the law was enacted in 1898, it was not customary for the insured to reserve the right to change the beneficiary. Policies were either payable to the insured's estate or they were payable to a named beneficiary. In the latter case, they were "vested" in the beneficiary and did not pass to the trustee on the 132 See note 17. 133 In re Lissak, 110 F. (2) 370, (C. C. A. N.Y. 1940); In re Newmaier, 11 F. Supp. 341 (D. C. N.Y. 1935). The same is true where disability income is B o u g h t - W i l s o n v. Relin, 135 F. (2) 99, (C. C. A. N.Y. 1943). 134 Burlingham v. Crouse, 228 U.S. 459 (1913). 135 Richter v. Rockhold, 253 Fed. 941 (C. C. A. Tex. 1918). 136 In re Mertens, 205 U.S. 202 (1907). But see Matter of Gannon, 247 Fed. 932 (C. C. A. N.Y. 1917). 137 Everett v. Judson, 228 U.S. 474 (1913). 138 Idem; also Andrews v. Partridge, 228 U.S. 479 (1913).

93 R I G H T S OF I CREDITORS bankruptcy of the insured.139 Within a few years after the turn of the century the practice grew up of reserving the right to change the beneficiary. Such policies did not literally come within the terms of the proviso, but the bankrupt had it within his power to make them payable to his estate and by another part of Section 70a the trustee succeeded to powers which the bankrupt might exercise for his own benefit. After some indecision,140 the Supreme Court finally settled the law in the well-known case of Cohen v. Samuels141 by holding that the policy did come under the proviso and the trustee was entitled to the cash value or its equivalent if the insured had it within his power to obtain it by a reserved right to change the beneficiary to his estate. Serious possible consequences of this decision for the companies were averted by a subsequent holding that, if a company without notice from a trustee of his interest paid a death claim, it would not be required to pay again. 142 During the half-century which has elapsed since the passage of the present Bankruptcy Act, there has been very considerable change both in certain technical phases of life insurance and in its relative importance to the general economy. The doctrines developed by the cases have been vigorously assailed for their deviation from the original intent of Congress and for their want of statutory and logical justification.143 Granted that theoretical deficiencies can be proved, it may be doubted that this is of much consequence apart from a general argument on behalf of creditors. And so far as creditors are concerned they would seem to have far better grounds for complaint, if any are to be made, in the state laws and their interpretation. Nature of Bankrupt's Interest. Since the great majority of 139 Matter of Simons and Griffin, 255 Fed. 521 (C. C. A. Mass. 1919). 140 For an account of earlier cases and speculation on the subject see Howland, "National Bankruptcy Act as Relating to Life Insurance," I. Proc. Assn. of L. Ins. Counsel II, pp. 4-10; see also Patten, "Do General State Exemption Statutes in Favor of Insured's Wife Protect 'Right to Change' Policies Payable to Her, Containing No Endowment Feature, from His Trustee in Bankruptcy?," I Proc. Assn. L. Ins. Counsel LII (1921); and Patten, " T h e Effect of Insured's Bankruptcy on Policies Payable to His Wife, but Reserving the Right to Change," IV Proc. Assn. L. Ins. Counsel 259 (1929). 141245 U.S. 50 (1917). 142 Frederick v. Fidelity Mut. L. Ins. Co., 256 U.S. 395 (1921). 143 Cohen, " T h e Role of Life Insurance as an Asset in Bankruptcy: Part I," 28 Va. L. Rev. 211 (1941).

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BENEFICIARY IN LIFE INSURANCE

insureds are men a n d since most b a n k r u p t s are men, it is not surprising that the normal interest of a b a n k r u p t in an insurance policy is that of an insured. A n d this was in all likelihood the relation which was contemplated when the Act was drawn a n d has been the basis of the foregoing discussion. Occasionally, however, a b a n k r u p t will have some other interest, either that of beneficiary, assignee, or other form of ownership in life insurance on the life of another. T h e law is not clear in its application to these special interests and there is some authority that where the interest is vested 144 the exemption features of the Act will apply. 1 4 5 It has also been held, however, that the cash surrender value privilege does not apply and that the policy passes to the trustee as an ordinary asset. 146 T h e r e lias been some effort to reconcile these cases on the basis that the cash surrender value privilege was extended only in instances w h e r e the b a n k r u p t was a d e p e n d e n t of the insured. 1 4 7 The Effector-Beneficiary

Debtor

Protection of the effector-beneficiary debtor is the most difficult to justify and while the subject is touched u p o n at various other points in this paper, it would seem useful to consider it by itself. N o form of e x e m p t i o n is particularly palatable to a creditor who is experiencing difficulty in the collection of a d e b t which is owed to him. But, at least in theory, the typical insurance exemption statute merely protects donee-beneficiaries from creditors of the donor, or where creditors of a donee-beneficiary are barred, the life insurance is property which has been given to the debtor, u p o n which, it can be argued, creditors have no right to rely. T o permit a debtor to effect t h e exemption of his own 1 « Of course where the bankrupt is named beneficiary subject to the right of the insured to change the designation, there is no substantial right for the trustee to succeed to—Matter of Hogan, 194 Fed. 846 (C. C. A. Wis. 1912). 145 Curtis v. Humphrey, 78 Fed. (2) 73, 103 A. L. R. 236 (C. C. A. Miss. 1935), cert. den. 296 U.S. 605 (1935); Matter of Jacobson, 24 F. Supp. 749 (D. C. N.J. 1938). 146 International L. Ins. Co. v. Carroll, 26 F. (2) 369 (D. C. Tenn. 1928); Wolter v. Johnson, 34 Fed. (2) 598 (C. C. A. Pa. 1929); Clements v. Coppin, 61 F. (2) 552 (C. C. A. Calif. 1932). 147 E.g., see 39 Col. L. Rev. 507 (1939), 87 U. of Pa. L. Rev. 344 (1939). Mr. Cohen in his article (see note 143) says of these notes: "This kind of analysis merely follows the courts into a quagmire of error, judicially created, and fails to insist on a proper construction of the statute." 28 Va. L. Rev. 211, 249 footnote 121 (1941).

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property, on the other hand, runs contrary to a principle which eeems to have become deeply embedded in our law. 148 There are a number of instances where the effector-beneficiary exemption may occur. There are traces of it in the interpretation given to some married women's acts. T h e · fraternal statutes typically have barred all creditors but are relatively unimportant so far as creditors are concerned. In disability income and annuity statutes, the effector-beneficiary exemption problem becomes critical and requires careful limitation. 149 The spendthrift statutes likewise offer opportunity for the problem to arise. 150 It is probably, however, in the "55-a" type of statute that the most serious consequences could occur. Effector-beneficiary protection is rather carefully excluded from this type of statute. 151 One notable exception is the provision in Section 166 of the New York Insurance Law permitting a wife to secure her own funds without limit, other than actual fraud, by purchasing life 148 Dean Griswold, however, appears to question its validity—Gris wold, Spendthrift Trusts (1936) Sec. 474—and cites in support of a contrary view Costigan, "Those Protective Trusts which are Miscalled 'Spendthrift Trusts' Re-examined," 22 Calif. L. Rev. 471 (1934). Professor Costigan suggests that the spendthrift trust principle "should be carried farther than it has been so far carried by any court so that one who is actually a spendthrift and who knows that he will be an easy prey for designing persons who seek to tempt and impose upon wasters, may create such a reasonable income spendthrift trust for himself, so long as and to the extent that, his spendthrift trust is not in fraud of existing creditors or a subterfuge used with fraudulent intent to enable him to speculate to the detriment of future creditors" (p. 495). For further comment on the general question see Nabors, "Proposals for Amendment of the Louisiana Trust Act and the Louisiana Life Insurance Exemption Statute," 8 Tul. L. Rev. 522, 533-37 (1934). 149 T h e amount of income which is exempt is generally limited by a ceiling. 150 it has been concluded that while a beneficiary cannot effect a spendthrift exemption when electing an option in the absence of a statute, the contrary may be true if there be a statute; see Barker, " T h e Spendthrift Clause in Life Insurance," 1 Jour, of Am. Soc. of Char. L. Underwriters 77, 82, 84 (1946), who cites Provident Trust Co. v. Rothman, 321 Pa. 177, 183 A. 793 (1940), and Roth v. Kaptowsky, 393 111. 484, 66 N.E. 664 (1946), for the second proposition. This is not invariably so; e.g., the New York courts do not construe the statute to permit a beneficiary to create spendthrift protection for himself.— Matulka v. Van Roosbroeck, 25 N.Y. S. (2) 240 (City Ct. 1940), aff. 25 N.Y. S. 247 (App. T . 1st Dept. 1941). This has long been the interpretation of the section where a true trust is involved.—Newton v. Hunt, 134 App. Div. 325, 119 N.Y. S. S (1st Dept. 1909) aff. 201 N.Y. 599, 95 N.E. 1134 (1911); Carlebach v. Central Hanover Bank, 269 App. Div. 45, 53 N.Y. S. (2) 707 (1st Dept. 1945). IBI In Hirst, How New York State Protects Life Insurance and Annuities (3rd ed. 1946), the explanation of how Sec. 166 of the Insurance Law excludes effector-beneficiary protection is described under the title "Preventing Abuse of the Exemption Law" (p. I I ) .

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BENEFICIARY IN LIFE INSURANCE

insurance on the life of her husband. T h e wisdom of this provision is certainly open to argument. 152 While the statute by its terms is restricted to cases where the wife purchases insurance out of her own funds, it might in time come to be construed to cover policies taten out for her benefit by her husband, on the theory that he was acting as her agent when he applied and paid for the insurance. While one New York case so far has rejected this view,153 a lower federal court in that state seems to have held that Section 166 bars the wife's creditors even where the husband pays the premiums. 154 It may, of course, be argued that in the long run virtually the same result can be obtained by combining the results of a general statute with a spendthrift statute. But this is not entirely true. T h e future development of this part of the New York statute will be of great interest. OF MATTERS RELATING PRINCIPALLY T O T H E LIFE INSURANCE Types

of Benefits

Protected

Cash Values. Regardless of the exemption statutes, cash value cases have always presented difficulties for creditors. 155 It is an illusive sort of property at best and the legal machinery designed to cope with it has always been complicated and difficult even for 152 Mr. Hirst explains that this is a "special situation" (p. 10), and apparently is based in part upon the exemption wives enjoyed under the New York Married Women's statute as illustrated by Baron v. Brummer, 100 N.Y. 372, 3 N.E. 474 (1885); Amberg v. Manhattan, 171 N.Y. 314, 63 N.E. I l l (1902). It would seem, however, that Sec. 166 goes beyond the older exemption. Needless to say this provision provoked violent disapprobation from the creditors' side. See Cohen, "Exemption of Property Purchased with Exempt Funds," 27 Va. L. Rev. 573, 573-584 (1941). T h e author concludes (p. 614) in the following vein: "Somehow, sometime, reaction must come. It is beyond belief that the spread of the full-blooded exemption in favor of the beneficiary from her creditors as well as those of the insured will not react to the ultimate harm of the community, notably those least able to defend themselves. For, if it be argued that the pauperism of the widows of insured debtors is what worries the 'State,' what of the widows of the creditors? T h e tort creditors, for example. The widow and her brood of orphans whose father has been killed by an insured. Are they ill-favored in the eyes of the law? It is a bitter reflection that the answer must be yes. "When the sentimentalists weep over the prostrate corpse of an insured, remember the other dead man. There are tears in his house, too." 153 Levine v. Laurdan Management Corporation, 179 Misc. 241, 38 N.Y. S. (2) 442 (City Ct. 1942) aff. 180 Misc. 672, 41 N.Y. S. (2) 123 (App. T. 1st Dept. 1943), afï. 266 App. Div. 840, 43 N.Y. S. (2) 751 (1st Dept. 1943). 154 Dellefield v. Block et al, 40 F. Supp. 616 (D. C. N.Y. 1941). 155 Some of these difficulties and related matters are catalogued in Boughton, "Creditors and Surrenders," III Proc. Assn. of L. Ins. Counsel 311 (1926).

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lawyers. When a creditor obtains a judgment against a man who owns an automobile, let us say, he can call on the sheriff to seize the automobile and to sell it on execution to satisfy the judgment. If the judgment debtor has no tangible property but has a bank account, the problem is more difficult, but ultimately the result is the same. If, however, the only asset is a life insurance policy on his life, payable to his estate, there isn't even a "bank account" in the eyes of the law until the insured has elected to take the cash surrender value. T h e law has quite generally had difficulty enforcing collection processes against property which requires affirmative action on the part of the debtor before the nature of the property becomes fixed. With this background, it is not surprising to find an authority on this subject concluding that in general it is not possible to attach the cash value of life insurance policies payable to the insured's estate. 156 He is using the term "attach" in a technical sense, meaning a proceeding employed where the debtor is not in the jurisdiction and cannot be sued in the normal manner. This leaves open the question of whether the cash value of a policy payable to insured's estate can be reached by any means after a debtor has been sued and judgment obtained in the normal manner. T h e answer to this last question, after some indecision in the New York cases, 157 was settled in the affirmative for that state. 158 T h e question has had various answers in other states, sometimes in the affirmative, 159 sometimes in the negative. 160 T h e procedural difficulties just alluded to, of course, exist to 15« See Cohen, " T h e Attachment of Life Insurance Policies," 26 Cor. L. Q. 213 (1941). The leading case seems to be Columbia Bank v. Equitable L. Assur, Soc., 79 App. Div. 601, 80 N.Y. S. 428 (1st Dept. 1903). Also see Ross, "Writs of Attachment Against Life Insurance Policies," III Proc. Assn. of L. Ins. Counsel 105 (1925). Creditor was denied right to file creditor's bill in equity in Hamburger Apparel Company v. Werner 17 Wash. (2) 310 135 P. (2) 311 (1943). 167 See Cohen, "Execution Process and Life Insurance," 39 Col. L. Rev. 139, 144 (1939). 168 Rockwood b Co. v. Trop, 211 App. Div. 421, 207 N.Y. S. 507 (2nd Dept. 1925), (reargument) 212 App. Div. 883, 208 N.Y. S. 459 (2nd Dept. 1925). 169 E.g., Anthracite Ins. Co. v. Sears, 109 Mass. 383 (1872). 160 E.g., Farmers ir Merchants Bank v. National Life Ins. Co., 161 Ga. 793, 131 S.E. 902 (1926); see note on this case: "Rights of Creditors of Life Insured as to Options or Other Benefits Available to Him in His Lifetime," 44 A. L. R. 1188 (1926) supplemented by 57 A. L. R. 695 (1928) for a collection of cases; Molloy v. Prudential Ins. Co. of Am., 129 Conn. 251, 27 A. (2) 387 (1942).

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BENEFICIARY I N LIFE I N S U R A N C E

at least an equal extent where the policy is payable to some one other than the insured. 1 6 1 In addition, the exemption statutes must be taken into account. A few of these statutes specify that their protection extends to cash values. 162 States having the "55-a" type statute generally have no difficulty in interpreting "proceeds and avails" to cover cash values. In some states, however, language that would seem at first sight clearly to exclude cash values has been held to cover them. T h e cases in Tennessee provide an interesting example of a broad interpretation of this sort. 163 T h e foregoing discussion on cash values has been based on the assumption that the insured has not elected his right to surrender the policy or apply for a loan. If he does so and the exemption statute is confined to protection of the beneficiary's interest, as most of them are, at some point along the line the protection will cease. In an earlier New York case an insured who borrowed on his policy to pay a premium while under an injunction forbidding him to dispose of his property was punished for contempt. 1 6 4 In a later case of the same sort, the insured was again punished under the same facts except this time he was held in contempt for failure to tell the facts and the court said that since he didn't acquire the property (i.e., make the loan) until after the injunction had been served, there was no violation of the injunction. 1 6 5 ιβι Recovery denied in Fidelity Coal Co. v. Diamond, 322 111. App. 229 54 N.E. (2) 240 (1944). i«2 E.g., Fla. Sec. 222.14 St. 1941. 163 T h e cases are collected and discussed in Grade, "Exemption of Life Insurance Policies Under Tennessee Statutes and in Bankruptcy," 11 Term. L. Rev. 84, 89-95 (1933). T h e Tennessee statutes are silent o n the subject of cash values and the early cases hold they applied only after death of the insured. Indeed the early laws appear in a chapter of the Code entitled, "Of the Administration of Estates." N o n e the less, the modern cases have refused to follow the early rulings and have held the statutes applicable to cash values. T h e author of the article concedes that the law has been settled by Dawson v. National Life Ins. Co., 156 T e n n . 306, 300 S.W. 567 (1927), but submits that the case "is wrong (1) o n principle and (2) public policy." 164 Hall v. Hess, 97 Misc. 331, 161 N.Y. S. 418 (App. T . 1st Dept. 1916). 165 mo Park Avenue Corp. v. Hagerty, 151 Misc. 758, 272 N.Y. S. 406 (City Ct. 1934). Mr. Cohen is critical of this case in "Execution Process and Life Insurance," 39 Col. L. Rev. 139, 150 (1939), but it probably represents the trend. In fact, it has been held that an insurer may not refuse to make a loan to pay premiums because an ordinary third party order injunction is in force. -Prever v. Aetna L. Ins. Co., 43 F. Supp. 752 (D. C. N.Y. 1941).

R I G H T S OF CREDITORS

99

Dividends. Much the same reasoning that is applicable to cash and loan values applies to dividends. It is not the intention of most statutes to protect the insured's property, but when do the dividends cease to be the beneficiary's insurance and become the insured's cash? Out of a series of New York cases on dividends there is one where the creditor was successful in getting the dividends.166 In another instance dividends on a paid-up policy were allowed to accumulate.167 In two other cases the insured was permitted to use dividends to reduce the premium.168 A Pennsylvania case has held that a creditor cannot compel a debtor to take his dividend in cash.169 Disability Income. Disability income does not fit into the pattern of the ordinary general exemption statute because payments are normally made to the insured rather than to a third party. And yet it is perfectly clear that there should be some protection since in many cases such income takes the place of the insured's normal source of livelihood. In New York, as a result of historical development, disability income was not accorded the protection enjoyed by other types of income where creditors are permitted to take no more than ten per cent. And by a series of lower court cases, it was held that Section 55-a did not apply.170 The result was the enactment of Section 55-b of the Insurance Law which exempted such payments in their entirety except for claims based on necessaries. But this perhaps went too far. 171 At any rate, the New York Legislature in the 1939 revision placed a four-hundred-dollarper-month ceiling on such payments.172 In a few other states, disability income has been the source of litigation. In the District of Columbia a wife was permitted to recover alimony in spite of a statute exempting disability 166 242 West 38th St. Corp. v. Meyrowitz, 162 Misc. 488, 293 N.Y. S. 708 (1936) aff. 248 App. Div. 708, 290 N.Y. S. 109 (1st Dept. 1936). 167 Francis H. Leggett & Co. v. Frank, 161 Misc. 613, 291 N.Y. S. 681 (City Ct. 1936); also Matter of Keil, 88 F. (2) 7 (C. C. A. N.Y. 1937). 168 Robro Realty Corp. v. Lazarus, 161 Misc. 610, 291 N.Y. S. 678 (City Ct. 1936); Randik Realty Corp. v. Moseyeff, 147 Misc. 618, 263 N.Y. S. 440 (City Ct. 1933). 169 Martin v. Balis, 18 D. & C. 187 (Pa. 1932). 170 The cases are cited in Cohen, "Execution Process and Life Insurance," 39 Col. L. Rev. 139, 157 (1939). 171 Mr. Cohen, of course, felt so. Idem., p. 158. 172 Sec. 166, subsec. 2, Insurance Law, enacted by Laws of 1939, C. 882.

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income. 173 Under a Virginia statute exempting such payments from execution, the company was not allowed to make a set-off.174 Under a Texas statute a one-sum payment was held not exempt. 1 7 5 In Tennessee the life insurance statute was construed to cover a death benefit under an accident policy 176 but not disability income. 177 T h e r e is no disability exemption statute in Florida but a cash value statute was held to cover a lump sum disability settlement. 178 In North Carolina an insured was receiving three hundred dollars per month disability. There was no disability statute but the constitution contained an exemption from execution up to five hundred dollars. T h e court concluded that it could grant protection on the basis of a "continuing exemption." 1 7 9 Regardless of the need for some protection; the wisdom of this conclusion is open to argument. Endowment Policies. There has been some confusion over the question of whether endowment policies were covered in the scope of the typical general statute. T o some extent this reflects the feeling that such statutes should not protect the one effecting the policy. But, of course, in their modern form at least, endowment contracts generally have an insurance element under which beneficiaries may be named. A second factor is undoubtedly the wording of the particular statutes in question. Section 55-a of the Insurance Law of New York has been held to cover endowments, as have the California, Ohio, and Washington statutes. 180 But, on the other hand, the contrary has been held of the Nebraska and New Hampshire statutes. 181 173 Schlaefer v. Schlaefer, 71 App. D.C. 350 112 F. (2) 177 (1940), 130 L. R. 1014. 174 Atlantic Life Ins. Co. v. Ring, 167 Va. 121, 187 S.E. 449 (1936) approved in 23 Va. L. Rev. 494 (1937). 175 Preston v. Martin, 69 S.W. (2) 472 (Tex. Civ. App. 1934). 17β American Trust fr Banking Co. v. Lessly, 171 Tenn. 561, 106 S.W. (2) 551 (1937), and see annotation, "Accident Insurance as Life Insurance Within Exemption Law," 111 A. L. R. 61 (1937). 177 Legg v. St. John, 296 U.S. 489 (1936). 178 Bank of Greenwood v. Rawls, 117 Fla. 381, 158 So. 173 (1934), contra Baxter v. The Old National City Bank, 46 Ohio App. 533, 189 N.E. 514 (1933). 178 Commissioner of Banks v. Yelverton, 204 N.C. 441, 168 S.E. 505 (1933). 180 In re Horowitz, 3 F. Supp. 11 (D. C. N.Y. 1933); Hing v. Lee, 37 Calif, App. 313, 174 P. 356 (1918); County Savings & Loan Co. v. Wright, 20 Ohio Opinions 437 (1941); and Turner v. Bovee, 92 F. (2) 791 (C. C. A. Wash. 1937), respectively. 181 Bank of Brule v. Harper, 141 Neb. 616, 4 N.W. (2) 609 (Neb. 1942) and In re Bray, 8 F. Supp. 761 (D. C. N.H. 1934), respectively.

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101

Annuities. The double problem presented by annuities was commented upon in connection with the survey of statutes.182 T h e cash value of the deferred annuity is not protected by the ordinary insurance exemption statute, 183 unless annuities are expressly included.184 T h e protection of payments made under the annuity presents a far more serious problem. Impressive arguments can be presented for the need of some minimum protection. 185 But equally weighty reasons can be advanced for the need of limiting this protection. 186 A rather novel question was raised in a recent suit by a creditor against a company to rescind the purchase of an annuity on the ground that it constituted a transfer in fraud of creditors.187 The court pointed out that the company had given full consideration and in the absence of a showing of bad faith upon the part of the insurer, it denied recovery.188 Group Insurance. There has been very little litigation involving the special statutes passed to protect group insurance from creditors. These statutes, it will be recalled, are patterned after the "workingman's insurance" type, being very broad in scope and excluding creditors of both the insured and the beneficiary.189 In one case in New York an employer continued to pay wages to a disabled employee on the latter's promise to repay such amounts out of the proceeds of his group disability insurance. 190 In the ensuing litigation the employer attempted to 182 i.e., cash value and income payment problems. 183 In re Walsh, 19 F. Supp. 567 (D. C. Minn. 1937). 184 Gordy v. Buscilla, 18 D. & C. 224 (Pa. 1932). Even then some courts seem reluctant to apply the statute; E.g., In re Bowers, 11 F. Supp 848 (D. C. Pa. 1934), reversed, however, on appeal 78 F. (2) 776 (C. C. A. Pa. 1935) cert. den. 296 U.S. 640 (1935). 185 By and large, annuitants are individuals disabled by age. ΐ8β in fact, failure to set some limit would seem hard to defend. 187 Osgood v. Massachusetts Mut. L. Ins. Co., 93 N.H. 160, 37 A. (2) 12 (1944). 188 T h e problem of the creditor in this instance seems to have been that the annuitant had died. Suppose he had lived and also suppose that a statute protected annuity payments up to such amount as precluded his recovering anything on his claim? 188 it has been held, however, that the Virginia group statute does not prevent beneficiary from assigning proceeds after death of insured. Beneficiary was indicted for murder of insured. She had assigned her interest in policy to lawyers to defend her. After acquittal, she had repudiated assignment.—Carney v. Poindexter, 170 Va. 233, 196 S.E. 639 (1938). 190 Williams v. John Hancock Mut. Life Ins. Co., 154 Misc. 504, 277 N.Y. S. 429 (1935), rev. on other grounds, 245 App. Div. 585, 283 N.Y. S. 87 (4th Dept. 1935), reargument den. 246 App. Div. 891, 285 N.Y. S. 840 (4th Dept. 1936).

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BENEFICIARY IN LIFE INSURANCE

assert a lien on the group insurance proceeds which the court denied on the basis of former Section 101-d of the Insurance Law exempting such proceeds from the claims of creditors. So far as disability payments are concerned, the same result would probably be obtained under Section 166 of the Insurance Law which has now replaced Section 101-d. But since the present section merely states that ". . . the provisions . . . applicable to any insurance policy . . . shall likewise apply to any group insurance policy . . ." the effective exemptions with regard to death proceeds would seem to be considerably diminished. It would seem entirely proper that the group insurance exemption should be no greater than the exemption afforded to ordinary insurance so far as the policies for larger amounts are concerned. Whether the same should be true with respect to the smaller amounts may be subject to a difference of opinion. Deferred Settlement Proceeds. By the time the insurance asset has reached the point where it is being held on a deferred settlement basis, it has ceased to be the property of the insured in any sense and has become vested in the beneficiary. Hence, by and large, it is the beneficiary's creditors, not the insured's, who are to be reckoned with. As has already been noted, the general statutes, with some exceptions,191 do not have any application to such a situation. T h e special spendthrift statutes, on the other hand, were specially designed to protect such proceeds but there seems to have been relatively little litigation arising under them. T h e complete immunity of such funds from attack by a beneficiary's creditors has been affirmed even where the exact statutory A disability payment equal in amount and in lieu of the death benefit was protected, despite its unusual nature under the Pennsylvania statute.— Baranovich v. Harvath, 113 Pa. Super. Ct. 467, 173 A. 676 (1934). l e i T h e statutes which have been classified in this paper as "procedural" (see notes 26-36 of the preceding lecture) probably provide protection within their restricted amounts. It seems doubtful whether any other type of general statute would be effective except for a few comprehensive ones. Dean Griswold suggests the Louisiana law is broad enough to afford spendthrift protection.— Griswold, Spendthrift Trusts (1936) Sec. 125. Among the special types the fraternal statutes are generally broad enough but would not seem particularly important in this connection, nor would the group type. T h e annuity type might be important but it doesn't seem to exist in any state which does not have a spendthrift statute.

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language is not used. 192 This includes protection from garnishment of income. 193 And even when the beneficiary has needed the money, there could, until recent amendment of Section 17 of the Personal Property Law in New York, 1 9 4 be no invasion of the proceeds. 195 T h e spendthrift statutes do not, however, carry over to a contract containing no spendthrift clause. 196 Of course a spendthrift clause will not protect the proceeds if creditors of the insured can establish a right to rescind a fraudulent transfer. 197 In the early days of deferred settlements before special spendthrift statutes for insurance had become common, there was a great deal of discussion over the possibility of obtaining protection of the desired type from the common law and statutory doctrine of spendthrift trusts. While it was obvious that in almost all cases such settlements were not true trusts for .a number of reasons, it was hoped that the doctrine would be broadened by the courts to furnish the desired shield from creditors. There are some cases along this line even down into modern times in states which do not have an insurance spendthrift statute, 198 but it is dangerous to count on protection from this source. Nor does it seem particularly desirable, since to confuse these deferred settlements with true trusts is likely to produce unforeseen results. In a case where a creditor sought to reach a one-sum payment 192 Grossman v. Rauch, 263 N.Y. 264, 188 Ν .E. 748 (1934), rev. 238 App. Div. 299, 264 N.Y. S. 111 (1st Dept. 1933), except, of course, for claims for necessaries in states such as New York where this exception is contained in the statute. 193 Gardiner v. Rauch, 179 Misc. 829, 43 N.Y. S. (2) 547 (1942); Adams v. Strong, 171 Miss. 510, 158 So. 204 (1934); Provident Trust Co. v. Rothman, 321 Pa. 177, 183 A. 793 (1940); Mutual L. Ins. Co. of N. Y. v. Lattimer, 23 F. Supp. 259 (D. C. Calif. 1938); Manufacturers Trust Co. v. Lewis, 18 N.Y. S. (2) 714 (N.Y. 1939); Roth v. Kaptowsky, 393 111. 484, 66 N.E. (2) 664 (1946). 194 See note 78 of the preceding chapter. 195 in re Nires, 290 N.Y. 78, 48 N.E. (2) 268 (1943), motion den. 290 N.Y. 745, 49 N.E. (2) 1010. 196 Matulka v. Van Roosebroech, 25 N.Y. S. (2) 240 (City Ct. 1940), aff. 25 N.Y. S. (2) 247 (App. T . 1st Dept. 1940); Roth v. Kaptowsky, 393 111. 484, 66 N.E. (2) 664 (1946). 197 John Weenich ir Sons Co. v. Blahd, 73 Ohio App. 67, 54 N.E. (2) 426 (1943). 198 Mullin v. Trolinger, 237 Mo. App. 939, 179 S.W. (2) 484 (1944); Holowaty v. Prudential Ins. Co. of Am., 282 111. App. 584 (1935); Michaelson v. Sokolove, 169 Md. 529, 182 A. 458 (1936); Chelsea-Wheeler Coal Co. v. Marvin, 134 N.J. Eq. 432, 35 A. (2) 874 (1944).

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which was to be made from a deferred settlement on a future date if the beneficiary were living, the court held that such an interest was not subject to levy and sale. 199 T h e creditor had not appealed from a denial of his claim against the income. One interesting and very important problem connected with deferred settlements is whether giving the beneficiary a full or partial right to withdraw the proceeds destroys the spendthrift protection. Probably the weight of opinion in the insurance business has been that such would be the case, 200 and in Genessee Valley Trust Company v. Glazer, the lower courts agreed with this view 2 0 1 but the Court of Appeals held that the right to withdraw did not nullify the spendthrift clause. 202 As in so many other instances, opinion about this historymaking decision will be governed in large measure by the point of view with which the whole subject of exempting insurance from creditors is approached. Advocates of liberal exemptions will feel pleased over its "soundness," while creditors will be depressed. 203 Right

to Change

Beneficiary

If the insured or other owner of a policy payable to a named beneficiary has n o right to change the beneficiary normally, apart from any possible reversionary right, there is no property 198 Cohen v. Cohen, 126 N.J. L. 605, 20 A. (2) 594 (1941). 200 In "Report of the Special Committee on 'Modes of Settlement Undei Policy Provisions' to the Association of Life Insurance Counsel, II Proc. Assn. of L. Ins. Counsel 361, 366 (1923), it is stated: "It should be borne in mind that provisions permitting withdrawal are plainly inconsistent with spendthrift trust provisions." And later on, referring to this note of caution a further warning was added by another writer: "Whether or not the statutes under which the companies are operating are broad enough to cover this mismated combination, public policy is not likely to look with favor upon it. If such an agreement were before a Court the restraining clauses would probably have to go, and a precedent might be established which would lead to a general holding that all such clauses were ineffective in the jurisdiction."— Thompson, "Some Practical Problems Connected with Optional Settlements," 4 Proc. Assn. of L. Ins. Counsel 83, 89 (1928). 201 183 Misc. 980, 51 N.Y. S. (2) 654 (1944), aff. 269 App. Div. 722, 53 N.Y. S. (2) 704 (4th Dept. 1945). 202 295 N.Y. 219, 66 N.E. (2) 169 (1946). Apparently there was also a partial right of withdrawal in Cohen v. Cohen (note 199). 203 Whether or not with just cause, creditors will be particularly depressed by a recent suggestion that the next step in New York may be to permit a beneficiary to effect a spendthrift clause while retaining rights of withdrawal. —Barker, "Spendthrift Clause in Life Insurance," 1 Jour, of Am. Soc. of Char. L. Underwriters 77, 84 (1946). It is a bit dubious whether this could be accomplished without a statutory change in the light of the New York cases. See Note 150.

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interest which requires protection from creditors of such insured or other owner. If, however, the policy owner has a right to revoke the designation of a beneficiary and to name his estate or another person in place thereof, it is clear that such owner does have very important rights in the policy. This was, of course, the basis for the decision in Cohen v. Samuels,20* which has already been discussed. 205 Many exemptions protect cash values and other lifetime rights against creditors of the policy owner despite the existence of an unrestricted20® right to change the beneficiary. 207 Is this an instance of effector-beneficiary debtor protection? Certainly a common complaint of creditors is that it is. If it is, the argument in justification of it is that such protection is a necessary minor incident in the protection of the much more important interests of the debtor's family in the death benefit. 208 It has been said, however, that this clause in former section 55-a of the New York Insurance Law was not intended to protect the interest of the debtor 2 0 9 and point has been given to this conclusion by providing in bankruptcy that any benefits inuring to the bankrupt from such policies should become a part of the bankrupt estate. 210 While this may not be an entirely effective device even in bank204 245 U.S. 50 (1917). 206 See discussion in bankruptcy section. 206 Of course, if the right to change is restricted so that the policy cannot be made payable to the owner's estate, the presence of the right may be of no consequence— Massachusetts Mut. L. Ins. Co. v. Switow, 30 F. Supp. 809 (D. C. Ky. 1940). 207 This is characteristic of the "55-a" statute and is found in some other types. For a time it was believed that this clause in the Wisconsin Married Women's Act gave the wife a vested interest—Dietz v. Dietz unofficially reported in 38 A. L. C. Legal Bull. 407 (Wis. 1938)—but the true purpose, namely, to bring revocable policies under the exemption statute, was recognized in Hickey v. Aetna L. Ins. Co., unofficially reported in 40 A. L. C. Legal Bull. 402 (Wis. 1939). 208 See Hirst, How New York State Protects Life Insurance and Annuities (3rd ed. 1946) 15. 209 E.g., see In re Messinger, 29 F. (2) 158 (C. C. A. N.Y. 1928). 210 Idem, 161, the court said, " . . . if the bankrupt shall at any time exercise his power to change the beneficiary for his personal advantage, the cash surrender value shall constitute unadministered assets of the bankrupt estate." Seemingly the court developed this ingenious limitation from language of the opinion in In re Weick, 2 F. (2) 647 (C. C. A. Ohio 1929). It would be an interesting study to attempt to ascertain how widespread and how effective this practice has become. It has been used at least in some other instances. In In re Yeager, 21 F. Supp. 324 (D. C. N.Y. 1937), the opinion shows that the decree contained a similar stipulation. Of course it would not be used in a state where the exemption statute was interpreted to protect the policy on behalf of the bankrupt.

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ruptcy and would not be available for use against any debtor not in bankruptcy, it is a pretty clear indication of the disfavor with which protection of the effector-beneficiary debtor is viewed. Reversionary

Interest

In

Insured

It is customary in "55-a" type statutes to provide that the insurance shall be exempt "whether or not the policy is made payable to the person whose life is insured if the beneficiary, assignee or payee shall predecease such person." T h e purpose of this clause may not be readily apparent to one unfamiliar with the history of this type of statute. 211 It was inserted to preclude creditors from reaching the contingent interest of the insured under an intimation by a Massachusetts case.212 It is interesting to note in passing that while the "55-a" type law contemplates the purchase of insurance on the life of another, it does not afford similar protection of a reversionary interest in such purchaser. Policy

Payable

to

Trustee

If insurance policies are not payable directly to the beneficiaries but a trustee is named for their benefit, does this fact affect the exemption which they would normally enjoy? It was decided in a New York case where a creditor sought to get the cash value, that "55-a" of the Insurance Law still applied despite the designation of a trustee. 213 A recent Pennsylvania case at first reading seems to hold differently. 214 But perhaps the cases can be distinguished. 215 211 T h e presence of this clause seems to have helped to confuse the court in the Kindleberger case; see note 40. 212 Blinn v. Dame, 207 Mass. 159, 93 N.E. 601 (1911). Such a reversion has only a speculative or nuisance value. See on this point Hirst, How New York State Protects Life Insurance and Annuities (3rd ed. 1946) p. 19. 213 40 West Fifty-seventh St. Realty Corp. v. Starr, 149 Misc. 470, 267 N.Y. S. 740 (1933). 214 In re Renin's Trust Estate, 343 Pa. 549, 23 A. (2) 837 (Pa. 1942). 215 In the latter instance the policies were payable to a trustee who was in turn to pay over to a testamentary trustee. T h e insured at death was insolvent and the Supreme Court of the state affirmed a holding that the proceeds be applied to the claims of creditors. T h e court held, on the analogy of an earlier decision under which insurance proceeds were subject to an inheritance tax when they were payable to testamentary trustees, that these proceeds were the subject of what essentially was a testamentary disposition. Earlier cases in Pennsylvania seem to recognize that ordinarily the intervention of a trustee will not jeopardize the exemption.—Matter of Phillips, 7 F. Supp. 807 (D. C. Pa. 1934); In re Bosak, 12 F. Supp. 278 (D. C. Pa. 1935); Potter Title ir Trust Co. v. Fidelity Trust Co., 316 Pa. 316, 175 A. 400 (1934).

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CONCLUSION An attempt has been made to supply the reader with a general background rather than to develop extensively any one problem or to present a case for any particular thesis. But the conviction has been growing on the writer during the preparation of these lectures that the subject generally is in need of a searching reexamination. T h e interests of beneficiaries and of creditors are necessarily in conflict. As a practical matter this cannot satisfactorily be resolved either by abolishing exemptions or by making them absolute. Some middle course must be pursued and in some respects the present New York law is a decided advance over anything which has gone before. But it is doubted that it is perfect. T h e limitations contained in the recently enacted statutes in Virginia would seem to merit careful consideration, at least with respect to the principles which they embody. Is there, however, presently available adequate data on which to base judgment as to the effectiveness of various alternatives? For example, from a legal point of view, the conditioning of exemptions of policies payable to a named beneficiary, by decreeing that the proceeds shall become unadministered assets of the bankrupt estate if they are ever diverted to the use of the bankrupt, seems highly ingenious. But how has this worked out in practice? Are a majority of such policies continued in force for the beneficiaries or are they permitted to run out as extended insurance? Can a trusteee in bankruptcy, whose duty it is to liquidate as promptly as possible, adequately police such an arrangement? What about values created by future premium payments? A case study might yield valuable answers. Or again, how do the opposing definitions of fraud work out in actual practice as contrasted with the respective arguments made on behalf of constructive fraud and actual intent to defraud? Perhaps the files of some of the larger companies could furnish a good deal of useful material for a case approach. It is the personal view of the writer that neither life insurance men nor lawyers for creditors are alone capable of making such a reexamination with sufficient objectivity. Nor is it a narrow inquiry involving solely the science of life insurance or principles of law. It would require, to be sure, some knowledge of

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each, but it would also need the point of view and techniques of the social scientist. A series of critical studies of the facts would be of more value than any number of vague generalizations about the necessity for protecting widows and orphans on the one hand, or dire predictions of the imminent collapse of the credit structure because of the growth of exemptions on the other. Is it too much to hope that among those at the college and university level, who, it is encouraging to note, are reported to be turning in increasing numbers to the study of life insurance, there may be some readers of this paper who might be tempted to explore the possibilities of such an approach?

DEVELOPMENT OF OPTIONAL SETTLEMENTS By Richard C. Guest, F.A.S., F.A.I.A.*

FREQUENTLY we in the insurance institution, as in other fields, are so intimately involved in current developments that we do not pause and step aside to get a view of the general movement as an observer rather than as a participant. Customs which we are prone to take for granted are the result of long years of development and of gradual social and economic change. Human nature, which is largely the slave of customs, tends to resist changes. However, economic and social changes inevitably exercise an overpowering force to overcome individual and mass inertia and conscious resistance. T h e life insurance institution of which we are now a part is in reality a very young enterprise in this country. T o be sure, a start was made in the 18th century and most of the now leading life insurance corporations were formed in the 19th century. Nevertheless, the change has been so great and the developments so many in the 20th century that we sometimes have difficulty in recognizing the present institutions as developments of those originating in the 19th century. Undoubtedly, persons closely associated with life insurance in the past spent hours and days in what appeared to be rather aimless excursions along unexplored trails in their efforts to enlarge the field of service to the public. These excursions were approached from the social and economic viewpoints as well as from that of pure profit, within the limits of the individual capacity to weigh the various possibilities. There is little or no record of these excursions and it is probably now too late to • Vice President and Actuary, State Mutual Life Assurance Company. 109

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make a satisfactory record in retrospect of the thinking behind recorded mechanical changes. H u m a n nature is such that it is apt to proceed to conclusions which prove valid and to forget all too quickly the steps leading to those conclusions, leaving no record of even its best thinking. In approaching the subject of the development of settlement options, it seems to me that we should examine the past for economic, social, and business trends in the light of their possible effect upon the recorded developments. I have a feeling that in the long run if mechanical changes purporting to reflect the best for our economy and society are found wanting in either one or the other regard, they will either die a natural death or be so completely changed as to emerge almost unrecognizable. Although in more mature European economies the concept of measuring one's affluence by one's annual income instead of by accumulated capital value is one of long standing, this has not been true in the United States or, as a matter of fact, in Canada. Although in recent years, as will be developed later in this paper, there has been an increasing awareness of the importance of income in contrast with accumulated capital, it is safe to say that the capital concept almost completely predominated the thinking of this country until but a few years ago. Even now, although we are fast beginning to think of income when we think of beneficiaries, we still think of vigorous primary lives in terms of capital wealth rather than of income. Recognizing these peculiarities as inherent in our national philosophy, I shall examine the development of settlement options in this country in the following sequence: a. General survey of conspicuous landmarks in the chronology of our economic development. b. Introduction with definitions of various options and their acceptance by the public. c. Interrelationship of economic developments and other influences with the development of settlement options. d. Concluding observations. Although an exhaustive study of these four phases would require a great deal of time and much more space than is available or even desirable, the time and the space do permit an objective although somewhat general approach.

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CHRONOLOGY OF ECONOMIC HIGHLIGHTS Just as a general commentary on the acceptance of insurance over the last century, it might be said that it was not until the recent severe depression of the 'thirties that the growth of life insurance in force was ever seriously retarded. T o be sure, prior to the 'thirties the rate of increase was affected at several points and there have been periods of slight decline in the amount of insurance in force. However, it has been a peculiarity of the life insurance institution that it continued to grow even through periods of most adverse circumstances economically and otherwise until the 'thirties. Moreover, following the reaction of the 'thirties, we have seen another extremely rapid rate of progress in the industry. Probably the War between the States (1861-65) was the first economic crisis with which the then infant institution was confronted. Since that time three other war crises have been experienced—the Spanish-American War of 1898; the First World War, 1917-18; and the Second World War not so long completed. Following the War between the States, there was considerable unsound expansion in the number of companies which, combined with the economic growing pains following the war and the subsequent depression of the middle 'seventies, resulted in a less rapid rate of growth during the period of readjustment than the phenomenal rate prevalent during the war. Soundly managed companies experienced rapid growth in the late 'seventies and the early 'eighties. This was followed by a period of what might be considered a normal rate of growth from the new economy through the 'eighties, with only a slight hesitation in the depression of 1884, until the panic of 1893. Temporarily slowed up for a few years in the middle 'nineties, the companies again experienced a rapid rate of growth stimulated by the Spanish-American War of 1898. In the first few years of the 1900's during a period of business prosperity, public opinion became aroused at certain practices of management culminating in the celebrated Armstrong Investigation in 1907, a year of general economic panic. The resulting New York Insurance Laws to standardize insurance practice and to control expense constitute probably the most significant legal milestone in the

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development of the industry. Insurance survived the concurrent panic and the uncertainties due to the World War of 1914, in which we first participated in 1917. As in the case of the previous wars, public response to insurance protection skyrocketed during the war prosperity. From 1918 until October 1929, with the exception of a short lag during the depression of 1920-22, life insurance experienced a persistent rapid rate of growth in a generally expanding economy. As stated before, in the early 'thirties new business and insurance in force dropped off. Along with other conspicuous enterprises, the insurance industry was carefully investigated by the Temporary National Economic Committee. Due to good management, a genuine sense of trusteeship, and thorough supervision, the record of life insurance was such that its acceptance by the public was strengthened by the findings of the Investigation, and the institution proceeded to show the rapid rate of growth which has been a part of the recent upswing in our economy just prior to and throughout the Second World War. S E T T L E M E N T O P T I O N S AND T H E I R D E V E L O P M E N T Following is a list of the more generally accepted settlement options: a. Instalments far a Fixed Period. b. Fixed Income until Proceeds Exhausted. c. Annuity for Fixed Period and for Life. d. Life Annuity. e. Cash Refund Life Annuity. f. Instalment Refund Life Annuity. g. Joint and Survivorship Life Annuity. h. Proceeds at Interest. i. (Trusts)—The Payment of Proceeds by the Insuring Company to Corporate Trustees.

In order to study the development of the various modes of settlement, questions were asked of thirty leading companies. Although I am not at liberty to divulge specific information given me by these companies, representing a preponderance of the business now being issued, the companies themselves fall into the following pattern by years of incorporation-one company in the 1830's; eight companies in the 1840's; six in the 1850's; nine in the 1860's; four in the 1870's; three in the 1880 s;

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and three in the twentieth century. I wish sincerely to express my appreciation to officials of these companies for their kind cooperation in helping me to authenticate the following discussion of the development of the use of settlement options and related contracts. Instalments for a Fixed Period. This option provides for the payment of the proceeds in instalments of equal amount over a predetermined fixed period. T h e amount of each instalment is governed by the amount of proceeds, the period selected, and the guaranteed rate of interest. Upon the death of the primary beneficiary prior to the end of the selected period, the remaining payments may be continued to subsequent beneficiaries or the commuted value of the unpaid instalments may be paid in a lump sum. As early as 1867, one company permitted the payment of proceeds to be settled in instalments for a fixed period. In 1883, a company introduced a policy which provided payments to the beneficiary in equal annual instalments over a fixed period of twenty years following the death of the insured. In 1889, a settlement option providing for instalments over a fixed period by rider was introduced. During the next few years a number of companies brought out such riders or corresponding agreements, and a number of companies designed policies providing for the instalment settlement in the face of the policy rather than as an option by rider. In the early years of the twentieth century, this option could be found in one form or another in nearly all life insurance policies issued. T h e pinnacle of its universal availability is coincident with the standard policy provision requirement of the New York laws enacted following the Armstrong Investigation. Parenthetically, a most interesting similar, although recent, development has been that of the family income policy which was first introduced in this country in 1930. T h i s policy provides an income commencing at the death of the insured and continuing for a fixed period measured from the date of issue of the policy rather than from the date of death, the face of the policy being payable at the termination of the income. Fixed Income until Proceeds Exhausted. This option provides for the payment of the proceeds in instalments of a selected

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amount. The period over which such instalments will be paid is governed by the amount of proceeds, the amount of each instalment, and the rate of interest. Upon the death of the primary payee, any unpaid principal and interest is immediately payable. Although somewhat similar to equal instalments over a fixed period, this interesting variation in an optional settlement did not appear until 1901 when it was offered by one company. A few companies followed, although it was not until the 'twenties and 'thirties that the option was incorporated in the policies of a substantial number of companies. Annuity for Fixed Period and for Life. This option provides for instalments of equal amount over a selected fixed period and for the remaining lifetime of the primary payee if living at the end of such period. The amount of each instalment is governed by the amount of proceeds, the fixed period selected, the age of the payee, the guaranteed interest rate, and the mortality table used. Upon the death of the primary payee during the initial fixed period, the commuted value of the remaining fixed period instalments is immediately payable. If death occurs subsequent to the fixed period, nothing further is payable. This particular option first appeared in 1889 and then by endorsement. In 1895, it was introduced by two companies as a rider. The growth in its use is closely parallel to that of the growth in instalments for a fixed period, culminating in practically universal availability in 1908. Parenthetically, a number of companies introduced in the early years of this century what were popularly called continuous instalment policies. These policies provided for a specific income to a specific beneficiary upon the death of the insured, the income being fixed by ages at the date of purchase of the original insurance, usually with the income guaranteed for a fixed period independent of the survival of the beneficiary. These policies are survived by two forms, one the extremely popular insurance with income endowment policy and the other the less generally used survivorship annuity policy. The insurance with income endowment policy, which in its later durations has cash values and insurance amounts in excess of the original face of the policy, is sold in units of usually

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one thousand dollars, or sometimes twelve hundred and fifty or fifteen hundred dollars, with maturity income of ten dollars per month, or fifteen dollars per month, for a fixed period and for the life of the insured. It is one of the most popular contracts now existent to provide for retirement by individuals, and is frequently purchased by corporations for individual employees through pension trusts. More recently, the same type of coverage has also been provided for retirement plans through the so-called group permanent retirement income contracts. T h e survivorship annuity, which has no specific face amount of insurance, is offered by only a few companies, and is not very widely used. It provides an income to a specified beneficiary upon the death of the primary life, usually with the income guaranteed for a fixed period, the level of income being set at the date of issue of the policy. These two special types of policies are the outstanding survivors of the competition with the more universally accepted settlement options. Life Annuity. This option provides for instalments of equal amount over the entire lifetime of the payee. The amount of each instalment is governed by the amount of proceeds, the age of the payee, the guaranteed rate of interest, and the mortality table used. Nothing further is payable upon the death of the payee. In 1877, one company introduced an option to use the cash value of a paid-up life policy at age 65 to purchase a life annuity on the insured equal to seven per cent of the face amount of insurance. In 1893, one company offered, as a matter of practice, to settle the proceeds in the form of a life annuity to the beneficiary. Gradually during the next ten years a number of companies announced options extending the life annuity privilege by rider or agreement. Although this option is in rather general use, its acceptance has not been as universal as that of the options involving instalments for fixed periods, annuities for fixed periods and for life, or proceeds left at interest. There is hesitancy to chance the serious loss by the beneficiary upon early death in return for the equivalent larger income. This is particularly true, of course, in connection with insured designations but is to some extent true even in connection with beneficiary designa-

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tions. Also, owners of small insurance estates must be content with limited settlements rather than life annuity settlements in view of lack of funds. Cash Refund Life Annuity. This option is a life annuity with the further stipulation that upon the death of the primary payee the difference, if any, between the total of the instalments paid to the date of death and the net proceeds of the original life insurance will be payable. The amount of each instalment is fixed by the amount of proceeds, the age of the payee, the interest rate used, and the mortality table used. In 1901, one company offered to settle proceeds on a cash refund life annuity basis. Since then a comparatively few companies have adopted this option, it being even less popular than the life annuity without any refund either in cash or instalments. As in the case of the life annuity option, the cash refund life annuity option seldom can be conveniently used in connection with small insurance estates. Although the cash refund feature obviates the unusual loss upon early death, both insureds and beneficiaries seem to prefer the annuity for a fixed period and for life which was popularized much earlier, which fulfils the basic requirement, and which is more apt to coincide with available options in the policies of different companies. Instalment Refund Life Annuity. This option is a life annuity with the further stipulation that upon the death of the primary payee before the total of the instalments paid equals the net proceeds, such instalments will continue to subsequent beneficiaries until the total of all instalments paid shall equal the net proceeds. T h e amount of each instalment is fixed by the amount of the proceeds, the age of the payee, the interest rate used, and the mortality table used. Beginning in 1933, a few companies offered an instalment refund life annuity option. This option has been still less universally adopted than other life annuity options, although it is in use in seven companies out of approximately thirty companies covered in the analysis. As in the case of the cash refund life annuity, acceptance of the instalment refund annuity option is limited for financial reasons and is restricted by the preference for the annuity for a fixed period and for life option.

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Joint and Survivorship Life Annuity. This option is a life annuity based on two lives, providing instalments of equal amounts so long as both lives continue and the same or a reduced instalment for the remaining lifetime of the survivor. Nothing further is payable upon the death of the survivor. The amount of each instalment is fixed by the amount of proceeds, the age of each payee, the interest rate used, the mortality table used, and the ratio of the instalments payable to the survivor to the instalments payable jointly. As early as 1901, one company incorporated a joint and survivorship life annuity option settlement by supplementary agreement. This particular earliest option involved the very unusual feature of a guarantee of the instalments for a fixed period of twenty years. In 1917, a rider providing a joint and survivorship life annuity settlement was introduced without the special fixed period previously offered. Since that date various companies have offered, usually by rider but occasionally by contract, to provide for joint and survivorship settlements, usually without a fixed period guaranteed. More recently, such options have permitted the income to be paid jointly with two-thirds of the original level of income to be continued to the survivor, the reduced income to the survivor permitting the payment of larger instalments during the joint lifetime. Although these options are rather generally offered, usually by special rider or agreement, their acceptance by the public is anything but universal. This option in companies where all the other annuity options are offered would appear to be the least used by policyholders. Analysis will show that the proper utilization of the joint and survivorship settlement is normally in connection with substantial estates involving probably a husband and wife with no dependents. Although the option is a valuable one, the above combination of circumstances is an unusual one; hence, the total use of the option is relatively small. Proceeds at Interest. This option provides for the payment of the guaranteed interest only. T h e principal proceeds remain intact unless permission to withdraw them in whole or in part has been arranged. Upon the death of the payee, the principal remaining is payable in cash or by some alternate prearranged plan within the options.

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As early as 1889, one company offered to retain the proceeds after death and to pay interest thereon. Over the next twenty years this option was rather generally adopted. Commencing about the time of the First World War more and more insureds elected to have proceeds left with the company at interest for at least some period of time following death. This option is now universally included in policies and is very widely used both through insured elections and beneficiary elections. Generally speaking, a basic interest rate is guaranteed beyond which excess interest may be paid as a dividend. In a few instances the option is available without a specifically guaranteed minimum rate. It is not unusual for flexibility to be introduced into settlements by permitting withdrawal or permitting the proceeds to be transferred from the interest option to one of the other options, involving depletion of the principal through the payment of instalments either for a fixed period or for life. Any dividend under an option which provides for participation is usually paid with the guaranteed instalments. This is true in case of all options except that providing for a fixed income until the proceeds are exhausted. There it is accumulated and used to extend the period required to consume the proceeds. The Payment of Proceeds by the Insuring Company to Corporate Trustees. A check was made with a large number of companies as to the frequency with which proceeds are paid over to a corporate trustee to be administered as a trust by that trustee for individual beneficiaries. The so-called "Pension Trusts" were not included in this query since they usually are insuring company-employer-employee arrangements which utilize insurance policy options or their equivalent, with the trustee merely acting as an administrator of a clearly defined relationship among employee, employer, and insuring company. Although over a period of years, beginning with the 'twenties, considerable interest has been evidenced by trust companies and by individuals in the creation of trusts to settle insurance proceeds, it appears that their present use is almost negligible. Exact tabulations were not available, but from estimates based upon random sampling and upon individual personal opinion in the several corporations, it appears practically certain that in most companies the extent of use is quite small and only in a

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few companies does it involve as much as two to five per cent of proceeds. Possibly if we examine the peculiarities inherent in such trusts as compared with settlements arranged within life insurance policy settlement provisions, we shall arrive at the fundamental reason why there is such a lack of popularity. For a brief comparison, let us include what might be considered the more obvious underlying factors—the security of principal, the security of income, possible flexibility, and costs entailed. Security of Principal. Proceeds left under settlement options continue to be mingled with the general life insurance company assets. This gives them the advantage of participation in the general over-all investment portfolio of the company which is designed to minimize capital losses and to have such losses absorbed as a relatively small proportion of the total principal account. In the case of the individual trust administered by the outside trustee, the funds or property placed in trust necessarily constitute a separate account. Even in a large trust, the failure of a particular investment is a serious jolt to the account in question. In fact, it may almost be catastrophic measured in terms of its effect upon the results to be desired from the account. Security of Income. In settlements through the use of optional policy provisions, a life income may be guaranteed; early instalments of such life income may even be made independent of the survivorship of a beneficiary, being guaranteed as payable in any event; if the conditions warrant, a larger income may be payable for a fixed period not contingent upon survivorship; or a principal sum may be left to earn a guaranteed rate of interest, supplemented by whatever dividends may be available in excess of the guaranteed rate. T o sum up, probably the most fundamental characteristic of the policy settlement option is its basic guaranteed income, and it is well to remember that income guarantees are not made merely for a period of five or ten years, b u t are frequently made to become effective over indefinite periods in the f u t u r e whether the indefinite period be five years, ten years, or even fifty years. Of course, there is a variation in the level of dividends that can be earned in excess of the basic guarantee. I n fact, the basic guarantee may be so liberal that no dividend will be forthcoming in a period of declining

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interest rates preceded by liberal guarantees, in which case guarantees take on the aspect of an unusually valuable purchase made in the past and retained for profitable use. O n the other hand, the trust company is not in a position to underwrite any guarantees. It invests a relatively small f u n d in most cases, and although occasionally it may obtain a higher yield than the average yield earned by the huge assets of a life insurance company, it is correspondingly subject to extreme fluctuations or perchance to the complete elimination of net income. Even a comparatively small capital loss may entirely offset the income of a given year. Moreover, the individual trust does not have a normal annual flow of funds, such as come into an insurance company, which would make possible the payment of principal sums as well as income without maintaining a biased investment portfolio designed primarily to accommodate liquidity rather than just assure the security of principal and continuity of income. By the use of appropriate policy provisions, insurance companies are able to prevent the ill-considered or even foolhardy transfer of insurance proceeds by a beneficiary, unless the insured has specifically given the beneficiary the right so to do. Moreover, by the use of the so-called "spendthrift clause," where permitted by statute, the companies have been able to protect beneficiaries against creditors. These protections have traditionally been inherent in a carefully drawn trust. T h e development of the corresponding safeguards in insurance policies have to a great extent made it possible for equal protection to be secured in insurance settlements. Flexibility. Theoretically, an individual trust can permit almost unlimited flexibility by the use of discretion. As a practical matter, however, such flexibility is limited by the size of the trust and by the danger of defeating the primary purpose of the trust through giving too much discretionary power to the trustee. Due to the nature of a life insurance settlement option, the important feature of guarantee does limit the degree of flexibility. However, in cases calling for flexibility and where the amount involved warrants flexible provisions, an option providing that principal be left at interest, or that principal be used to pay instalments for a fixed period subject to carefully con-

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sidered withdrawal privileges, accomplishes the degree of flexibility which probably is at the one time most desirable and most protective. Cost. Although, of course, the overhead cost of handling special insurance settlements is in the final analysis paid by the body of policyholders, the agreements are so numerous as gradually to become somewhat standardized, thus, in turn, permitting economy in administration. On the other hand, substantial fees must be paid to trust companies and even though the maximum fees may be fixed by statute, they are a direct drain upon the individual trust. Unfortunately the relative importance of the fee is greater for the small trust than for the large one. I n insurance companies, the overhead is absorbed as a relatively small item in the general cost of the insurance coverage as contrasted with the direct assessment of specific fees against specific trusts administered by trust companies. PUBLIC ACCEPTANCE OF O P T I O N S During the generations u p through 1929, fortunes were made and lost by enterprising individuals in a generally expanding economy related to a comparatively undeveloped and fundamentally rich country. T h r o u g h all this period, financial security centered around the family. A forward-looking people, by hard work, by dogged tenacity, by a spirit of venture, and by great ingenuity, gradually raised the standard of living, generation after generation, and increased the financial security of the individual and his family to unprecedented heights. Over the years, the relative stability of life insurance became more and more impressed upon the minds of the public and their confidence was reflected in the rapid growth of business in force. Although the survey previously mentioned shows that early opportunity was extended to the public to use optional modes of settlement, it has not been until very recent years that the opportunity and its acceptance by the public have culminated in a substantial proportion of endowment and death claims becoming payable under the options. Among the outstanding companies questioned, the proportion of claims settled under options generally amounted in 1920 to less than five per cent, although sometimes as much as ten per cent, or rarely twenty

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INSURANCE

per cent. For the same companies, the claims settled u n d e r o p t i o n s had increased in 1930 to ten or fifteen per cent and occasionally to thirty per cent. I n 1946, o n the o t h e r hand, ordinary business, n o t i n c l u d i n g such lines as g r o u p insurance and industrial insurance, was s h o w i n g fifty or sixty per cent, a n d occasionally a higher percentage, of matured e n d o w m e n t and d e a t h proceeds left u n d e r settlement options. U s u a l l y the o n l y o p t i o n offered i n g r o u p insurance is instalments for a fixed period. Its acceptance has b e e n rather limited. Probably a more general acceptance and use of settlement o p t i o n s will d e v e l o p coincident w i t h the d e v e l o p m e n t of g r o u p p e r m a n e n t insurance. FACTORS CAUSING

ACCEPTANCE

In retrospect, it w o u l d appear that the acceptance, t h o u g h tardy, by the p u b l i c of settlement o p t i o n s has been due to a n u m b e r of causes. 1. T h e trend toward a more mature economy following the First World War, when we became a creditor rather than a debtor nation, has been accompanied by a more receptive attitude toward the desirability of income for beneficiaries rather than principal sums. From observation of trends abroad, this would appear to be a natural reaction of our society in general to the more mature economy. 2. W i t h the more complete utilization of our f u n d a m e n t a l national resources, increasing numbers of buyers have tended to use insurance as a major factor in their savings and have been impressed by the opportunity to continue income to beneficiaries on a substantial basis by the use of settlement options involving relatively high yields. Although in Europe the tendency u n d e r similar circumstances had been to tie u p accumulated wealth to a considerable extent in land holdings and related interests, this has not been the case in the United States where much of such money has been tucked away in the purchase of life insurance. 3. Following long periods of deep-rooted confidence in integrity of insurance, the public attitude in the 'twenties reached a pinnacle of such confidence. This, in turn, has expedited the acceptance by the public of a new concept that the duties of the insuring company do not cease u p o n death or maturity, but may well continue beyond these events. 4. Exercising typical American ingenuity, production departments have p u t on vigorous promotional pressure to bring about the more rapid acceptance of settlement options by the public.

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5. Specialized legal service has been offered to clarify income and beneficiary designations on a more individual basis. 6. Life insurance agents have been intensively trained to approach the insurance sale from a more professional aspect and to give specialized advice on utilizing insurance proceeds to the best advantage by providing security to dependents logically and more permanently through settlement options. 7. During the 'twenties many were able to attain moderate financial independence and thereupon were attracted to the purchase of insurance and its use under options to obtain much needed security and conservation of values. Settlement options being guaranteed at that time were on an extremely liberal basis. Also, interest earnings were so high on invested assets that substantial dividends were being paid above the guarantees. 8. Although the crash of 1929 significantly lowered the additional dividends on options and sometimes eliminated them, the crash emphasized the unique dependability of the insurance program under settlement options in contrast with the uncertainty of market operations. 9. The sharp decline in interest rates of the 'thirties emphasized the financial value of options to buyers of insurance. 10. During the 'twenties the average amount of insurance purchased by the individual increased rapidly, and the implications of larger sums of money being left unprotected in the hands of inexperienced beneficiaries tended to influence the thinking of buyers of insurance in the direction of protection after death. Moreover, the very size of each block of proceeds expedited the more extensive use of the options. T h e more extensive use of the options in turn crystallized the thinking of the buyers of insurance as to the significance of capital amounts and resulted in still further purchases in order to get more sizable amounts in terms of the new income concept. 11. This new income concept and its interrelation with size of purchase was a revelation of a newly recognized obligation by the primary life to the next generation. T h a t obligation has become so completely accepted in this country as to be taken for granted. Such a change in attitude and its implementing by the use of insurance with annuity or other option settlements should be considered a milestone in the social progress of the country. 12. The enactment of the Social Security Act in the 'thirties indicated a fundamental change in our social thinking, a crystallization of the thinking having been accelerated by the severe depression following October 1929. With everyone thinking of income for various contingencies, it was natural that more and more interest should have been developed in the use of insurance settlement options to augment the basic Federal program.

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13. Beginning, generally speaking, in the 'twenties, trust companies advertised widely the advantages of trust administration for insurance proceeds. Our survey reveals that this advertising resulted in a negligible amount of business being left under such trusteeship. I think unquestionably that the advertising of the trust companies ultimately acted as an impetus to the use of settlement options rather than the creation of trusts. Thus we see that the competition of the trust companies for the settlement service resulted in aiding the development of settlement options rather than in encroachment upon them. 14. Although the above influences have set the stage for the increase in the proportion of claims settled under options, it, of course, has taken a period of years to effect the substantial increase in percentage to fifty or sixty per cent, or even more, occasionally, of claim proceeds being left under settlement options.

C O N C L U D I N G OBSERVATIONS Economically and socially the United States has developed phenomenally over the last one hundred years, growing first from a debtor nation to a creditor nation, and more recently to the position of the leading financial power in the world. With this more mature economy, society has progressed by recognizing its obligation as carrying over to the next generation. T o implement this progressive change, large volumes of life insurance have been used, first settled in lump sums and more recently settled in a form of protected and carefully planned income. As insuring companies, we must recognize the full significance of this development and change. Whereas traditionally we have been looked upon primarily as insurance companies, the wide use of the settlement options and the extensive development of the use of individual policies, group permanent insurance, and group annuities for retirement purposes, have changed the character of most companies so that fundamentally they are becoming predominantly annuity companies rather than insurance companies. In this connection, I think of the phrase "annuity companies" as reflecting the financial obligation following the death of the first life or the maturity of the endowment, whether the obligation be merely to maintain interest earnings on proceeds left at interest or whether it be in the form of the more usually understood disbursement in annuities for fixed periods or for life. T h e financial implications of this change in the general char-

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acter of the companies are discussed elsewhere in this volume. 1 I would like to mention, however, the two outstanding obligations inherent therein, namely, the acceptance of the obligation to continue liberal interest assumptions beyond death or maturity, and the acceptance of the obligation to continue annuity payments on a prearranged basis through another generation in the face of continued marked improvement in the longevity of our population in general and annuitant lives in particular. Both are of major importance and merit careful study. ι See Edward W. Marshall, "Financial Aspects of Optional Settlements," on pp. 146 to 155.

PLANNED SETTLEMENTS: CURRENT PRACTICES By Eugene M. Thoré, LL.B.*

INTRODUCTION settlements generally have been conceded in recent years to be a proper function of the modern life insurance company. Today there are few who question the soundness of extending life insurance contracts beyond the life of the insured, to the end that the fruits of the contract may be invested and distributed in a manner that will best serve the needs of the beneficiary. Thus, the planning of such settlements is recognized as essential to the complete fulfillment of the high social purpose to which the institution of life insurance has dedicated itself. However, as is true in most areas of social service, divergent views exist with respect to the extent of the distributive service the life insurer should render to the owner of a policy, or to the beneficiaries of insurance death benefits. T h e s e differences in viewpoint find expression in the rules and practices which have been adopted by the various companies to govern their extra contractual services. T h e s e practices frequently reveal dissimilarities in philosophic and technical reasoning, and are highly significant in any appraisal of planned settlements. PLANNED

Regardless of one's attitude toward the deferred settlement function, this service is rapidly expanding. O n e company reports that its planned settlements have increased by five times during the past fifteen years. Even during the war years, when service was reduced to a minimum, deferred income settlements were on the increase. T h e magnitude of these developments and the resulting administrative problems offer a real challenge to the • General Counsel, Life Insurance Association of America.

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institution, and it cannot be dealt with intelligently unless current practices are carefully analyzed. In fact, the most disturbing factor seems to be our inability to develop uniformity of practice to the end that the public will understand and appreciate more fully the service being offered. Factors Responsible

for Variations

in

Practice

Probably the most important factor is the financial impact of certain phases of settlement service; this is discussed elsewhere.1 For our purposes let us say that there is a direct relationship between planned settlement practices and (1) administrative expense, (2) interest earned on funds being settled, and (3) mortality experience with respect to payment plans involving longevity of payees. In addition to these financial problems, there are legal and actuarial rules regarding which there may not be unanimity of opinion either as to their application or as to the risks involved. Also of significance is the sales factor. Competition in the sale of life insurance has a great influence on the practices of many companies. Within the framework of these influences, it is the objective of most companies to provide maximum settlement service consistent with their standards of financial safety and equity among policyholders. Definitions

In order to simplify our consideration of this subject, I shall give the following terms the meaning indicated: Planned Settlement: Used in the broad sense to describe the function of arranging the settlement of insurance proceeds to meet future needs of policy owners or beneficiaries, and then reducing the arrangement to an agreement supplementary to the insurance policy. Policy Owner: Used to designate an individual who owns a policy of life insurance that gives him the right to make a planned settlement. He may or may not be the life insured. Beneficiary: Used to indicate a single beneficiary or class of beneficiaries entitled to the benefits of a policy of life insurance. Beneficiaries fall into several classes commonly designated as primary, first contingent, second contingent, and final. 1 See Edward W. Marshall, "Financial Aspects of Optional Settlements," on pp. 146 to 155.

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of Planned

INSURANCE Settlements

T h e r e are three basic types of p l a n n e d settlements: a. Agreements with policy owners to distribute endowment or surrender benefits. T h i s type is usually designed to provide a retirement income payable to the policy owner for life, or an income payable to the policy owner and a beneficiary designated by the owner until the death of the survivor. It is general practice to complete this type of agreement prior to maturity of the policy as an endowment in order to derive a more favorable income tax treatment. T h e popularity of the retirement income endowment type policy, which provides on its face for the payment of a life income to the owner, has greatly reduced the number of agreements with policy owners. b. Agreements with the beneficiary following the death of the insured. T h i s type of settlement is completed after the insured's death in those cases in which the beneficiary is entitled to a single sum benefit but elects to receive the single sum in accordance with a planned settlement. It is general practice to permit an election by the beneficiary at any time after proof of claim, provided the death claim settlement check has not been cashed. Most companies insist that the election be made within a reasonable period after the insured's death, usually six months. Generally, if the election is made promptly, interest on the proceeds is allowed from the date of death or the date of proof. There is a tendency not to allow retroactive interest in those cases in which the beneficiary delays too long in making an election. c. Agreements with the policy owner to distribute death benefits. This category represents the greatest use of planned settlements. An agreement is made with the owner whereby benefits payable at the insured's death will be distributed as income to designated beneficiaries to meet their needs for food, shelter, education, and miscellaneous expenses. I n the case of a settlement p l a n n e d by the policy owner to provide i n c o m e for his r e t i r e m e n t , the a g r e e m e n t is usually simpler t h a n one in which he plans a settlement for his beneficiary. T h e r e t i r e m e n t p l a n normally is created l a t e in life when children a r e grown a n d the principal need is i n c o m e for the life o f the owner a n d his wife. A p l a n a r r a n g e d by a beneficiary following the insured's death is seldom as c o m p l i c a t e d as o n e devised by the policy owner for his beneficiary. T h i s is d u e in p a r t to the tendency of most beneficiaries to create simple, flexible plans, a n d in p a r t to the fact t h a t some companies will n o t p e r m i t the beneficiary to elect

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a plan which will extend beyond the life of the beneficiary who establishes the plan. These companies fear that an agreement with an original lump sum beneficiary who elects a settlement option to pay the residue remaining at the death of that beneficiary to a contingent beneficiary designated by him may be regarded as testamentary. The greatest complexities arise in plans created by the policy owner for his beneficiaries, because in a large measure such plans must serve all the needs of the insured's widow and children extending over many years. Numerous contingencies must be covered by the agreement. Integration with insurance in other companies and with survivorship benefits under Social Security also introduces additional complications. POLICY OPTIONS Each of the three general types of insurance settlement plans is built from insurance contract rights described as options. T h e nature of these options has been dealt with elsewhere.2 T o review briefly, there are five3 basic options: (1) the interest option for life of the payee, (2) the fixed amount installment option, (3) the fixed period installment option, (4) the life income installment option, and (5) the joint and survivorship life income installment option, frequently not available for settlement of death benefits. From the standpoint of company practice, it is important to note that most insurance contracts give the owner or beneficiary the right to elect but one of these settlement options. Combinations of options are permitted only with the insurer's consent. Planned settlements would present few administrative, legal, or actuarial problems if confined to a single option plan. However, estates seldom lend themselves to such a simple arrangement. As plans are devised to cover multiple needs, and to protect several classes of beneficiary, it becomes necessary to combine options and introduce flexibility through extraordinary powers, 2 See R. C. Guest, "Development of Provisions for Optional Modes of Settlement," on pp. 112 to 118. s Others may be permitted by certain companies. Mr. Guest describes eight, including life annuity, cash refund life annuity, and installment refund life annuity, in addition to the five here mentioned.

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as for example, withdrawal privileges, the power to change from one option to another, and, of more current origin, the right to increase or decrease installment payments. Contract

Limitations

Most contracts contain restrictions with respect to the optional settlement privilege. It is generally provided that the company will not retain less than one thousand dollars under an option; that installment payments must amount to not less than ten dollars per month (in some companies not less than twenty or twenty-five dollars per month); and that payments under the fixed amount option shall be not less than five per cent of the original principal in any one year. T h e last provision means that at the latest the principal will be paid out within approximately thirty years, depending on the interest guarantee. T h e right is reserved by many companies to deny the option privilege if the policy is assigned, or if the owner or beneficiary is not a natural person. However, the assignment restriction frequently does not apply if the assignment is collateral. T h e provision that only a natural person may receive settlement under an option is based upon the view that deferred settlement service should not be available to corporations or institutions, as they have ample facilities for investing funds. It is also believed, perhaps without justification, that corporate trustee beneficiaries should not be entitled to an optional settlement, although in deserving situations some companies make exceptions. Except for these few contract limitations, individual company practice controls the planned settlement service that will be granted under the myriad of situations which touch upon the lives and needs of the American policy owner and his beneficiary. Procedure

for

Election

Not so many years ago an optional settlement was created by a simple request for the option, followed by a suitable endorsement of the policy. This method was so simple that it led to trouble. Questions arose with respect to claim settlements. If a beneficiary receiving settlement under the fixed income option died, who was entitled to the residuary installments, the contingent beneficiary, the primary beneficiary's estate, or the in-

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sured's estate? As a result of these difficulties and the increasing emphasis placed upon the importance of covering all contingencies that might arise, it has become general practice to prepare agreements covering the plan of settlement. These settlement agreements have become more and more complicated as planning techniques have developed. Today, the preparation of these agreements requires skillful draftsmanship. Many hours may be consumed in the drafting of some of the more extensive types; this, of course, greatly adds to the administrative expense. T h e following steps are generally taken in completing a settlement agreement. First, the underwriter or the policy owner supplies the description of the plan desired. The special agreement is then prepared in the company's home office and is delivered or mailed to the policy owner for signature. The signed agreement is returned, together with the policy if endorsement of the policy is required. The agreement is then recorded by endorsement on the policy, or if endorsement is not required, the agreement becomes effective when signed by the company. A copy of the agreement is attached to the policy or, in a case where a company completes the settlement agreement without requiring the presentation of the policy, a copy of the signed agreement is sent to the owner. Basic Rules of Practice

Because judgment, philosophy, and experience are the crux of rule-making, it is only natural that there will be marked variation in the extra contractual services of various companies as contrasted with the situation approaching uniformity which prevails with respect to the policy limitations. Certain of these special rules will be discussed briefly in order to provide a working knowledge of some of the situations in which they are controlling: Duration of Planned Settlements. There is a direct relationship between types of beneficiaries and the duration of a plan. Most companies will provide deferred settlement service to meet the needs of the original beneficiary and the first contingent beneficiary. In most situations this means that the plan will continue during the lifetime of the widow of the owner and at least until his children are of mature age. Settlement with the

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second contingent beneficiary is usually in a lump sum, thus bringing the plan to an end when the immediate family has been served. However, when parents of the owner are named as second contingent beneficiaries, it is considered desirable to extend the plan to provide income for them. T h e duration of a settlement plan may be limited further by the type of option selected. Thus, the interest option which involves no reduction in principal generally cannot be elected for several successive classes of beneficiaries, thereby extending the guaranteed interest income until a far distant future date. However, on this point there is considerable variation in company practice. Some companies limit the interest option to the lifetime of the original beneficiary, or thirty years, whichever is longer. A relatively few will not grant the interest option beyond the life of the original beneficiary. A majority will pay interest during the lives of the original and first contingent beneficiary, which is a very liberal service. In considering the duration of the interest option, it should be recognized that relatively few estates are sufficiently large to make it feasible to preserve the principal during the lives of primary and first contingent beneficiary. In recent years the lowering of the interest rate guarantee and increased living costs have made invasion of the principal a necessity in most estates. Furthermore, the trend toward paying a still lower rate of interest, or making no guarantee of interest if the withdrawal privilege is granted, causes the beneficiary to supplement her income through withdrawals. Withdrawal Privilege. T h e right of withdrawal is essential in many plans in order to provide for emergencies. T h i s right may be limited to a fixed amount per year, or may be unlimited as to amount. Generally it is provided in the agreement that withdrawals must be in multiples of fifty or one hundred dollars and that the beneficiary may not make more than three or four withdrawals per year. It is also the practice of many companies to provide that the company reserves the right to delay the withdrawal payment for 60, 90, or 180 days. T h i s latter provision is similar to the standard policy provision which permits deferment of 180 days in the exercise of the cash surrender option. Another privilege ordinarily permitted is to limit the withdrawal

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to a stated date or period, thus making possible larger withdrawals during the period children are in college. The withdrawal privilege is available if the fund is retained under the interest or fixed amount option, but generally is not available under the fixed period option, or under the life income option. The reason for not permitting withdrawals under the fixed period option is that a withdrawal upsets the essential character of the option because it necessitates a reduction in income, or if the same income is continued, a shortening of the original payment period. In the case of the life income option a withdrawal cannot be permitted, except when the option provides a period certain. A few companies will permit a provision for withdrawal of the commuted value of the period certain payments. Right to Change from One Option to Another. In recent years there has been a strong tendency to grant the beneficiary power to change the plan better to fit her needs or the needs of her family. This can be accomplished in part by giving the beneficiary the privilege of changing from one option to another. T h e privilege operates best when the interest option has been elected originally, but can also be utilized with success where the fixed income or fixed period option has been elected. T h e latter arrangement is best suited to the case in which fixed income is needed for a specified period, following which the beneficiary can elect the continuance of the fixed income or request that the remaining income be commuted and paid as a life income. Some companies will not permit this combination, in which event the result can be accomplished, with some added complexity in the agreement, by dividing the fund into two parts, one of which is paid under the fixed installment option for the period desired, the other being held at interest subject to change to the life income option at the end of such period. It may be argued with some force that a rule which can be circumvented in this manner is of doubtful value, particularly when the solution creates additional administrative expense. In granting the power to change to another option, additional control may be obtained by the owner through limiting the amount of the monthly income elected. One of the popular settlement plans contemplates the reten-

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tion of the proceeds under the interest option, with the right in the beneficiary to make annual withdrawals and to elect the life income option after a fixed future date. This creates a high degree of flexibility and allows the beneficiary to use as much of the fund as is necessary to bring up the family, and then subsequently elect to receive a life income. Since the date as to when the change to the life income would be desirable is frequently uncertain at the time such a plan is drafted, the owner may request that the beneficiary be permitted to make the election at any time. Thus, if a widow-beneficiary is employed after the children grow up, and does not need the life income immediately, she could defer it until later. Actuaries frown on this arrangement, however, because their studies show that if the life income can be elected at any time, there is a tendency to make the election only when the beneficiary's longevity appears promising. T h e effect of such antiselection is to produce greater liabilities than those anticipated. Some relief from rules prohibiting the election of the life income at any time can be obtained if the privilege is exercisable only "within one year" of a preselected future date, or "within one year" of the insured's death. Unfortunately, the introduction of such limitations creates additional contingencies which add to the administrative expense of preparing agreements. T h e hope often is expressed that some way can be found to grant this broad privilege without impairing security or equity among policyholders. Some feel that a substantial reduction in the cost of arranging plans and preparing agreements may tend to offset some of the losses the rule is established to prevent. Right to Increase Payments. An important power of rather recent origin is the power to increase the amount of income, usually under the fixed amount option. Social Security death benefits created a need for some method whereby the life insurance planned settlement could readily be coordinated with the Social Security income. Many plans for accomplishing this have been developed. It should be recognized, however, that Social Security death benefits, which are payable as income in the case of a widow with a child under age 18, may be discontinued in whole or in part under various circumstances. In such cases a planned settlement which is rigidly dovetailed with the

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Social Security income may create a hardship, unless some way can be devised to permit a change in the life insurance payments. It was this problem which brought into being the power to increase payments. More recently, this right has been emphasized as a means whereby income can be increased to meet higher living costs or to overcome loss of income from other property, or even from other insurance which, through circumstance or inadvertence, was out of force at the time of the owner's death. It is now standard practice to permit a contract provision whereby the beneficiary may increase the income. The owner may establish upper limits of income—for example, "not to exceed five hundred dollars per month." It can be provided that this power may be exercised at any time, after a specified date, or within a fixed period. Some companies limit the number of times this power can be exercised in order to avoid too much expense in making changes. Primary and Secondary Beneficiary. T h e needs of a primary beneficiary can be served by combining options and granting special powers. Almost any reasonable combination of options is available. As already indicated, in the case of the primary beneficiary the impact of rules is felt most in connection with powers designed to create flexibility. However, in connection with the secondary beneficiary's problems, the restrictions deal not only with special powers, but also with option combinations. T h e term "secondary beneficiary" is here used in its narrow sense to describe the situation in which the primary beneficiary survives the insured, dies before receiving all the fund, and the balance of the fund or of the installments becomes payable to a secondary beneficiary. T h e service the companies will render in this situation depends to some extent upon the type of option which is operative at the time of the primary beneficiary's death. If the primary beneficiary dies while the interest option is operative, practically all companies will agree to settlement with the secondary beneficiary under any one of the installment options or even under the interest option for at least a limited period of time. T h e real conflicts of practice occur when the owner desires that at the death of the primary beneficiary, the unpaid installments certain under the fixed income, fixed period, or life income

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option be commuted, and the commuted value settled under the interest option, or under one of the installment options. T h e hopeless disagreement as to sound practice in this type of situation is one of the major practice problems. Before explaining these conflicts, it would be well to mention again that service of this character must be confined to that which may be furnished within the margins available for expense. An insurer, having set u p a plan of installment settlement utilizing an income option, may find it quite costly under its particular system to terminate the plan and establish a new set of records for the distribution of the remainder of the f u n d by means of an entirely new arrangement. Furthermore, since the date of the primary beneficiary's death cannot be determined in advance, there is no way of knowing how much the remainder will be. Thus, in actual experience, the balance may be so small that the plan of distribution destroys the practical value of the remaining fund. T h i s may be particularly true if the secondary beneficiary is to be paid under the fixed period or life income option. Accordingly, these options should not be made automatically operative in those situations where the balance of the fund, upon the death of the primary beneficiary, is apt to be relatively small. On the other hand, where the primary beneficiary dies while receiving settlement under an installment option, there are compelling reasons for commuting the unpaid installments and providing for the settlement thereof under an interest or fixed income option. T h e income the primary beneficiary receives is not always the appropriate amount of income for the secondary beneficiary. Assuming the primary beneficiary was the owner's widow, and the secondary beneficiary his children, it may be highly desirable to convert the plan to an interest or fixed income option, with certain withdrawal privileges that may be exercised by the guardian to the better advantage of the children. T h e needs of the children will not always be served best by an inflexible arrangement under which the income payable to the primary beneficiary will be continued to them for a fixed period. Nor is it a satisfactory answer to suggest that the plan for the primary beneficiary be kept on an interest basis so that there may be more flexibility in the plan for the secondary beneficiary. Practically all companies will permit an arrangement whereby,

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in the case of the death of a primary beneficiary, the installments then being paid will be continued to the secondary beneficiary. In fact, many companies encourage this, particularly if the insurance estate is small. The right of a primary beneficiary entitled to a single sum payment to elect an option is usually granted by contract. If such a primary beneficiary predeceases the insured, the secondary beneficiary may elect settlement under an option. But, if the primary beneficiary survives the insured, and dies, it is general practice not to grant to a lump sum secondary beneficiary the right to elect a settlement option; nor will many companies permit a primary beneficiary the right to designate a secondary beneficiary to receive a fund which otherwise would be paid to the primary beneficiary's estate. Miscellaneous

Practice

Problems

Remarriage Clause. Frequently the owner will request that payments be discontinued if his wife, the primary beneficiary, remarries. Most companies object to the inclusion of such a clause because it may put the burden on the company of determining whether a valid marriage was consummated. This burden may be avoided to some extent by the terms of the clause, in which event the soundness of the clause may be questioned along broader lines. Generally in such a clause it is provided that the payments will be discontinued if proof of remarriage is furnished the company by the secondary beneficiary or his guardian. Since the widow probably would be the guardian, there is doubt as to whether the proof would be furnished. Also, from the social standpoint, the remarriage of the widow does not necessarily mean that the secondary beneficiary will be served better by a plan which would necessitate the appointment of the widow as a guardian to receive the income for the benefit of her children. Spendthrift Clause. Most companies automatically include a clause in settlement agreements which provides that the funds held and the payments made shall be free from the claims of creditors of the beneficiary. Such a clause finds legal support in the statutes of many states. Common Disaster Clause. One of the many advantages in a

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planned insurance settlement is the protection afforded when the insured and the primary beneficiary die in a common disaster. If the policy proceeds are payable in a single sum, and the primary beneficiary survives only a short time, the benefits vest, and would be paid to the beneficiary's estate. Since a planned settlement defers the vesting of the proceeds, the common disaster cannot result in a misdirection of the bulk of the benefits. However, large single sum payments due at death, as for example the clean-up fund to cover final expenses, might pass to the beneficiary's estate unless the so-called common disaster clause is included in the agreement. The usual form of clause defers the vesting of any payments provided until fifteen or thirty days after the insured's death, and generally is not included unless requested. Dividing Proceeds. Most companies will permit the settlement of proceeds of several policies under a single agreement, provided the installment and interest rates are the same. They also allow division of a fund into parts, with one part payable in a single sum or under an option, and the other under another option. This may result in several different plans of settlement under a single agreement, and frequently adds substantially to the length of the agreement. Settlements with Minor Beneficiary. Settlements with minor beneficiaries involve a few rules which should be borne in mind and which apply regardless of whether the minor is a primary or secondary beneficiary. Most companies will not make payments direct to a minor beneficiary on the ground that such payments, under the law, must be made to the legal guardian of the minor's estate. In order to avoid the necessity for guardianship, settlement plans frequently provide that the payments be made to an adult trustee for the benefit of the minor. Many companies do not deem such a provision in a settlement agreement as sufficient in itself. These companies require some proof that a written trust instrument has been completed embodying the purpose of the trust and the powers of the trustee. This is deemed desirable in order to avoid settlement difficulties. Designation of Unborn Children or Future Spouse. The desire of many policy owners to provide benefits in the far distant future brings into focus possible happenings in the life of a

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family which cannot be determined when the planned settlement is created. Children and grandchildren that may be born in the future, and future marriages, are contingencies which present questions regarding identity, if the unborn child or the future spouse is included as a beneficiary. Social necessity has prompted almost all companies to permit the designation of unborn children of the policy owner. Few companies, however, will permit the designation of unborn grandchildren. A majority of the companies will not permit the designation of an unnamed spouse of a beneficiary because it might be burdensome to determine whether the beneficiary was ever married. Furthermore, difficulty is involved in those situations in which there has been more than one spouse, and it becomes necessary for the company to determine the rightful payee. A New Approach

to Planned

Settlements

Having charted some of the more important practices with respect to planned settlements, it might prove helpful to discuss some of the by-products of such practices. T h e bald statement of a rule does not always carry with it a true picture of the part the rule plays. T o appreciate adequately the full impact of practice it is essential that we think through the various steps which must be taken in order to bring into being a planned settlement and to appraise the over-all aspects. Reference is made elsewhere to the place of the life underwriter in the sales function, the classic examples of planning, and the advantages of estate planning from the standpoint of the insurance buyer, the underwriter, and the company.4 However, the general approval given such service by writers and speakers is sometimes difficult to reconcile entirely with current experience. For example, a high percentage of insurance sales is still on a lump sum basis. There is a tendency to provide planned settlements only in the larger estates, which is contrary to the philosophy of the business that estates, both large and small, are entitled to complete service. A few underwriters make sales on the basis of an estate plan, but do not follow through and furnish agreements which carry out the plan adopted. Fortunately, * See John O. Todd, "Programming to Meet Beneficiary Needs," on pp. 212 to 232.

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this latter practice is not widespread, and every precaution is being taken in agency management to induce underwriters to assume the responsibility. It is mentioned, however, because it is a symptom which is directly related to company practice. T h e other tendencies described are also symptoms of something less than full satisfaction among underwriters with respect to our planned settlement practices. Whether experts in the field agree or disagree with the conclusion that company practice discourages underwriters from furnishing proper programming service, I feel confident that most of them will concur in the thought that lack of uniformity creates a real educational problem. T o train a new underwriter in the practices of one company is a major undertaking which some agencies will not attempt until after so-called package selling has been mastered. Add to this the problem of arranging settlement agreements for policies issued by other companies, and the training problem becomes more complex. What is the solution? Does it lie in fewer rules which would mean more liberal practice, with resulting greater expense? Should some of the more liberal practices be curtailed to approach an optimum of service agreeable to all companies? My answer to both of these questions would be in the negative, because it does not seem practical to expect that all companies could or should adopt similar standards of practice. I submit, however, that a careful analysis of the planned settlement function might lead to ways and means of reducing administrative expenses to the extent that many companies might find reasonable bases for liberalization in practice. In such a study I would first suggest that we abandon the concept that a planned estate must be strictly individual to each insured and his family. It is true that no two policyholders have exactly the same needs, and that no two settlement arrangements are exactly alike, but the patterns of a large percentage of plans are so similar that a high degree of standardization is possible. T o accomplish such standardization, the sales talk which likens the planned settlement to a tailor-made suit must be modified to meet modern conditions. In fact, the problems of the average family are quite similar. A study which I made of a number of tailor-made agreements confirmed this statement, and also disclosed that difficulties of

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practice often resulted from overemphasis of detail and of remote contingencies. This latter result is a natural outgrowth of the method employed in creating a plan. Too frequently the underwriter raises too many questions regarding remote possibilities. Too often he asks the untrained buyer what plan he desires instead of offering a plan. Then there has been a slight tendency to create prestige by showing that a competitor's agreement lacks something. If the objective is to provide planned settlement service to policyholders of both large and small estates, I submit that management should not rely on a web of rules to guide the agent, but rather it should offer standard ready-made agreements which can be adjusted here and there to meet the needs of the individual family. Such agreements might be compared with readyto-wear clothes, without which we would experience difficulties in clothing Americans, at least at a reasonable cost. This does not mean that the standardization method will meet all demands. As is true in other fields, there will always be a need for special service. Generally this will arise in the large estates where the company and the underwriter can afford to create a tailored agreement. Furthermore, the large estates frequently are handled by more advanced underwriters, who may be more capable of coping with practice variations. As a second step, I would suggest that studies be made to determine the type and extent of deferred settlement service a life insurance company should provide as a reasonable fulfillment of its social responsibility. T h e approach to such a study should be a positive one. Historically, it would seem that underwriters initially developed the settlement plans. T h e companies eventually found such plans to be out of line with their legal, actuarial, and expense concepts. Rules of practice were then introduced to prevent certain abuses. This evolution, while natural, has led to uncertainty and has destroyed some confidence among underwriters in the sense that, currently, certain of them are dubious as to whether a given plan developed in the field will survive the gauntlet of company practice. If it does not, some degree of prestige is lost, and in a few situations in which the buyer is adamant, the sale may be lost. Out of these experiences some underwriters have reached the conclusion that it is

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practical to offer planned settlement service only where the amount of insurance is substantial. If we feel strongly that planned insurance estates should be made available to all owners, then it would seem that we should attempt to define such service in terms of standard plans—plans which the companies can afford to offer; plans which will reasonably serve the public; plans which are salable by the underwriter. As a third step, I would suggest new methods of educating the underwriter. Currently it would seem that the underwriter is trained in the use of the options and in his own company practice, but the actual development of the terms of a given settlement agreement often depends on the personal and possibly nebulous views of both the underwriter and the insured. This naturally leads to many complicated and unsatisfactory agreements. It is no reflection on the thousands of underwriters, who are exceptionally well qualified to design settlement plans, to recognize in a field as technical as this that there are marked differences in the abilities of those who render the service. My thought is that improvement in the educational function can be accomplished primarily by training in terms of standard plans which need only minor adjustments to meet particular needs. This gives the underwriter a track to run on. It simplifies his training; it removes uncertainty; it saves his time. More important, it eliminates those endless voyages into the seas of remote contingencies which, from the practical standpoint, should be disregarded. STANDARDIZED AGREEMENTS Let us now become more definite about a program of standardization. Can it be achieved? T h e answer is yes. A few companies, during the past ten years, have experimented with standard settlement plans. Their efforts have been along two different lines, but the objectives have been quite the same. Some companies have a standard "order form" which includes the usual arrangements found in the average insurance estate. T h e clean-up fund for final expenses, the income for the family until the youngest child has reached maturity, income for the widow thereafter, emergency funds, etc., are set forth in proper

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order, with reasonable arrangements for the secondary beneficiary. The underwriter can complete the form by checking the arrangements desired and inserting the amounts of income required by the beneficiary. The completed form is then sent to the home office. There the agreement is drafted and returned for the owner's signature. T h e other method contemplates the actual preparation of the settlement agreement in the field by the underwriter. A standard settlement contract is devised which will serve a large percentage of family need cases. Like the "order form" plan, the options and provisions are so arranged that by checking boxes and filling in amounts of income, an agreement for the average case can be completed in a few minutes. It is then forwarded to the company where it becomes a contract when signed. Such an agreement can be devised in a manner that eliminates practically all rule problems. For example, if a company will not permit the commutation of future income and the payment of the discounted value in installments to a secondary beneficiary, the agreement form will not include such an arrangement. T h e principal objections to the use of a standard agreement are: 1. An agreement which rests to a great extent upon provisions that have been checked is risky from a legal standpoint. This criticism usually overlooks the necessity for writing in income and other data which clearly show the intent of the parties. A ten-year experience in the company I represented until recently did not produce a single controversy that would support the criticism. 2. It is too difficult to educate an underwriter to use such an agreement. This, of course, depends on how much simplification can be accomplished in the drafting. In the early stages of developing the idea of standard agreements we did experience educational difficulties. Streamlining the agreement overcame this problem. 3. A standard agreement detracts from the underwriter's prestige. Those who have used standard agreements claim the opposite result. The agreement is prepared so quickly, and the plan is so complete, that buyers are impressed with the service.

Some of the advantages in the use of a standardized settlement agreement follow: I. It simplifies the major problem of estate planning; i.e., how shall payments be made? The agreement solves this by furnishing the under-

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writer a "track to r u n on," a n d by providing a complete "model" plan which will fit the needs of most large a n d small estates. 2. It prevents oversights. T h e automatic inclusion of the spendthrift clause, the provisions for withdrawal privileges, etc., assure maximum benefit from the insurance. 3. It offers convenient, comprehensive, flexible settlements. For example, a policyholder may make provision for many diverse matters such as adjustment by beneficiaries of the amount of income (within specified limits if desired), an income for family needs, an income supplementing Social Security benefits, an educational f u n d , an emergency fund, automatic transfer of funds to other needs as certain needs expire, and so on. 4. It saves time. T h e agreement is available for final execution at the first interview. It thus saves the time of both the underwriter and the policyholder. 5. It eliminates red tape. Legal technicalities a n d difficulties with the company's rules are avoided by its use. 6. It increases prestige. T h e plan carries with it the prestige of company approval and many years' study by the company. 7. It enables new as well as old underwriters to do programming work. Programming the insurance sold to cover a need is accomplished by completing a form which requires only a few simple "fill-ins." 8. It facilitates delivery of the insurance. T h e agreements can be used with new applications as well as old policies; hence, the agent is able to deliver the final plan, not simply a policy.

In addition, there are these administrative advantages: 1. Since the agreement is completed by the underwriter, all home office expense in the preparation of the agreement is eliminated. Reviewing and signing the agreement, and endorsing the policy if necessary, can be performed by clerks. T h r e e clerks can handle between five hundred a n d one thousand of such agreements per month. 2. Costly correspondence criticizing plans and explaining rules or reasons for rules is reduced to a minimum. 3. Service is speeded u p a n d the inevitable bottlenecks are avoided. This was particularly true during the war period. 4. Claim handling is simplified. T h e claim department has fewer interpretation questions. 5. Savings can be made in the methods employed in distributing income. Since the agreements are standard, it is easier to mechanize the payments.

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Proposal for New Option T h e present options appearing in most policies have been employed, with little change, since the turn of the century, although they did not receive much attention until after World War I. Each option produces a certain benefit, either interest or income. With the increase in size of insurance estates, a single option rarely provides a satisfactory plan of settlement. In order to meet the problem of employing more than one option at the same time, as distinguished from employing an interest option to be followed by an income option, it becomes necessary to split funds into parts which, in turn, are settled under different options. This is quite cumbersome, and I venture the suggestion that further simplification might be accomplished by designing an option which would treat the f u n d as an account from which payments will be made as directed, and to which interest will be credited. As long as the payments from the fund exceed the interest, the option would be as favorable to the company as the regular interest option. In the case of the usual family plan, payments could be made from the f u n d until a fixed future date, and then the balance of the f u n d could be disposed of under one of the other options. T h i s would be much simpler than creating two funds and utilizing two options as is now necessary. CONCLUSION It is not practical to discuss here all of the many technical questions that arise in this field. Accordingly, the discussion has been limited to a general explanation of the current practices as I have observed them, my knowledge being supplemented by that of writers who have dealt with the problem. T h e suggestion on standardization and the development of a new option are ideas which have been tested during the past ten years and found workable. A standard agreement is attached: 5 it is estimated that it will be used in ninety per cent of the planned estates handled by the company I formerly represented. It includes the new option concept and is the result of years of experimentation by the home office and the field in trying to simplify and standardize planned settlements. 5 See Appendix D, starting on page 241.

FINANCIAL ASPECTS OF OPTIONAL SETTLEMENTS By Edward W. Marshall, F.A.S., F.A.I.A.*

IMPRESSIVE picture of the valuable service to policyholders and beneficiaries offered by the optional methods of settlement contained in life insurance policies has already been given. One of the unique features of this service is that these settlements usually provide a guaranteed rate of return on the policy proceeds left with the company, with a promise of an increase in the income if interest earnings of the company permit. T h e provision for a guaranteed income poses some interesting and important problems to the companies in whose policies the guarantees appear. These problems are so difficult that in recent years some life insurance authorities have recommended that optional methods of settlement on a guaranteed income basis should no longer be included in new policies. Inasmuch as the desirability of continuing to offer this service to future clients is so great, a discussion of these problems and possible solutions merits serious consideration. As others have indicated, the optional methods of settlement usually provide that the policy proceeds may be left with the life insurance company under one of three general arrangements: (a) to be kept on deposit and earn interest at a guaranteed rate; (b) to be paid out in a limited number of installments with interest at a guaranteed rate; or (c) to provide some form of life annuity on a guaranteed basis. All of these options require the company to decide in advance on the interest rate which it will thus guarantee, and the life annuity option also requires an assumption regarding the future longevity of annuitants. AN

• Vice President and Actuary, Provident Mutual Life Insurance Company of Philadelphia; Past President, Actuarial Society of America. 146

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The life insurance company is confronted with the problem of fixing these guarantees on a basis which will be sound and at the same time will be satisfactory in the highly competitive life insurance field. Inasmuch as the optional settlements will mostly begin when the policies are terminated many years hence by the death of the insured or the maturity of the endowment, and may continue for at least a generation more, the problem becomes doubly difficult. At the moment, for example, authorities even hesitate to predict to us what will be the course of interest rates over the next five years. Consider, then, the greater problem of wisely choosing the interest basis for a guarantee effective far in the future. VARYING CONCEPTS ON FINANCING There are various schools of thought regarding the ways in which optional methods of settlement may be financed. Inasmuch as they may involve an interplay between cost of insurance to policyholders and size of guaranteed return under optional settlements, it seems worth while to discuss them at this point. The three main schools of thought may briefly be summarized as follows: 1. According to the first school of thought, there should not be any guaranteed rate of return under optional methods of settlement, but merely a promise to make the settlement on the basis of interest, mortality, and expense conditions prevailing during the currency of the settlement. Some authorities outside and inside of the life insurance business have urged this course. Obviously it minimizes the financing problems. Unfortunately it would reduce considerably the value of optional settlements in programming insurance because a guaranteed return introduces an element of certainty into the picture. Furthermore, as nearly all of the companies offer optional methods of settlement with a guaranteed return, competition makes it difficult for a company to depart from the established contractual pattern. 2. T h e second school of thought urges that if optional methods of settlement in new policies are to include a guaranteed return, the return must be based on what are now considered to be truly conservative assumptions as to interest, mortality, and expense rates, with a provision for increasing the return if these assumptions prove to be too conservative in the light of future earning conditions. This school of thought is attracting adherents because of the uncertainties which prevail today regarding the course of future interest and mortality

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rates. Under this method it would be reasonably probable that the optional methods of settlement would be nearly or entirely selfsupporting under any conditions now considered at all likely to occur, so that the problems of financing them would be minimized. 3. T h e third school of thought prefers to sail closer to the wind and to offer guarantees based on less conservative assumptions, perhaps with the thought that if it later appears that the optional settlements are not likely to be self-supporting, the expected deficiencies can be met by reductions in dividends on the class of policies containing the favorable optional settlement provision. A problem in planning is obviously involved here. T o administer this method systematically, the company must continually observe probable trends in interest, mortality, and expense rates, and if necessary make advance dividend adjustments in the group, so that when the optional settlements begin to occur in material volume, additional funds will then be available to take care of the substantial deficiencies likely to be caused by the over-liberal guarantees.

Certainly, when the optional settlements actually begin, there should be sufficient funds on hand and set aside to take care of them thereafter without question. From that time on, the settlements should be self-supporting from these funds. T h e n , even if the class of the company's insurance policies from which they originated were completely closed out by the termination of all policies by death, endowment maturity, or otherwise, the optional settlements would carry themselves until they would be completed by their terms. With this principle in mind, it will be seen that the essential difference between the results of following the three schools of thought outlined above is the extent to which the policy proceeds may have to be augmented from some other source to provide the return guaranteed under the optional settlements. If they have to be so augmented, the additional funds needed in a participating company would probably have come from previous earnings which would otherwise have been payable as dividends to the policyholders of the block of insurance containing the optional settlement guarantees responsible for the condition. In this lecture we shall consider only the ways in which a participating company would meet the situation. Such a dividend adjustment would of course not become necessary if the first school of thought were followed. It would probably be very minor under the second school of thought if

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it occurred at all. Under the third school of thought, the greater the seeming liberality of the optional settlement guarantees, the greater the likelihood that substantial dividend adjustments would be required to pay for the excessive guarantees. T h e situation would be particularly pronounced on endowment income or retirement annuity policies which provide on their face for a guaranteed income payable at maturity, as a very large percentage of the holders of such policies elect to take the maturity income. Within limits any of these three schools of thought might be considered to offer a reasonable solution from the standpoint of the public, provided that under the third school the guarantees are not very excessive and the policyholders realize that overliberal guarantees will be much more likely to affect future dividends adversely. Outstanding Policies. Under the older policies of most companies the optional settlement guarantees are larger than under new policies now being issued. Naturally the companies must carry out these old guarantees and adopt suitable financing arrangements accordingly. If the guarantees are more liberal than will be justified by current and probable future earning conditions, as explained above the surplus earnings on the old policies containing these guarantees will necessarily be drawn upon in advance to meet the situation. T h e remainder of this paper will deal with the problems connected with the guarantees to be made under new policies hereafter issued. BASES OF O P T I O N A L S E T T L E M E N T GUARANTEES IN NEW POLICIES With this background it will now be interesting to discuss the various factors the companies must consider in fixing their guarantees under optional methods of settlement in new policies and in financing them later. These factors are of two general classes: (1) those which might be considered economic or physical in nature, such as future interest, mortality, and expense rates; and (2) those somewhat dependent on human volition, such as financial anti-selection, and cash withdrawals. Let us review these factors in the light of current optional settlement guarantees in policies now being issued.

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Interest Rate. What will be the rate of interest which a company can obtain on its assets a generation or so hence when optional settlements under new policies now being issued begin to appear in considerable volume? For 1946 the average net rate of interest (after deducting investment expense) received by the companies was in the neighborhood of 3.0 per cent on outstanding investments and of 2.8 per cent on new investments. The experience of individual companies varied, of course, from these averages. Twenty years ago these rates averaged about 5.0 per cent. Will interest rates a generation hence remain at present levels or be greater or less? Frankly, no one can foresee whether the social, political, and economic forces of the future will cause interest rates a generation hence to be higher or lower than they are now. Nor can the possibility of net investment losses over the business cycle be ignored. Furthermore, as will be explained later, allowance must be made for the adverse effect on interest caused by financial anti-selection and the need to maintain liquidity to meet cash withdrawals. Also provision must be made somehow for the expense of administering the settlements. Some of the life insurance companies therefore base their optional settlement guarantees on what now seems to be a reasonably conservative rate of interest for the purpose, with a promise to increase the interest beyond this minimum if current future earnings justify. Until recently, interest rates assumed in connection with optional settlement guarantees have usually ranged from 3.0 per cent to 3.5 per cent, with a very few instances of 4.0 per cent for life income settlements. Of late the tendency has been to adopt 2.0, 2.25, or 2.5 per cent, and the indications are that within the next few months most companies will have adopted one of these bases with a preponderant number using 2.0 per cent when the proceeds are left at interest and 2.5 per cent in connection with life income settlements. T i m e only will tell whether these rates are sufficiently conservative. Mortality Rates. It seems to be a fact that annuitants live longer, on the average, than other people. Furthermore, the longevity of annuitants has been increasing steadily over the recent decades and there seems to be a considerable probability that advances in medical science will result in much greater

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longevity among annuitants in the years to come. Already we have seen what miracles sulfa drugs and penicillin have wrought in reducing the death rate from pneumonia, especially in the middle-aged and older segments of the population where pneumonia was formerly a major cause of death. Vigorous attacks are currently being made on the causes of cancer and heart disease, and the science of geriatrics (concentrating on the diseases of the middle and older ages) is coming to the forefront in medical education. T h e effects of infection and major bone fractures which formerly took such a toll among older people are gradually becoming minimized. All these developments suggest that the increase in annuitant longevity to date will be overshadowed by increases in longevity in the future. Obviously life income optional settlements seem unlikely to be self-supporting if, as is mostly the case today, they offer guarantees based on past or present rates of mortality among annuitants. Under the circumstances it may become desirable for companies either to make no life income guarantee whatever, or to follow the second school of thought described above. In the latter case they could employ a "forecast" annuity basis, taking into account what seems likely to be the probable increase in annuitant longevity over the next generation as judged from past trends and present indications. Then, if they promise to increase this guaranteed income in event these assumptions later turn out to be too conservative, the public is well served and the life income optional settlements are likely to be kept approximately selfsupporting. Expense Rates. As a rule, the life insurance companies have not been providing directly for expenses in fixing the assumptions underlying their optional settlement guarantees. Apparently they have assumed that the expenses would be covered by favorable margins over the interest or mortality assumptions. With increased levels of maintenance expense following the increased cost of living, however, and with some doubt whether there will be favorable margins in the mortality and interest assumptions, there is much to be said for making a direct provision for expense in determining optional settlement guarantees. Information in hand suggests that the present annual cost of issuing and maintaining optional settlements may be roughly

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equivalent to 0.1 per cent interest on the average balance of policy proceeds in hand. This of course is not large but is too great to disregard. The expense of optional settlements is considerably greater if the type of settlement is complex, involving more than one type of optional settlement arrangement and many beneficiaries. Life insurance companies have required that settlements be kept relatively simple because they are not in a position to administer optional settlements requiring discretionary powers or complex contingent arrangements necessitating expensive investigations to determine the rightful recipients. Nevertheless, there has been a distinct tendency for the complexity of the average optional settlement to increase. For example, a cross-section of the optional settlement elections made in one company by the insureds for their beneficiaries showed that ten years ago about sixty per cent of them might be classed as relatively simple and forty per cent complicated, whereas recently, by the same mode of classification, about twenty-five per cent of the settlements were relatively simple and seventy-five per cent complex. As a rule the policies provide for one optional settlement to one beneficiary, which the companies by extra-contractual practice have permitted to be extended reasonably in some areas. Life insurance optional settlements admittedly must have their practical limitations and where more complex structures are desired it is necessary for the client to turn to the local trust company to administer them. Anti-selection. A potent cause of additional cost, which must be allowed for in financing optional settlements, is what may be termed anti-selection or selection against the company. This occurs because the optional settlements can be elected for or by the recipient when conditions are most favorable to him and least favorable to the company. For example, one reason why the mortality under the life income option is unfavorable to the companies is because many of the potential recipients in poor health decide to take some other form of optional settlement, so that the average longevity of those who take the life income option is considerably above average. Of course, when a policyholder does not give his beneficiary the right to elect another option or a lump sum equivalent,

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this opportunity to exercise anti-selection is not present. A few companies recognize this situation by providing two levels of life income guarantees, the lower one available to those potential recipients who thus have the right to exercise anti-selection, the higher level to those who have no right. Most companies, however, for various practical reasons, do not attempt to make any such differentiation. Another equally important example is what might be termed financial anti-selection. When outside investment conditions are difficult, and the yield on new investments is low, clients are much more likely to leave their policy proceeds under an optional method of settlement with its guaranteed return and safety of principal. This puts the investment burden on the companies at a time when they cannot invest the money to advantage. Also at such a time there is a trend away from the use of trust company service to the use of optional settlements. The situation is particularly pronounced if the guarantees under the optional methods of settlement are much greater than the return on new investments which the clients could safely make elsewhere. On the other hand, when the yield on outside investments is relatively good, the proportion of clients using the optional settlements is likely to be reduced. Also, some of those who previously had left their policy proceeds with the companies are likely to withdraw them for investment elsewhere. This might make it necessary for the companies to sell assets to meet the cash demand and in any event would reduce the funds which the companies would otherwise have to invest on the favorable market. Financial anti-selection thus adversely affects the interest rate of the companies at both extremes of the business cycle, and creates a loss which must be taken into account in fixing the interest assumption underlying the optional settlement guarantees. Anti-selection is a greater force today than it has ever been because the insuring public has become more educated to the use of optional settlements than a decade or two ago. Cash Withdrawals. Finally, as most of the recipients under optional settlements have the right to withdraw all or part of the proceeds in hand, the companies must keep a larger propor-

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tion of their investments liquid than would otherwise be the case. This means the purchase of a larger proportion of shorter term investments with less than average yields under present investment conditions, which correspondingly lowers the companies' earned interest rate and gives another reason to adopt a conservative guarantee. T o offset this factor a few companies have provided a lower return to recipients who have the right to withdraw the remaining proceeds, either through a reduction in the rate of interest guaranteed, or in the dividend of excess interest, if any, allowed in addition thereto. Most companies, however, have not attempted to follow this course. Incidentally, the banks today do not usually allow any interest on checking accounts, and many savings fund institutions pay only about li/£ per cent on deposits. None of them guarantees to continue to pay any interest whatever. They base their return on the earning conditions of the day. Thus they can offset both the effects of financial anti-selection and cash withdrawals by adjusting the interest rate on deposits. Under the life income option the problem of cash withdrawal is not so great as when the policy proceeds are left on deposit to produce a periodic interest return. Thus, as already mentioned, some companies use a higher interest assumption on life income settlements than on the latter type of settlement. Other companies, however, feel that the likelihood of an increase in future annuitant longevity is easily an offsetting factor, and thus employ the same interest assumption for all types of optional settlements. Are Optional Settlements Still on Trial? T h e foregoing remarks show that the financing problems connected with optional settlements are not easy. In fact, as already mentioned, there are some authorities who believe that optional settlements with fixed guarantees are still on trial. They question whether the companies should continue to provide for them in their new policies. The ideal, of course, is that the optional settlements shall be completely self-supporting under any future developments. When the guarantees are not sufficiently conservative, this ideal is not likely to be realized if future interest, mortality, and expense rates take an unfavorable turn. In such case, as we have seen, the anticipated loss under the optional settlements properly would

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have to be financed in advance from the surplus earnings of the group of policies from which the settlements would be derived. It seems preferable, however, to fix guarantees so that this will not be likely to occur at all, or only to a trivial extent. There are those who believe that a sound and reasonable solution is to offer considerably lower optional settlement guarantees than are now contained in any new life insurance contracts, supplementing these guarantees by the contractual promise to give the optional settlement recipients the full benefit of the earning conditions of the companies prevailing at the time the settlement is made, taking into account all the elements of cost outlined above. While this plan does not give the degree of definiteness to clients that a higher scale of guarantees furnishes, it may represent a reasonable compromise solution. Optional settlements undoubtedly have outstanding advantages, both for the insuring public and for the companies. T h e service they render to policyholders and beneficiaries is immeasurable. They make possible effective insurance programming which appeals to the highest type of clientele, attracts excellent men to the field of insurance selling, creates a larger volume of stable business with lower than average lapse rates, and greatly enhances the public appreciation of the value of life insurance. It is therefore to the advantage of both the companies and the insuring public that this valuable optional settlement service should not only be continued in connection with future new insurance, but should be on a basis that will prove satisfactory to the entire group of policyholders under the test of time.

COROLLARY LEGAL ASPECTS OF SUPPLEMENTARY CONTRACTS By Berkeley Cox, LL.B.*

THE title of this chapter is more comprehensive than illuminating. T h e first requirement for intelligent consideration of it is, therefore, to define its terms. As it is f u n d a m e n t a l to this discussion that we all have in m i n d the same kind of agreement, I shall first define the term "supplementary contract," as that term is herein used. T h e definition is broad enough, I believe, to include nearly all of the agreements by which provision is made for deferred settlements under life insurance policies. A supplementary contract is a contract which is: (1) either a part of a life insurance policy or a separate instrument, which may or may not be designated a trust agreement, referring to the proceeds of a policy, (2) made between a life insurance company and the policyholder or the beneficiary, (3) made before the maturity or surrender of the policy, or after the policy has matured by reason of the death of the insured, or after it has matured as an endowment, or upon surrender of the policy, (4) by which the company agrees to make definite future payments, but which does not require the company to segregate or hold any particular f u n d for the payees, (5) such payments to be made to the person with whom the company contracts, or to some other person, or to both, as may be provided in the contract, (6) in consideration of the payment of premiums to the company or in consideration of the company's not making a payment presently due under the terms of the policy. Before proceeding to define what is meant by "corollary legal aspects," it may be well to consider the legal relationships created • Associate Counsel, Aetna Life Insurance Company. 156

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by a supplementary contract as it has just been defined. It is, without doubt, a contract, by which, for a valuable consideration, one party (the insurance company) promises to do certain things in the future. In so far as the promise is to make payment to some person other than the promisee, it is a contract for the benefit of a third person, which in most, if not all, jurisdictions may be enforced by that person.1 SUPPLEMENTARY C O N T R A C T DISTINGUISHED FROM T R U S T Does the supplementary contract, as above defined, create a trust? It seems clear to me that it does not. T h e insurance company obligates itself to pay. This is a general obligation supported by all the assets of the company, not an obligation to preserve a segregated fund. T h e relationship created by the contract between the company and the payee, whether the payee be the promisee or someone else, is that of debtor and creditor. 2 "One of the major distinctions between trust and contract," says Professor Bogert, "is that in the former there is always a divided ownership of property, the trustee having usually a legal title and the cestui an equitable to the same res; whereas in contract this element of division of property interest is entirely lacking. T h e debtor owns his property absolutely, and the unsecured creditor has no interest in it. T h e interest of the creditor is a chose in action; the interest of the cestui que trust amounts to equitable ownership of definite things." 3 This is not to say that a life insurance company retaining policy proceeds cannot be a trustee. It becomes a trustee if it agrees to hold the proceeds in a separate trust fund, the equitable title to which is in the beneficiary or cestui que trust. But that is not the situation created by a supplementary contract as above defined. Even a statement in the supplementary contract that the funds are to be held in trust should not be held to create 1 American Law Institute, Restatement of the Law, Contracts, Sec. 135. T h e duty of the promisor to such third person cannot be released without that person's consent unless the power to do so has been reserved. Idem, Sec. 142. 2 See paper entitled, "Sawing the Procrustean Bed in Two," by Mr. John Barker, Vice President and Counsel of the Berkshire Life Insurance Company, VIII L. I. C. 645, at p. 652, and cases there cited; In re Nires, 290 N.Y. 78, 48 N I . (2) 268 (1943), 145 A. L. R. 1368 and note. 3 1 Bogert, Trusts and Trustees, 65, (italics mine).

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a trust if the effect of the contract as a whole is to create a debtor and creditor relationship. A provision in the supplementary contract that the company may mingle the proceeds with its general corporate assets negatives the trust concept. If a contract provides that the proceeds are to be held in trust and also that they may be mingled with the company's general assets, it contains a contradiction within itself. This should, of course, be avoided wherever possible. If the company is to mingle the proceeds with its other assets, the supplementary contract should be worded in terms of a general obligation to pay rather than in trust verbiage. Professor Bogert goes on to point out the "highly practical" effect of the distinction between trust and contract described in the above quotation. If there is a segregated trust fund and the trustee becomes insolvent, the beneficiary of the trust may take the fund and does not have to share as a general creditor. Where there is no segregation of funds, the payee under a supplementary contract has only a general creditor's claim. On the other hand, if there is a trust fund and it is lost or diminished in value through no fault of the trustee, the beneficiary suffers the loss; the ability of the trustee to pay his own debts does not help the beneficiary in such a case because the trustee owes no debt to the beneficiary. As to income in the true trust, the beneficiary is entitled to what the fund earns, while the creditor is entitled to the rate of interest the debtor has agreed to pay. T h e stability of the life insurance companies in this country being what it is, and the rates of return on first class investments, as compared to the interest rates guaranteed by most supplementary contracts, being what they are today, there seems to be little question that the payee of such a contract is better off, both from the standpoint of security and income, than he would be if the policy proceeds were held as a trust fund. SUPPLEMENTARY CONTRACT AS A DISPOSITION OF PROPERTY Is the making of a supplementary contract a disposition of property? T o this question we may respond with another. What do we mean by disposition of property? In a broad sense, I suppose that every transfer of title or right to property may be

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a disposition of property. In this sense, a disposition of property occurs when a policyholder pays a premium to an insurance company in return for certain contractual promises, whether the promise be to pay something to the policyholder or to someone else,4 or when a beneficiary agrees to forego the immediate collection of a sum due in return for a similar promise by the insurance company. The transfer of money to the insurance company in exchange for certain rights is not the kind of disposition of property which has caused so much discussion in connection with deferred policy settlements. I mention it only because I want to draw a parallel between the payment of premiums on an unmatured policy and the payment of the amount of the policy proceeds by the beneficiary to the company (or foregoing the payment of the proceeds by the company to the beneficiary, which amounts to the same thing) in exchange for the company's promise to make certain future payments. In each case there is a payment made by one party to the other in exchange for a promise. In each case the promise may be for the benefit of the promisee or a third party or both. In each case the rights of the third party beneficiary may become irrevocably vested only upon the death of the promisee. I believe the same rules should apply to both cases. I cannot see that there is any difference in the validity of the contract because the consideration paid in the one case differs from that paid in the other, or because the risk of loss to the promisor is different. If there is any difference as to the validity of the contract on this last account, it would seem to be in favor of the contract with less of a wagering element. Yet the validity of the contract with the greater wagering element is firmly established. It is not the payment to the insurance company but the creation of rights in third persons as a result of that payment which has given rise to the questions about disposition of property. Every life insurance contract payable to a beneficiary other than the insured's executor or administrator creates such a right, even though it may be defeasible if the policyholder reserves the right to change the beneficiary. T h e validity of such a designation, with or without the right to change being reserved, and the right of * Cf., Kansas City Life Insurance Company τ. Rainey (Mo. 1944), 182 S.W. (2) 624, at p. 627.

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the third-party donee-beneficiary to collect on the policy are too well established to be questioned. It makes no difference in such a case whether the insurance company is obligated to make one payment or a series of payments or whether payment is to be made to one person or to more than one, or whether the payee is to be determined on the basis of future contingencies. It has been stoutly argued that there is no disposition of property involved in the designation of a third party beneficiary before maturity of a life insurance policy, because the property (i.e., the proceeds of the policy) only comes into existence on the death of the insured, but that the situation is different after maturity because then there is a fund in existence which belongs to one person and which is transferred to another if that other is named as payee in a supplementary contract. A difference is readily apparent if the proceeds are to be held as a fund, the equitable title to which is in one person and in the event of some contingency is to be transferred to another. However, that is not the situation we are considering. T h e situation is that a contract is made by which the insurance company, in consideration of its keeping certain money, which is entirely its own property to do with as it pleases and to be mingled with its other funds, agrees to make certain payments. T h e company continues to own the money. It simply makes a new promise to pay. I am not arguing that the designation of a third party payee in a supplementary contract made after maturity of a policy is not a disposition of property. I am arguing that it is no more a disposition of property than the naming of a beneficiary by a policyholder to receive the proceeds of the policy at his death; the two situations are essentially the same so far as any question of property disposition is concerned. It is probably fortunate, from the standpoint of our present discussion, that the early life insurance policies were simply contracts to pay at death without any values which the insured could take during his lifetime, and also that the purchaser of the policy was often not the person whose life was insured. If, in the early days of life insurance, the courts had considered the payment at death under a life insurance policy taken out by the insured to be a disposition of the insured's property rather than a contractual obligation of the insurer, they might have

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held that the proceeds could be disposed of only by will. T h e effect on the development of life insurance as a great stabilizing influence in our national economy might well have been disastrous. It would, at least, have been very harmful. In the evolution of the life insurance business, cash surrender values, endowments, and life income policies have been developed. The cash surrender value is often a substantial part of the amount payable to the beneficiary at death, and under life income policies sometimes equals the death benefit. It is difficult to see how the designation of a third party payee in a supplementary contract made after maturity of such a policy is any more a disposition of property than a similar designation made before its maturity, yet I have never heard any question raised as to the validity of such a designation made before maturity even though the right to change is reserved, as it usually is. A single premium cash refund annuity may give the same amount as a cash surrender value to the contract holder or as a benefit payable on the death of the contract holder to someone else, and designated by him with the right to change reserved. The validity of such a contract was upheld in Kansas City Life Insurance Company v. Rainey.5 T h e element of property disposition in supplementary contracts will be further discussed as we go along. The term, "corollary legal aspects," which appears in the title of this discussion, has to do with the application to supplementary contracts of the rule against perpetuities, the rule against restraints on alienation (involving spendthrift trusts), and the legal requirements for testamentary disposition of property. They will be considered in turn. The somewhat extended discussion of the nature of the supplementary contract should serve to shorten the discussion of its corollary legal aspects. It may be noted at the outset that all of these rules relate to the ownership and transfer of property, and not to the law of contracts. It may be, and has been, argued that they have no application to contractual obligations. On that basis, this discussion might end right here, but the questions that have been raised about these aspects of supplementary contracts deserve somewhat more adequate consideration. s Supra.

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APPLICATION OF RULE AGAINST PERPETUITIES T h e common law rule against perpetuities is that the vesting of the ownership of property cannot be deferred for longer than a life or lives in being and twenty-one years (plus the period of gestation) thereafter. So, if this rule is applicable to supplementary contracts, a policyholder can agree with the insurance company that the company will pay interest on the policy proceeds to his wife and to his children then living until the youngest child is twenty-one, and then pay the principal to the children or to someone else. But if the agreement is to pay interest until the insured's youngest grandchild is twenty-one (the grandchildren being unborn) and to distribute the principal among the then-living descendants of the insured, it would be prohibited by the rule. In some states the common law rule against perpetuities has been changed by statute. Thus in New York by statute first enacted in 1829,® any limitation on the absolute ownership of personal property for a longer period than two lives in being at the date of the instrument containing the limitation (or if the instrument be a will, at the death of the testator) is prohibited. 7 In 1930, the late Louis Danzinger, Associate Counsel of the Massachusetts Mutual Life Insurance Company, presented a paper before the Association of Life Insurance Counsel in which he ably presented the view that the rule against perpetuities has no application to supplementary contracts.8 The Holmes case,9 decided twelve years later, lends support to this view. Mr. Danzinger quoted Gray on Perpetuities, 10 that the rule "concerns rights of property only, and does not affect the making of contracts which do not create rights of property." His argument was that the supplementary contract, being simply a general obligaβ Now Sec. 11 of the Personal Property Law. τ This statute, however, has been held by the Court of Appeals of New York, in Holmes v. John Hancock Mutual Life Insurance Company, 288 N.Y. 106, 41 N.E. (2) 909 (1942), to be inapplicable to a deferred settlement agreement between insurer and insured, where no trust was created and the relationship was that of debtor and creditor. β IV L. I. C. 467. »See note 7. 10 4th Ed., Sec. 329.

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tion of the insurance company to pay, did not create rights of property, and that the funds of the company were freely transferable, so that the purpose of the rule to keep property in commerce was served no matter how long the final vesting of the beneficiaries' rights was postponed. It seems to me that a supplementary contract does create rights of property, even though there is no fund to which the payee has even an equitable title. An unsecured bond issued by a corporation is, like a supplementary contract, simply a promise to pay. I think it would be generally agreed that ownership of such a bond is a property right. I cannot agree, therefore, with the conclusion in Mr. Danzinger's paper that the rule against perpetuities has no application to supplementary contracts, even though the decision in the Holmes case gives it support. It should be noted, though, that it is not the postponement of payment to which the rule applies. I recently saw a railroad bond issued in 1897, the principal of which is not payable until 2047. There is no question about the validity of the bond; the rule against perpetuities does not apply to it because the ownership of it became vested immediately upon its issuance and will remain so until its maturity a hundred and fifty years later, though it may have many owners during that period. It is only when a supplementary contract postpones the complete vesting of the right to demand payment that the rule comes into play. T h e question of the applicability of the rule against perpetuities to supplementary contracts is largely academic, because the insurance companies do not want to postpone final payment beyond the period which the rule permits, and because few policyholders desire them to do so. I believe the companies have, in practice, adhered to the rule. RESTRAINTS ON ALIENATION T h e rule against perpetuities has to do, as we have just noted, with the vesting of future interests. T h e common law courts in England long ago developed another rule, even more directly aimed at keeping property in the free channels of commerce, that general restrictions imposed in a disposition of property on its alienation or transferability are contrary to public policy and therefore void. For this reason spendthrift trusts have been held

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invalid in England and in some American states. However, in many states spendthrift trusts which impose restraints on the sale or transfer by the beneficiary of his right to future income and which protect the income from claims of his creditors are valid. 11 But a restraint on the voluntary or involuntary transfer of a right of the beneficiary to have the principal of a trust fund conveyed to him is generally invalid unless authorized by statute. 12 Another rule of general application in the trust field is that when the person creating the trust is also a beneficiary under it, provisions to prevent his creditors from reaching his interest are invalid. 13 Although, as we have seen, supplementary contracts are not trusts, the courts might apply the same rules to them in the absence of statute. More than twenty states have enacted statutes relative to spendthrift provisions in deferred settlements of policy proceeds. 14 Some of these statutes apply only to domestic companies, but most appear to be broad enough to include any company doing business in the state. Some refer only to policy provisions for deferred settlement, but most include both provisions in policies and contracts supplemental thereto. Some refer to holding in trust, and others do not; very few are limited to trusts. Not many of them appear to permit exemption of proceeds held for the benefit of the insured from claims of his creditors, though most permit exemption of the beneficiary's rights from the claims of creditors of the beneficiary when the agreement is between the company and the insured. There are, of course, other statutes in most states relative to the exemption of certain life insurance proceeds from the claims of the insured's creditors, but those statutes have no special application to supplementary contracts. It is, I think, questionable under most of the statutes we are considering whether the interest of a beneficiary who has a right to a lump sum payment and agrees with the insurer on a deferred settlement can be exempted from the claims of creditors of that beneficiary, though it has been held under the 11 1 Bogert, Trusts and Trustees, Sec. 222; Restatement of the Law, Trusts, Sec. 152. 12 Bogert, p. 718; Restatement, Sec. 151. 13 Bogert, Sec. 224; Restatement, Sec. 156. κ Additional comment on these statutes will be found on pages 56 to 60. T h e statutes are listed in footnote 70 on page 58.

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Pennsylvania statute that the exemption applied in the case of an election by a beneficiary of a deferred settlement pursuant to a right given in the policy.15 Of course, if the beneficiary has irrevocably parted with certain rights, as where the supplementary contract provides that interest is to be paid to the beneficiary during his lifetime and at his death the principal is to be paid to someone else, without right of change or withdrawal being reserved, subsequent creditors of the beneficiary can reach only the rights retained by the beneficiary, which in our example would be the interest payments as they fall due. Unless there is a statutory exemption, the right of a creditor, whose claim was in existence when the supplementary contract was made, to reach the principal in such a case would depend on whether the naming of a third party payee in the supplementary contract is considered a fraudulent transfer of the beneficiary's property. It is beyond the scope of this paper to examine in detail all the statutes authorizing spendthrift provisions. All that can be done here is to point out that they vary considerably, and that the applicability and effect of any of them must be determined with respect to the particular facts of each case. T E S T A M E N T A R Y DISPOSITION We come now to the question, much debated in past years, as to whether a supplementary contract may be void because it is an attempt to make a testamentary disposition of property without compliance with the formalities which the law requires in the making and probating of wills. T h e lawmakers and courts have been meticulous in requiring certain formalities in the making of wills. Generally a will must be in writing, signed by the testator, and subscribed to by two or more disinterested witnesses (the requirements vary somewhat in different states), who must certify that they saw the testator sign, that he declared it to be his will, and that he appeared to be of sound mind. T h e reason for these requirements is, of course, that the will determines the disposition of property after the testator's death, when he is not available to admit or deny that he signed it and that it was his voluntary act, or to be examined as to his mental capacity. When a disposition of property to be is Provident

Trust Company

v. Rothman,

183 Atl. 793 (1936).

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effective at or after death is made by a transaction between the person disposing of the property and another person, who is not to receive it but is charged with the duty of seeing that it goes to those who are to receive it, the injection of the disinterested third person serves to some extent the same purpose as the formal signing and witnessing of the will. Transfers of property in trust when the ultimate disposition is postponed until after the death of the transferor have frequently been upheld, even though the transferor retained during his lifetime the right to revoke or modify the trust. 16 The supplementary contract for the disposition of life insurance proceeds is like a trust agreement in that the bilateral transaction between the person making the disposition and a disinterested third person responsible for carrying it out may be considered an acceptable substitute for the formalities of signing and witnessing required for a valid will. Where the reason for such formalities disappears, the necessity should also disappear. This is not a conclusive answer to the testamentary disposition question, but it is a pointer toward the right answer. Let's get this testamentary disposition question whittled down to its proper size. In the first place, nobody seems to be bothered by it in connection with beneficiary designations (including supplementary contracts) made by the policyholder before maturity of the policy. Even as to contracts made after maturity or surrender, the question arises only where a payment is to be made at the death of one of the parties to the contract to someone other than the executor or administrator of that party. We can whittle it down still further. If the person to receive the payment is named irrevocably and there is no right of withdrawal, there is a present, irrevocable creation of a right in that person. Whether this is considered a transfer of property or not, it appears to be generally agreed that it is not testamentary in nature and is valid. The question of testamentary disposition is, therefore, whittled down to those cases where the supplementary contract is made after maturity or surrender of the policy, and provides for payment to someone other than the promisee's estate at the death 1« See Restatement of the Law, Trusts, Sec. 57; Kansas City Life Company v. Rainey, 182 S.W. (2) 624.

Insurance

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167

of the promisee, and also gives the promisee the right to change the ultimate payee or to defeat the ultimate payee's rights by requiring the company to make payment of the principal to the promisee during his lifetime. The promisee in such cases is usually the beneficiary named in the policy. I am, however, using the term "promisee" to include both the beneficiary, when the supplementary contract is made after maturity of the policy by death, and the insured or policyholder, when the supplementary contract is made after maturity of an endowment or upon surrender of the policy, since the same principles are applicable to these three situations. I believe the majority of life insurance companies in this country will make a supplementary contract, with reference to the proceeds of a policy after it has matured, which provides for specified payments to the promisee, gives the promisee the right to withdraw, and provides that the balance due from the company when the promisee dies shall be paid to another person, where no right is reserved to change the designation of the ultimate payee. It seems to be the prevailing practice in such cases, however, not to make a contract which will allow the promisee to change the designation of the ultimate payee, except possibly where the policy contained a provision purporting to give the promisee such a right. T h e theoretical distinction is that an irrevocable designation is not testamentary, even though it may become valueless because no money is left to be paid at the promisee's death, whereas a revocable designation does not give the designated payee any vested right and is, therefore, testamentary since the right vests only at the death of the promisee. There may be some authority for this distinction,17 but, as a practical matter it is hard to justify. The right of the payee designated may be destroyed as effectually by the promisee's taking full payment from the insurance company as it is by changing the payee who is to take at the promisee's death. Orville F. Grahame, now General Counsel of the Paul Revere Life Insurance Company, after an exhaustive study of the testamentary disposition question, reported in a paper entitled "Dispositions under Supplementary Contracts," 18 treated the right 17 Cf. Restatement of the Law, Trusts, Sec. 57, Comment G. i s Proceedings of the Legal Section, American Life Convention

(1936), 141.

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of withdrawal and the right to change payees on the same basis, stating: "If a contingent payee is named, do not grant to the first taker the right of withdrawal, or the right to change payees." In his paper, Mr. Grahame was very properly advising a cautious policy on the part of the insurance companies in this somewhat uncharted sea. Since Mr. Grahame's paper was written, some channel markers have been set u p for the guidance of the companies. Reference has already been made to the Rainey case in Missouri. T h e case of Aetna Lije Insurance Company v. Bartlett (1944), 19 was an interpleader proceeding involving the construction of a supplementary contract made after maturity of a life insurance policy between the beneficiary and the company, by the terms of which the proceeds were payable to the beneficiary in installments and at her death the balance was payable to her son and daughter. T h e contract gave the beneficiary the right to withdraw part or all of the proceeds at any time. Apparently neither court nor counsel felt there was any question as to the validity of the contract. N o mention of testamentary disposition appears in the court's opinion. T h e question was, however, squarely raised and decided in favor of the validity of the contract in Mutual Benefit Lije Insurance Company v. Ellis (1942).20 In that case the insurer agreed with the beneficiary that it would pay her interest monthly on the proceeds of a policy which had matured as a death claim, that she could elect one of certain installment settlements at any time, and that at her death the balance remaining in the hands of the insurance company should be paid to her three sisters, or the survivors or survivor of them. T h e court's opinion indicates that the contract contained a provision by which the original beneficiary could terminate the rights of her sisters by three months' written notice to the insurance company. T h i s notice requirement appears to have been a material factor in the court's decision, though I cannot see why it should have been. T h e court spoke of the notice requirement as a consideration. Leaving the policy proceeds with the 19 53 Fed. Supp. 1005. 20 125 Fed. (2) 127, cert, denied 62 S. Ct. 945.

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insurance company when the contract was made was all the consideration needed to sustain its validity. It is interesting, and important, to note that the court said the agreement involved in the case was not a supplemental insurance contract in the sense of its being the election of an option given in the policy. It was also held not to be a trust. It was considered as a new contract between the beneficiary and the company, and the sisters were held entitled to payment as thirdparty donee-beneficiaries. T h e court said: A sufficient answer to the argument that it would violate the Statute of Wills to enforce the agreement for the sisters lies in the fact that their right to enforce is based upon a contractual obligation and not on any interest in the property of the decedent.

It will be noted that the contract considered in the Ellis case comes within the broad definition of supplementary contract given at the beginning of this paper, and that the court did not find it necessary to hold that the contract was made pursuant to some right given in a life insurance policy in order to declare it valid. It is not necessary to say that life insurance contracts are sui generis, or that a supplementary contract is not a disposition of property, in order to agree with the court's decision. I think the true interpretation of it is that in the continuing development of the common law there have evolved at least three methods by which at the death of one person property rights which that person controlled during his lifetime are transferred to another—the first is by will, the second is by creation of a trust, and the third is by a contract in which the transferee of the rights is a third-party donee-beneficiary. This third method may have had its inception in the life insurance contract. That is still its chief application. But as indicated by the Ellis and Rainey cases and by the Restatement of the Law,21 it is not limited to contracts of life insurance. As Mr. Barker wrote in his paper on the Procrustean Bed: This organism, grown of good form, custom, usage and thought, the Common Law, which the Sarah Constant, Goodspeed and Recovery brought to what Drayton, seeing far beyond Indians and malaria, called "Earth's only paradise"—this Common Law is alive and adaptable. 21 Contracts,

Sec. 134, 135, 139, 142.

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When the contract for the benefit of a third party is considered as a recognized means of transferring property rights at death, the proper conclusions as to the corollary legal aspects we have been considering appear to me to be as follows: 1. T h e rule against perpetuities is applicable since the contract is o n e which creates "rights of p r o p e r t y . " 2. T h e rule against restraints o n alienation may also be applicable, b u t that rule has not been widely accepted in this country, a n d even where it is accepted the statutes relating to s u p p l e m e n t a r y contracts would s u p p l a n t or modify it as to contracts to which the statutes apply. I n the absence of such a statute, the rules of a p a r t i c u l a r jurisdiction gove r n i n g s p e n d t h r i f t trusts might be a p p l i e d by the courts through analogy to s u p p l e m e n t a r y contracts. 3. T h e question as to the validity of a s u p p l e m e n t a r y contract because it does not meet the f o r m a l r e q u i r e m e n t s for a will completely disappears.

Although it cannot be said that the recognition of the third party contract (aside from payments made under life insurance policies by reason of the death of the insured) as a means of transferring property rights at death has been universally accepted in our jurisprudence, 2 - it seems well on the way to acceptance in the continuing development of the common law. The life insurance companies will doubtless continue to keep a wary eye on the testamentary disposition question, but it is rapidly fading and should in time vanish completely unless other courts refuse to follow the precedent of the Ellis and Rainey cases.

ADDENDUM ELECTION OF DEFERRED SETTLEMENTS BY GUARDIANS OR TRUSTEES A l t h o u g h the subject m a t t e r of this a d d e n d u m is q u i t e distinct f r o m those matters discussed in the m a i n p a r t of the p a p e r , it may be considered to come within the scope of the title. T h i s brief note is therefore added. 22 Cf. McCarthy v. Pieret, 281 N.Y. 407, 24 N.E. (2) 102 (1939), where a contract to make payments under a mortgage to others in the event of the mortgagee's death was held invalid.

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When the proceeds of a life insurance policy become payable in one sum to a minor beneficiary, may the minor or his guardian elect a deferred settlement? Since such an election involves the making of a supplementary contract, even though it may be pursuant to a right given in the policy, it seems clear that an insurance company dealing with the minor without the intervention of a legally appointed guardian runs the risk that the minor may later repudiate the contract. Ordinarily, the company will not be willing to make a supplementary contract directly with the minor (or any other beneficiary legally incompetent to contract). In occasional instances, the risk of loss to the company from possible repudiation of the contract may be so small that the company is willing to assume it. For example, if the beneficiary is within a year or two of attaining his majority, the company may be willing to agree to a settlement involving the payment of interest only to the minor with a provision for payment of principal to him after he comes of age or to his estate in the event of his death. Elsewhere in this volume,ι reference was made to a New York statute 2 which provides that a minor who has attained the age of eighteen years shall be deemed competent to receive periodical payments of life insurance proceeds not exceeding two thousand dollars in any one year if the policy or settlement agreement specifically provides for payments direct to the minor. T h e effect of this statute appears to be limited to payments made to a minor beneficiary in accordance with an agreement between the insurer and an adult policyholder, and not to give the minor the capacity to make a binding supplementary contract after maturity of the policy. A more important question relates to the right of the guardian of a minor beneficiary, or of a beneficiary who is otherwise legally incompetent to contract, to elect a deferred settlement of policy proceeds which, by the terms of the policy, are payable in one sum to the minor or incompetent. 1 have not found any statute expressly authorizing such an election. A few states have statutes authorizing guardians or other fiduciaries to invest funds of their wards (generally only with court approval) in life insurance or annuity contracts. Some of these might be construed to authorize the election of an annuity option for the benefit of the ward, but beyond that there appears to be no statutory authority. There is also a paucity of court decisions on the subject. I have found only two. In Pendas v. Equitable Lije Assurance Society,3 it was held that when the death benefit under an annuity contract was payable to an insane person, his guardian could not elect a deferred settlement but that a court of equity could make the election. T h e court in that ι See Jas. S. Burke, "Designation of the Beneficiary," p. 17. 2 Sec. 145, N.Y. Insurance Law, as amended by c. 95, Laws of 1940. s (Florida, 1937) 176 So. 104, 112 A. L. R. 1051.

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case decreed that the Society hold the proceeds and pay interest monthly in accordance with one of the options specified in the contract. T h e other case is Latterman v. Guardian Life Insurance Company,* decided by the New York Court of Appeals in 1939. In that case, the proceeds of a life insurance policy became payable to minor beneficiaries. T h e insured had made no election of a deferred settlement, and the policy provided that the beneficiary could elect. T h e guardian of the minors notified the company that he elected to have the proceeds held by the company under the interest option until the beneficiaries attained their majority. T h e question before the court was whether he had the right to make the election. An interesting divergence of views as to the nature of the transaction, which may have some bearing on the matters discussed in the main part of this paper, is shown in the majority and dissenting opinions of the court. In New York, the investments which a guardian may make of his ward's funds are limited by statute. Judge Lehman, dissenting from the majority of the court, took the view that the exercise of the right of election was an investment of the proceeds, and that since the investment was one not permitted by statute, the guardian had no right to elect. T h e other six judges held that the right of election was an interest "in the nature of a property right" given by the policy to the beneficiaries, and that the guardian could exercise this right in their behalf. State laws vary in the limitations placed on guardians in the investment of their wards' funds. In some states, a guardian is protected from personal liability if he makes any investment which a prudent man would make of his own money. In such a state, it would seem that a guardian could elect to leave insurance proceeds with the company at interest, under the theory of either the majority or the dissenting opinion in the Latterman case. If an installment option is elected, obviously more is involved than an investment of the proceeds. If it is necessary to use principal for the support and education of the minor beneficiary, an installment option may be very desirable. It would seem that a guardian, with court approval, has the right to elect such an option when it is to the best interest of the ward. This would be in accord with the majority view in the Latterman case. T h e fact that several different options are usually given in the policy also strengthens the argument for the correctness of that view. It may be doubted, however, that a guardian has the right, unless expressly authorized by statute, to make an election which would interfere with the ward's free use of the proceeds, or the remaining balance, after the ward comes of age. T h e election of an installment settlement with payments extending beyond that time may well be open to question, unless the ward is given the right of withdrawal after attaining his majority. Also for this reason, as well as because the guardian is 4 280 N.Y. 102, 19 N.E. (2) 978, 127 A. L. R. 450.

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acting for the minor beneficiary, and in most states, as we have seen, a beneficiary cannot keep the use of the proceeds and exempt them from the claims of his creditors, a spendthrift clause in an election by a guardian would probably be ineffective. A guardian has no right to dispose of his ward's property after the death of the ward. Hence a supplementary contract with a guardian should always provide for any payment which may be made after the ward's death to go to the ward's estate. A different situation exists when the policyholder has designated as beneficiary the trustee under a trust created by the policyholder, but has made no election of a deferred settlement. Some policies, even when they give a right of election to the beneficiary, provide that a trustee-beneficiary may elect only with the insurance company's consent. The trustee's right to elect depends not only on the provisions of the policy, but also on those of the trust agreement. If the trust agreement expressly provides that the trustee may elect a deferred settlement, he has the right, subject to whatever limitations the policy may place on it. The trust agreement may, on the contrary, negative the right of the trustee to make such an election. This would be the case if the agreement required the trustee to collect the proceeds and invest them in government bonds or in some other specified manner. The fundamental difference between this situation and that of guardianship is that the trustee derives his powers primarily from the trust agreement while the guardian derives his from the law. If the policy places no express restriction on the right of election by a trusteebeneficiary and the terms of the deferred settlement options are not such that the right of election is limited to personal payees, and if the trust agreement neither clearly authorizes nor negatives an election by the trustee and does not specify that the trustee may invest the fund without regard to the restrictions imposed by law on the investment of trust funds, then the two situations become similar. Obviously, no general rule can be laid down as to the right of a trustee-beneficiary to elect a deferred settlement. It will depend in each case on the terms of the policy and of the trust agreement, and perhaps on statutory provisions regulating investments by trustees unless these are held inapplicable on the basis of the majority opinion in the Latterman case.

BUSINESS LIQUIDATION INSURANCE AND OPTIONAL SETTLEMENTS By John M. Huebner, LL.B.*

the beginning of the present century, the device of business insurance, whether of the key-man or business liquidation type, was seldom used. T h e earliest example which the writer has examined originated in 1883, although no policy matured for some fifty years. Where the orderly liquidation of a business interest was the goal, most of these early plans were notable principally for their simplicity. T h e r e was seldom any formal agreement between the interested parties. T h e i r thinking extended to making provision for a f u n d in the hands of the associate who should survive. He, it was asumed, would purchase the interest of the deceased and the problem was primarily one of enabling him to do so. Since the parties were not then so troubled by the stimuli of taxation and the need for a family settlement program, little attention was paid to the problems which confront us today. However, the development of taxation of incomes, the increased impact of estate and inheritance taxes, and, to an even greater extent, the tremendous amount of recent education in the field of estate planning, have joined to create in the insuring public a demand for business liquidation insurance and a simultaneous demand that it solve not only the problem of orderly liquidation of the business interest but also the need for a planned estate. As a preliminary to any discussion of the problems which these demands raise, it is advisable to review very briefly a number of background factors. UNTIL

• Associate Company.

Supervisor

of

Applications, 174

Penn

Mutual

Life

Insurance

BUSINESS LIQUIDATION SETTLEMENTS

175

TYPES OF BUSINESS ORGANIZATIONS T h e problems involve three common types of business organizations: the sole proprietorship, the partnership, and the closely held corporation; we shall examine each quickly to grasp the nature of the interest of the owner or owners, to identify the persons to whom that interest will pass upon the owner's death, and to visualize the effect of liquidation of that interest upon the person to whom it passes and upon the associates, if any, of the deceased. The Sole Proprietorship. In using this term we refer to the business owned solely by one man, whether or not it is incorporated, whether or not the owner is also the operator, and whether or not there are employees. In the event of the proprietor's death, all personal property, including the shares of stock if the proprietorship was carried on in corporate form, passes to the proprietor's personal representative for distribution according to law. Real property, however, owned by the proprietor and used by him in his business (not in a corporate name) may pass to the proprietor's heirs or may be subject to rights of dower under the laws of some states. Unless the proprietor can assure himself that upon his death his business will pass as a unit to dependents who are of proven business experience capable of carrying on that particular business, he must conclude that liquidation will be the only course. Experience has shown that the shrinkage upon liquidation of such a business is tremendous. T h e cash value of the assets such as stock in trade, furniture and fixtures and tools, and accounts receivable drops immediately. The liabilities, unfortunately, show no tendency to shrink and it is common to see a going concern become, overnight, by the death of the proprietor, an insolvent business. In reviewing his problem, a sole proprietor will do well to segregate his own life value from the value of his business assets and to provide against the loss of that life value by personal insurance. He may take some of the pressure off his personal representative by providing liquid funds by insurance to cover creditors' claims, and possibly by authorizing his personal representative to continue the business; but his representative

176

BENEFICIARY IN LIFE INSURANCE

must eventually face liquidation and, even if not pressed, may find no ready market for the business assets. T h e proprietor who attempts to plan this sale during his lifetime will, as a practical matter, find only one purchaser, an employee or group of employees capable and desirous of assuring their own futures. They may be willing to buy the assets, including the good will. The proprietor's problem, however, requires that they also be able to buy. The employee may be assured of his ability to carry out a planned purchase by purchasing insurance upon the proprietor's life. T h e Partnership. The Uniform Partnership Act provides that upon the death of a partner his right in specific partnership property vests in the surviving partner or partners and that his right in specific partnership property is not subject to dower, curtesy, or allowances to widows, heirs, or next of kin. T h e death of a partner causes dissolution, but upon dissolution the partnership continues until the winding up of partnership affairs is completed. Unless otherwise agreed, the surviving partner or partners have the right to wind up the partnership affairs and the right to an account of the interest of the deceased partner accrues to his legal representative as against the surviving partners. If the business of the partnership is carried on, the personal representative of the deceased partner is entitled to have the value of the deceased's interest ascertained. Thus, provision is made for liquidation, unless the partners have agreed otherwise, with the value of the deceased partner's interest in partnership property passing to his personal representative for distribution according to law. Agreement by the parties may avoid or defer these provisions, but, as a practical matter, liquidation of the deceased partner's interest is inevitable. A moment's thought will indicate the difficulty of liquidating one partner's interest without liquidating all partnership property. A purchase by the survivors from the personal representative would seem the only practical method, but surviving partners who, in the absence of an agreement with the deceased partner, purchase his interest from his representative, will find themselves likened to fiduciaries who deal with their beneficiaries and

BUSINESS LIQUIDATION SETTLEMENTS

177

held to the same standards of disclosure. The dangers of subsequent claims from creditors, heirs, or legatees are obvious. There is, therefore, need for a device which will permit the surviving partner or partners to liquidate the claim of the personal representative of a deceased partner without liquidating all partnership property and the survivors must be in a position financially to carry this program through. T h e Corporation. Since the liquidation of corporate shares listed on and traded through an exchange presents a relatively simple problem, this discussion is limited to those corporations, commonly known as "closely held corporations," whose shareholders are few in number and whose shares are unlisted and are infrequently, if ever, transferred. Upon the death of a shareholder in such a corporation, his shares pass to his personal representative for distribution according to law. Whether or not a sale takes place, this distribution may result in ownership by persons who are strangers to the surviving original shareholders, with possible disturbance in the balance of control and interference with the continuance of successful policy. T h e sale by the personal representative may be forced—the market for such shares is obviously limited—and severe loss to the estate of the deceased original shareholder may result. As mentioned above in connection with sole proprietorships and partnerships, there is accordingly need for a device which will permit the orderly liquidation of the deceased shareholder's interest and which will enable the surviving original shareholders to enjoy uninterrupted control. T H E LIQUIDATION AGREEMENT T h e so-called "buy and sell" agreement financed by life insurance on the life of the seller may supply the needed device in any of the three types of business organizations; the following paragraphs will discuss briefly the cardinal features of such an agreement. Whether the agreement provides for a one way sale, as in the case of a sole proprietorship, or for mutual obligations to transfer property, the first to die to be the "seller," as is the case where partners or shareholders are involved, there will be a number of features common to all.

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BENEFICIARY IN LIFE INSURANCE

The Agreement to Sell and to Buy. Each "seller" on behalf of himself, his heirs, and representatives should agree to sell and each buyer to buy all right, title, and interest which the deceased seller may have in the business property at his death. T h e property to be transferred should be described accurately and if there may be two or more purchasers, the shares or property which each is to receive should be set forth explicitly. It is obvious that any seller should be expected to pass clear title. Consideration must therefore be given as to the need, under the law of any particular state, of obtaining the joinder of other parties who may claim dower or community interests, or of requiring that the seller's will be drawn to lend support to the agreement, if necessary. Many agreements have been drawn which, instead of constituting an agreement to buy and sell, extend to the surviving associates an option to buy the business interest of the deceased. Such an agreement may have estate tax consequences very different from the flat buy and sell agreement, but aside from this aspect of the situation, it is difficult for the writer to see any advantage in failing specifically to provide for the assured orderly liquidation which the parties originally planned. Valuation of the Business Interest and Determination of the Purchase Price. It is doubtful whether any single question within the scope of liquidation agreements is more difficult of solution than that of choosing a proper purchase price or proper valuation formula to determine that price. There is no organized exchange or other ready market for interests in the three types of businesses under discussion and, while it may be difficult for a sole proprietor or for partners to value their interests in their businesses after excluding their personal life values, that is just what they must do, for in many cases the personal earning power of a producer is the principal worth of the going business. T h e plumber must not value his business for sale by capitalizing its earnings during a period when he was contributing his skill and effort. Nor may the lawyer or doctor. On the other hand, the value of the business is not limited solely to the sale value of tools, books, furniture, or equipment. Good will, the value of continued use of a name, and the value of uncompleted business acquired for the firm by the deceased must all be given consid-

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eration. Each business and each man in that business may have a problem all his own. T h e associates in any liquidation agreement must recognize this problem as fundamental. The taxing authorities will also be interested in the amount of the purchase price agreed upon or the formula chosen to fix it. The Federal Estate Tax Regulations 1 provide for the evaluation of shares of closely owned corporations "upon the basis of the company's net worth, earning power, dividend paying capacity and all other relevant factors having a bearing upon the value of the stock. Among such other relevant factors to be considered are the values of securities of corporations engaged in the same or a similar line of business which are listed on an exchange. . . ." The Federal Estate T a x Regulations 2 provide for the valuation of proprietorship or partnership interests by stating that "a fair appraisal . . . should be made of all the assets of the business, tangible and intangible, including good will, and the business should be given a net value equal to the amount which a willing purchaser . . . would pay therefore to a willing seller in view of the net value of the assets and the demonstrated earning capacity. Special attention should be given to fixing an adequate figure for the value of the good will of the business in all cases in which the decedent has not agreed, for an adequate and full consideration in money or money's worth, that his interest therein shall pass at his death to his surviving partner or partners." Will the taxing authorities be bound by the valuation set by the deceased and at which his interest is actually transferred to the purchasers? Not necessarily. There are conflicting cases on this question. Deane C. Davis3 has pointed out that these cases turn on the question of the right of a business associate, party to a liquidation agreement, to dispose of his interest during his lifetime. If he has retained that right, the taxing authorities seem not to be limited, in valuing the interest in the business for estate tax purposes, to the purchase price set by the agreement. If he has limited ι Reg. 105, 81, 10(c). 2 Reg. 105, 81, 10(d). 3 For two excellent articles treating the problem of valuation of business interests see Deane C. Davis, "Valuation of Business Interests," Journal of the American Society of Chartered Life Underwriters, Vol. 1, No. 1, September 1946, and "Liquidation Agreements for Personal Service Partnerships" by the same author in the same publication, Vol. 1, No. 2, December 1946.

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his right to dispose of his interest during his lifetime for a price greater than the agreed valuation at death, the case for limiting the estate tax valuation appears strong. It may be desirable, therefore, to include in the agreement a restriction upon each owner's right to dispose of his holdings during his lifetime, possibly by providing that he must first offer his holdings to his associates at a price not in excess of the price agreed upon or to be determined for transfer upon his death. There is no quicker way to invite trouble, however, than for the business associates to set an unrealistic price, and this principle is particularly true where a "purchaser" can be regarded as one of the "seller's" natural objects of bounty. Will the seller's creditors or persons claiming statutory rights in his estate be bound similarly by the valuation set by the deceased and at which his interest is actually transferred to the purchasers? Generally speaking, they will be bound. The weight of legal opinion today considers a mandatory buy and sell agreement not to be a testamentary disposition by the deceased seller, but there are several points of danger which may encourage attack. If the deceased seller's estate is insufficient to satisfy the claims of creditors, if the state law gives his widow or afterborn child a right to take against his will and he has not made adequate provision for them, or if he dies intestate, and if the valuation agreed upon appears unrealistic, litigation is invited. Moreover, the pertinent law of the community property states is as yet none too clear, and there is a possibility that in some of them a widow may be able to establish that the purchase and sale has worked a "fraud on her rights." In the absence of facts persuasive of a taint of fraud, most of these questions may be expected to arise in cases where the parties to the agreement have made a realistic valuation or established a reasonable formula but have neglected to keep the agreement up to date as the status of the business changed. Frequent review of the valuation is indicated. What will be the position of the surviving purchasers with regard to the Federal Income Tax when they come to liquidate the interest purchased from a deceased associate? They will, of course, be subject to income tax (capital gain) should they realize

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more than the amount paid. But the question arises whether the insurance proceeds which financed the purchase in whole or in part may be considered by them as part of the cost. Current authority on this question is the case of Legallet v. Commissioner* While the case involved a partnership, its principles seem equally applicable to all three forms of business organizations discussed. Briefly, Legallet and his partner O'Neill entered into a buy and sell agreement, financing it by insurance applied for and owned by each partner on his own life. Premiums were paid by the partnership, were charged against profit and loss and, therefore, were divided equally between the partners. The policy on O'Neill's life was payable at his death to his wife, who received the full proceeds of the policy. The face amount of the policy, $25,000, was credited on the purchase price which Legallet had agreed to pay for O'Neill's interest, and Legallet executed notes for the balance of $30,936. Legallet subsequently sold a portion of the assets so acquired. It was held that for the purpose of calculating Legallet's capital gain he was not entitled to use as a cost basis the sum of $55,936 but was limited to a cost basis of $30,936, since the insurance was not in fact paid by Legallet to O'Neill's widow. The court also expressed the opinion that "a mere contract entailing the elements here involved does not constitute constructive receipt" of the insurance proceeds by the surviving associate. Payment of Premiums. The Legallet decision alone is sufficient authority for the position that each potential purchaser associate should apply for and pay the premiums due under the insurance on the life of the potential seller associate. The writer can see no objection to the payment of all premiums from partnership funds so long as that procedure is a matter of convenience only and so long as the payments are charged to the individual accounts of the purchasers. Title to the Policies. Here again the Legallet decision suggests the advisability of retaining, in the potential purchaser who pays the premiums, ownership of the insurance on the life of the potential seller. If that course is followed, the parties to the * Legallet

v. Commissioner,

41 Β. T. A. 294 (1940).

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agreement will undoubtedly wish to provide for the transfer of ownership of insurance on the life of a survivor to that survivor who shall pay to the estate of the deceased owner a sum such as the cash surrender value of the policy transferred. In addition, ownership of the policies resting in the partnership or the corporation serves only to increase the value of the partnership or the corporate assets. Even if the parties choose to ignore this point, they must consider the possibility that the tax collector or others may seek to enforce that view. T h e Designation of Beneficiary. From the discussion which has gone before, the designation of the surviving "buyer" as beneficiary of the insurance he carries on the life of the "seller" would seem to be the logical procedure. From the point of view of the buyer, there can be little doubt as to its wisdom. The collection of insurance proceeds by him upon the death of the seller leaves the buyer in a position to "make payment" for the deceased's interest within the Legallet doctrine. He simply pays to the deceased's personal representative the agreed purchase price, receiving in return the property purchased and leaving the deceased's personal representative to attend to the distribution. This procedure foregoes, however, any possibility that the heirs or legatees of the deceased, who will in many cases receive shares of his estate outright, may enjoy the advantages of the settlement options contained in present-day policies. Pressure therefore arises for some device which may preserve the advantages of settlement options. Legallet and O'Neill, for example, agreed upon the designation of their wives as beneficiaries of the policies on their respective lives. But any such device which may operate to the prejudice of the buyer's rights will obviously be fatally defective. Business liquidation is the primary goal. The use of the options should be regarded as a convenient though important by-product. DANGERS I N H E R E N T IN T H E PRACTICE OF NAMING AS BENEFICIARIES PERSONS OF T H E INSURED'S CHOICE Unless the agreement is carefully drawn, there is a possibility that heirs or legatees of the deceased seller, who are also named

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as beneficiaries of the insurance on his life, may claim both the business interest and the insurance proceeds. Careful draftsmanship of the agreement and of the seller's will to make clear the agreement that the insurance proceeds are the price of a transfer will provide adequate protection against this danger. The receipt of the insurance proceeds directly from the insurance company by the beneficiaries throws the shadow of the Legallet case over the right of the purchasers to include the insurance in the acquisition cost of the deceased's interest for income tax purposes. It should be remembered, however, that the payment of premiums by the partnership, and the fact that the partners insured their own lives and each owned the policy on his life, contributed to the Board's refusal to recognize a constructive receipt of the insurance by Legallet. T h e removal of the business interest from the deceased's estate, by sale, without return to the estate of an adequate purchase price is, in the writer's opinion, a testamentary disposition by the deceased "seller." While there is opinion that no testamentary disposition is involved in an agreement between associates transferring to the survivors or survivor the interest of the first to die without consideration other than mutual promises to contribute skill and effort to the business during their lifetimes, it appears to the writer difficult to read into the agreement such an intent whenever business liquidation is contemplated, as is the case when a "purchase price" is established. And where insurance is provided and there is any indication that the proceeds, as all or part of the purchase price, are to be paid to anyone other than the deceased's personal representative, the testamentary nature of the transfer is apparent. It follows, therefore, that if the deceased's creditors cannot be satisfied, or if the deceased has not made adequate provision for persons claiming statutory rights in his estate, their claims may be prosecuted through, not to the insurance proceeds which were never part of his estate but to the business intevest, the asset improperly removed. It is obvious that a potential purchaser is likely to look with disfavor upon a proposal which binds him to pay insurance premiums upon the proposed seller's life for the benefit of the seller's family unless he is guaranteed his quid pro quo.

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T h e writer knows of no litigated case involving a solution of these problems but believes that the following provisions in the buy and sell agreement will overcome them: 1. Each prospective purchaser should insure the life of each prospective seller, personally pay the premiums u p o n the policy, and retain ownership of the policy. H e may agree with his associates that u p o n the death of any one the ownership of each policy carried by the deceased ehall be transferred to the respective insured thereunder, for an agreed consideration, such as the then cash surrender value, to be paid to the deceased's personal representative. 2. H e may agree with his associates that he will file with the insurance company under the policies which he owns a designation of beneficiary u p o n the plan and in favor of the persons chosen by the insured thereu n d e r from time to time, subject to a provision that the proceeds shall be left with the insurance company for a period of one year (or longer, but in any event, reasonably sufficient to cover the period within which creditor's claims or elections to take against the deceased's will must be filed), during which the prospective buyer as owner of the policy reserves the right to withdraw the proceeds in whole or in part. I n view of the belief in some quarters that an agreement giving each associate the right to name beneficiaries under the policy on his life, owned by his associate, may expose his estate to additional estate tax liability on the ground that he enjoys an incident of ownership in the policy, there is some authority for the proposal that the agreement merely require that each associate notify the other of the beneficiary set-up which he has established and give the others a period of notice before changing the beneficiaries named or the manner of payment. 3. T h e agreement should be executed in conformity with the requirements for wills, or the wills of the associates should incorporate explicitly or by reference the agreement and the designation. 4. T h e agreement should bind the buyers, if they withdraw the funds, to pay them to the seller's personal representative as the price for the business interest which the personal representative must convey to them. If no withdrawal appears advisable, the buyers will assign to the personal representative, as the price for the transfer, their right to withdraw. T h e buyers are fully protected and, even though the proceeds are finally paid by the insurance company directly to the seller's beneficiaries, there would seem to be no doubt that the buyers have enjoyed constructive receipt of the proceeds and may include the insurance proceeds in the cost basis of the purchase for income tax purposes. 5. Whether the personal representative receives from the buyers the proceeds or the right to withdraw the proceeds, he is in a position to

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make distribution of the estate and can avail himself of the proceeds if necessary to satisfy claims. If no withdrawal is required, he may either dispose of his right to withdraw as a matter of distribution o r allow it to lapse.

It is obvious that extreme care in draftsmanship will be required and that in any particular case attention must be given to the laws of the individual states regarding testamentary dispositions.

TAXATION OF LIFE INSURANCE POLICY PROCEEDS By Bernard G. Hildebrand, LL.B.*

of life insurance proceeds is a comprehensive subject, warranting extensive discussion. However, our present objective will be limited to the presentation of fundamental rules applicable to fairly common situations and to the consideration of important unsettled questions and matters which require clarification or which might well be given more favorable treatment. Emphasis will be placed primarily upon federal taxation but certain aspects of state taxation will be mentioned because of their importance. TAXATION

FEDERAL INCOME T A X Statutory provisions taxing or exempting life insurance proceeds have always been a part of the federal income tax law, and except for certain technical rules not affecting the general mass of insurance payments, such provisions have never been materially changed. Moreover, considering the large volume of insurance payments, there has not been as much litigation as might be expected. Only two cases, involving in a sense minor issues, ever reached the Supreme Court of the United States for decision. 1 In recent years much of the judicial case law has dealt with the taxability of death proceeds payable in installments. 2 For guides as to the meaning of the statutory provisions, taxpayers are compelled today to rely most heavily upoïi numerous Treasury Department rulings and regulations. • ι 279 2

T a x Attorney, Metropolitan Life Insurance Company. VS. v. Supplee-Biddle Hardware Co., 265 U.S. 189; Lucas v. U.S. 573. See discussion on following pages. 186

Alexander,

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T h e basic law affecting the proceeds of life insurance policies is found in Section 22(b) of the Internal Revenue Code, providing in part as follows: (b) Exclusions from Gross Income . . . (1) Life Insurance.—Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income); (2) Annuities, etc.— (A) In General. Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts and other than amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. . . . 8 In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance . . . contract . . . only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee shall be exempt from taxation. . . . 8 a Life Insurance Death Proceeds. U n d e r the statute and Treasury Department Regulations, 4 the general rule today as respects the proceeds of policies paid by reason of the death of the insured is that such proceeds, including retained or mortuary dividends, paid in a lump sum or in installments to any beneficiaries, including individuals, partnerships, trustees, and corporations, are not subject to income tax. If the insurance, however, is paid to a corporation, generally a distribution of the proceeds by the corporation in the form of dividends is not tax exempt. 5 T h e statutory exemption is grounded in part on social and economic 3 For annuity tax rule, see p. 193. 3a When this lecture was delivered in May, 1947, it was not anticipated that several months later the states of Michigan, Nebraska, and Oregon would adopt community property systems apparently to secure federal income tax advantages for spouses. Community property income tax rules may affect items of taxable income hereafter discussed to the extent that ultimate tax liability may be shared by spouses or shifted from one to another under certain circumstances and conditions. See also footnote 40a. Pennsylvania also adopted a community property Act which, however, was held unconstitutional under the federal and state constitutions, in the case of Willcox v. Penn Mutual Life Insurance Co., decided November 26, 1947, by the Supreme Court of Pennsylvania. 4 Reg. I l l , Sec. 29.22(b)(1)-!. 5 Cummings v. VS., 73 Fed. (2) 477; Golden v. U.S., 113 Fed. (2) 590.

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considerations. T h e proceeds are not income; rather they are paid as indemnity for loss of life and therefore are in essence capital payments. 6 Proceeds payable in installments ordinarily mean, under the above law and regulations, proceeds payable for a fixed period of years or for life with or without guarantees, which installments eventually exhaust the value of the policy proceeds. Where, under one or more options, the proceeds are retained by the insurance company under an agreement simply to pay interest, then the interest payments are taxable gross income to the beneficiary.7 T h e foregoing sound treatment given to insurance installment proceeds was the subject of considerable dispute during the years 1934 to 1946. T h e Treasury Department during this period, notwithstanding the language and legislative history of Section 22(b), attempted to tax installments to the extent of the interest or increment contained therein. As is well known, where an installment settlement is selected, the insurance company, by reason of retaining the death claim funds in its possession, adds interest to such funds, which practice has the effect of increasing the gross proceeds payable. T h e Treasury Department issued various regulations holding that the installment payments should be split into two parts, one taxable interest or increment and the other nontaxable principal, various methods for making this segregation also being prescribed. Since this method of taxing appeared improper, much litigation ensued. 8 T h e position of the Treasury Department was briefly that when the proceeds are left with the insurance company for payment in installments, additional amounts in the nature of interest are earned, which amounts are not solely paid by reason of the death of the insured. In the Winslow case,9 the first of a series of court decisions,10 involving policy proceeds where the insured had made the election for installment payments, the Circuit Court of Appeals, β U.S. v. Supplee-Biddle Hardware Co., 265 U.S. 189. τ U.S. v. Heilbroner, 100 Fed. (2) 379; Reg. I l l , Sec. 29.22(b)(l)-l. 8 For a complete discussion see E. S. Cohen, "Income Taxation of Life Insurance Settlements," N.Y. University Fourth Annua! Institute on Fed. Taxation, p. 73. » 113 Fed. (2) 418. 10 Prentice-Hall, 1947 Federal Tax Service, I, 8220A.

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First Circuit, disagreed with the contention of the Treasury Department, holding that the statute should be liberally construed and that Congress under its precise language, which otherwise was meaningless, intended that all life insurance should be exempt from tax and that no distinction should be made between lump sum payments and those made in installments. In 1943 the Treasury Department acquiesced in these decisions and modified its regulations by Treasury Decision 5231,11 which in effect held the statutory exemption complete, but controlling only where the installment election had been made by the insured. The Department persisted in its regulations with respect to settlements elected by the beneficiary after the death of the insured. The regulations as revised were promptly challenged by a beneficiary who had selected a policy option, and in the Pierce case,12 decided by the Circuit Court of Appeals, Second Circuit, it was held that the revised regulations were likewise invalid and that there was no satisfactory basis for a distinction between settlements elected by the insured and those elected by the beneficiary. Subsequently, following other court decisions, the Treasury Department deleted all such provisions from its regulations, this being done by Treasury Decision 5515, which had the general effect then of restoring the tax situation to where it stood about twelve years before. While this litigation clarified the essential issue, unhappily several of the court decisions created some doubts in incidental situations, as for instance, when the settlement option selected by a beneficiary is one not provided by a policy that was issued many years ago and before optional settlements became common. In the first decision in the case of Law v. Commissioner,13 the District Court seemed to be of the opinion that under such facts the insurance tax-free rule did not apply, and that the beneficiary's installment payments should be taxed as annuity payments 14 on the theory that the beneficiary had, in effect, with the lump sum to which she was entitled, made a new investment in the nature of an annuity. T h e tax consequence then would 11 Prentice-Hall, Cumulative Changes Service, I, pp. 10088-91. 12 146 Fed. (2) 388. 13 57 Fed. Supp. 447. 14 For annuity tax rule, see p. 193.

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be quite different. (This method of taxing annuities will be discussed subsequently.) T h e case was appealed, but on other questions. Although the foregoing District Court view recently received some publicity, 1 5 I think it unsound, and feel that if such result were adopted by the Treasury Department it would have so stated in amending its regulations by Treasury Decision 5515, which it did not do. Much the same contention had been made by the Treasury Department in one or more earlier cases, but the contention was rejected. 18 T h e view that the beneficiary is not entitled to a tax exemption unless the settlement elected is authorized by the insurance contract itself, flies in the face of reality and common practice which is for most companies today to extend by way of concession modern optional modes of settlement, for a period certain or for life, to all policies. As long as the concession otherwise revocable by the company stands, it in effect creates a quasi contractual right and probably has to be extended to all beneficiaries impartially. Not to do so might give rise to a claim of discrimination under various antidiscrimination statutes appearing in insurance laws and codes. 17 T h e n , too, the companies, as I understand it, make no distinction in their books, actuarial practices, and statement of liabilities between installment settlements provided for by the policies and those expressly allowed by concession. It would seem that if the beneficiary makes an election of installment settlement under a company concession she is sufficiently within the purview of the life insurance tax exclusion clause, which, as we have seen, is of the broadest possible type and has generally been liberally construed. T h e statutory provision quoted at the outset contains several exceptions, one of these dealing with the case of insurance payable to a transferee for a valuable consideration. 1 8 Such an 15 "The Income Tax and the Death Claim Proceeds of Life Insurance," Flitcraft Courant, Nov. 1946, p. 492; The National Underwriter (Life Insurance Edition), Feb. 7, 1947, p. 21. ιβ Winslow v. Comm., 113 Fed. (2) 418. See also Congressional Committee Reports referred to therein. 17N.Y. Ins. Law, Sec. 209 (Book 27, McKinney's Cons. Laws); Penna. Ins. Law, Sec. 471, Title 40 (Purdon's Stat.). 18 For a full discussion of this phase of the law, see S. J. Foosaner, "Life Insurance Assignments and Unnecessary Taxation," The Tax Magazine, Dec. 1943, p. 647.

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exception generally contemplates a factual situation where, subsequent to issuance of the policy, the beneficiary or some other person purchases the policy from the insured for a consideration in money or property. In such cases the proceeds payable at death of the insured (or at maturity in case of an endowment policy) generally are exempted from tax only to the extent of the amount or value of the consideration paid or given and any premiums thereafter paid by the transferee, the balance of the insurance proceeds being subject to income tax. 19 Although this unusual provision has been in the law for a long time and was modified in 1942 so as to permit exceptions in cases involving corporate reorganizations 20 and the like, I have some doubt as to the precise result intended. In the Treasury Department regulations it is held that this transferee rule does not apply where the transferee is the insured. 21 Such an exception is a worthy one but others might also be permitted. Although the statutory transferee provision is quite broad and apparently unambiguous, it is difficult to believe that Congress originally intended this provision to reach all assignments for value.22 Probably the purpose of Congress was to tax speculators and others with no insurable interest in the life insured who entered into the transaction with the expectation of making a profit by reason of the death of the insured. Such in fact at one time appears to have been the Treasury Department's interpretation. 28 As previously stated, this transferee rule was recently modified, chiefly for certain corporate purposes. Further relaxation of the rule should be permitted for a number of reasons, one being that generally it can easily be avoided. Instead of acquiring a policy by assignment, one can simply buy new insurance on the owner plan if he otherwise has the consent of the insured, who we shall assume is insurable, and if an insurable interest exists. At the same time the insured could cancel his existing insurance which, except for the transferee rule, he might have assigned. i»Reg. I l l , Sec. 29.22(b)(2)3; see also complete statute, Internal Revenue Code (hereafter referred to as I.R.C.), Sec. 22(b)(2). 20 Idem. 21 Idem. 22 Assn. of Life Insurance Counsel Procs., V, 107. 23I.T. 2591, C.B. July-Dec., 1931, p. 123.

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By so doing the insured acquires a cash surrender value for the existing policy from the insurer, which is the amount he probably would have received from the assignee, assuming an assignment for value were made. It seems to me, therefore, that the statutory rule ought to be reconsidered and liberalized. Perhaps this transferee rule should wholly exclude transactions for legitimate business reasons and when the transferees are members of the insured's family or otherwise have an insurable interest in his life. Another exception to the general rule exempting life insurance death claim proceeds from tax relates to policy proceeds which are used to pay or provide for alimony, now taxable as income to a wife under Section 22(k) of the Code. If the alimony is provided through the medium of a life insurance or endowment policy, the policy proceeds upon payment are characterized as alimony payments and will be taxable in full as gross income to the divorced wife. 24 Life and Endowment Insurance Living Benefits. With respect to payments which may be made upon maturity of endowment policies or upon cancellation of life insurance or endowment policies, the general rule based on the statute cited at the outset is that the proceeds received are taxable income in the year of receipt to the extent of the excess of the proceeds over the net cost of the contract. 25 T h i s appears to be the rule even though the proceeds are partially paid out in earlier years in the form of loans and the amount paid upon termination of the contract is not equal to any taxable gain. By net cost is meant gross premium cost less dividends. A taxable gain is taxable as ordinary income and not as a capital gain. 26 A loss sustained on termination of the insurance usually is not deductible. 2 7 If the proceeds of policies maturing during the lifetime of the insured or otherwise cancelled are left with the insurance company under an option whereby interest is paid, the interest paid or credited is taxable income. 28 Selecting an interest option normally does not defeat any tax on the policy gain. If, however, 24Reg. I l l , Sec. 29.22(k)-l; Sec. 29.22(b)l-l; Sec. 29.22(b)2-4. 25Reg. I l l , Sec. 29.22(b)2-l. 2β Farren, Β.Τ.Λ. Memo, 5 / 3 0 / 4 2 ; Perkins v. Comm., 125 Fed. (2) 150. 2TI.T. 1944, C.B. III-l, C.B. 145. 28I.T. 3202, 1938-2, C.B. 138; I.T. 2380, VI-2, C.B. 32.

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the person becoming entitled to the policy proceeds elects an installment option, that is, one in effect providing for annuity payments, and if such election is made or sufficiently communicated to the insurer before maturity or cancellation of the insurance, as the case may be, the policy owner is not subject to the gain rule above described.29 However, the periodic installments are taxable as annuity payments, generally using as a cost base the net cost for the insurance. 30 It has also been decided that for purposes of this rule it makes no difference whether the insured or policy owner had a right to take a lump sum at maturity, rather than installments. 31 Under a ruling of the Treasury Department, 32 if the election to take the policy proceeds in installments is made after maturity of an endowment policy or cancellation of the insurance, it appears the policy owner does not avoid the tax on the gain, if any. T h e theory is that the gain is constructively received. Moreover, the installment payments would be taxable as annuities, apparently using as the cost or purchase price the commuted value of the policy proceeds. Under the annuity tax rule, also prescribed by Section 22(b)(2) of the Code, annuity payments are income taxable annually to the extent of three per cent of the consideration for the contract. Excess amounts received are treated as tax exempt principal. This process continues until there has been a recovery tax-free of the consideration, after which the annuity payments are taxable in full as gross income. This annuity rule, incidentally, has recently been the subject of review by the Congressional Joint Committee on Taxation, and it is possible that eventually a more equitable rule of taxing annuity income will be enacted. With respect to dividends, the general rule is that dividends paid on insurance policies during the lifetime of the insured are not taxable as income, but they must be taken into account 29 G.C.M. 21666, C.B. 1940-1, p. 116. so The case of Thornley, 2 T.C. 220, not followed by the Treasury Department, applies the regular endowment gain rule where the installments are for a period certain and not for life. In several recent informal rulings, however, the Bureau of Internal Revenue decided that in "surrender" situations involving life policies, the cost base should be the policy cash value at the time of cancellation. It is submitted that such rulings are unsound and in any event cannot be reconciled with various published rulings already cited. 31 G.C.M. 22519, C.B. 1940-1, p. 330. 32 Letter ruling dated 9/3/43.

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in determining any gain upon maturity or surrender before death. 3 3 It is immaterial how the dividends are disposed of or whether at the time they are paid the policy is a paid-up contract. 34 If such dividends, however, were left with the insurance company at interest, such interest when paid or accrued and otherwise subject to withdrawal is considered to be taxable gross income. 35 Generally speaking, income tax liabilities arising under rules heretofore discussed are the sole concern of the insured or beneficiary receiving the taxable income. Collection or withholding by an insurance company of income taxes growing out of such tax obligations is only required in respect to certain taxable payments made to nonresident aliens. 38 Efforts by the Federal Government to seize policy cash values and proceeds in satisfaction of delinquent tax liabilities of the insured or beneficiary are discussed elsewhere in this volume. 37 FEDERAL ESTATE T A X T h e present unique and discriminatory Federal statutory estate tax provisions affecting the death proceeds of life insurance policies, enacted by the Revenue Act of 1942, were not produced by a single congressional legislative session. Rather, they represent the final stage of a concoction which had been brewing chiefly in the Treasury Department for a period of over twenty years. An analysis of this mixture would disclose many peculiar ingredients, including brief but ambiguous earlier legislation, decisions where courts struggled to fathom congressional intent, and vacillating Treasury Department regulations and rulings. We might also perceive various social and economic philosophies, some lack of understanding of life insurance contracts and general rules of law applicable thereto, and perhaps also a measure of failure to appreciate properly the social service performed by our privately operated system of insuring lives. In many respects this past history is dissimilar from that underlying the income tax rules we have already discussed. Although a study 33I.T. 3413, C.B. 1940-2, p. 58; Reg. I l l , Sec. 29.22(a)-12. 34 S.M. 5680, C.B. June, 1926, p. 32. 35 Letter ruling 9 / 2 2 / 4 1 . 36 I.R.C., Sec. 143(b). 37 See Howard C. Spencer, "Rights of Creditors in Life Insurance," pp. 80 to 82.

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of the earlier estate tax on life insurance is fascinating, I can only recommend to those interested in background that they read various texts, articles, committee reports, and judicial decisions.38 T h e present general tax rules on this subject matter are similar to the rules prescribed by Treasury Decision 5032,39 which in 1941 amended the then-extant tax regulations. Such decision, briefly speaking, invoked clearly for the first time the two alternative tests of taxing life insurance proceeds; namely, payment of premiums or incidents of ownership. In addition, it sanctioned the ownership test as a single and controlling test under certain conditions. T h e present specific statutory provisions are found in Section 811(g) of the Internal Revenue Code, which in part reads as follows: Sec. 811. The value of the gross estate of the decedent shall be determined by including . . . (g) Proceeds of Life Insurance.— (1) Receivable by the executor.—To the extent of the amount receivable by the executor as insurance under policies upon the life of the decedent. (2) Receivable by other beneficiaries.—To the extent of the amount receivable by all other beneficiaries . . . (A) purchased with premiums . . . paid directly or indirectly by the decedent, in proportion that the amount so paid by the decedent bears to the total premiums paid for the insurance, or (B) with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person. . . . For the purposes of clause (B) of this paragraph, the term "incident of ownership" does not include a reversionary interest. . . .

These statutory provisions, which were introduced into the law by Section 404 of the Revenue Act of 1942, have these general effects: First, all life insurance proceeds of every description 40 payable (in a lump sum or installments) by reason of the death of the insured occurring after the effective date of this new law, namely, 38 E.g., see Clark, Taxation of Life Insurance and Annuities, 2nd Ed., Part II; Paul, Federal Estate and Gift Taxation, 1942, c. 10, and 1946 Supp.; M. R. Schlesinger, "Taxes and Insurance; A Suggested Solution to The Uncertain Cost of Dying," 55 Harv. L. Rev. (Dec. 1941), 2. 39 Prentice-Hall, 1947 Federal Tax Service, par. 23841. 40 Reg. 105, Sees. 18.25, 18.26; also Sec. 81.28. If the proceeds are payable in installments, the taxable value is their commuted value.

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October 22, 1942, are taxable as part of the gross estate o! the insured, either where the insured paid premiums directly or indirectly or where he had at his death one or more incidents of ownership, except, however, a so-called right of reverter, that is, the right to regain control of the policy if the owner should predecease him. Second, if the insured at his death had no incidents of ownership b u t paid some premiums though not all, directly or indirectly, the policy proceeds are taxable in the proportion that the amount of premiums paid by the insured, directly or indirectly, bears to the total premiums paid. T o illustrate, if half the total premiums were paid by the insured, half the policy proceeds would be taxable, assuming he had no incidents of ownership at the time of his death. Section 811(g) also contains several exceptional rules applying where a policy was transferred otherwise than by way of gift and where the insurance was held by persons in community property states. T h e nature of these special rules is beyond the scope of this discussion.40» Although Section 811(g) of the Code seemingly contains the complete statutory rule for taxing life insurance proceeds, this section must be read with Section 404(d) of the Revenue Act of 1942. T h e latter provides that the new rules under Section 811(g) are applicable to estates of decedents dying after the effective date of that Act (October 22, 1942), b u t that in determining the proportion of the premiums paid directly or indirectly by the insured the amount so paid by him before J a n u a r y 10, 1941, should be ignored if at no time after such date the decedent possessed an incident of ownership in the policy. T h i s exception is based on the fact that Treasury Decision 5032, which first promulgated the alternative rules, was released on January 10, 40a Because the states of Michigan, Nebraska and Oregon established community property systems after the delivery of this lecture, the federal estate tax community property provisions contained in I.R.C. Section 811 must now be given serious consideration. These provisions should be read with applicable Treasury Department regulations. An examination of statutory and case law in states such as California and Louisiana, where community property doctrines have always prevailed, is also recommended. T h e attention of students is also drawn to the community property section (23) appearing in Volume No. 3 of the Insurance Research and Review "Advanced Underwriting Service."

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1941. In other words, whenever a deceased insured left a policy completely assigned before January 10, 1941, on which he had paid premiums, the premiums paid before January 10, 1941, are to be ignored for purposes of the premium payment test. T h e gross estate of the insured under existing law is entitled to various deductions and also a general exemption of sixty thousand dollars. 41 The specific life insurance exemption of forty thousand dollars was repealed by the 1942 Revenue Act. As already stated, there are now two alternative tests for taxing life insurance proceeds. The ownership test is partially based upon the Supreme Court decision in the case of Chase National Bank v. United States,*2 which dealt with the taxability of policies payable to beneficiaries designated revocably. The Court sustained the tax upon the policy proceeds, chiefly on the ground that the insured prior to his death had economic power or control over the policy and that the termination by death of such power was equivalent to a transfer of the policy and its proceeds to the beneficiary. T h e most common incidents of ownership in a policy, and ones which would permit this tax to apply are: the power to change the beneficiary, to surrender for cash or secure a policy loan, and to pledge or assign. Other powers of various types specified in the estate tax regulations 43 and suggested by Congressional Committee Reports, 44 are included in the term "incidents of ownership." One such suggested incident is the power to change the beneficiary reserved to a corporation of which the decedent or insured is the sole or controlling stockholder. Apparently the intent of this would be to permit the corporate entity to be ignored, which might virtually wreck or at least seriously interfere with many corporate life insurance programs. We do not yet know everything that may be considered a taxable incident of ownership, but we do know that such incidents are not necessarily limited to rights possessed by the decedent in a technical legal sense. One so-called power, namely, a right of reverter by the statutory provision, is expressly ex411.R.C., Sees. 812(a) and 935(c); for purposes of the primary tax of 1926 the exemption still is $100,000.—Sec. 812(a). « 278 U.S. 327. « Reg. 105, Sec. 18.27. ** Senate Finance Comm. Report on 1942 H.R. 7378, p. 187.

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eluded. 4 5 Moreover, it matters not that taxable incidents of ownership may be exercised only with the consent of other persons. 46 In the recent YVelliver case involving the proceeds of group life insurance and decided by the T a x Court, 4 7 that Court held that the power of the insured employee to change the beneficiary, apparently the only power he had, was sufficient of itself to require the taxability of the policy proceeds as part of his estate. Even though the incidents of ownership test is not perfect, it seems fairly reasonable in the light of existing tax philosophy. In essence the test involves ownership of the insurance or substantial property rights therein which, if not relinquished by the insured before his death, are treated as constituting property transferred by reason of his death to the beneficiary and valued by the a m o u n t of the proceeds paid. Except for various technical situations, it is a relatively easy test to apply as regards most policies. T h e alternative premium paying test, on the other hand, is impracticable and discriminatory. In most cases today where the insured naturally pays premiums, the test will result in taxability even though ownership is in another person. Such a test, however, is not new. Even before the year 1942 the courts at various times applied a test of that nature and it was also embodied at times in various issues of Treasury Department regulations. 4 8 Such a test is grounded on the theory of economic or generating source. O n e of the earliest cases subscribing to this theory is the Chase Bank case heretofore cited. 49 T h e r e the court, in answering an argument made by the estate, said that taxable transfers under the statute would include "the transfer of property procured through expenditures by the decedent with the purpose, effective at his death, of having it pass to another." Such language, it is submitted, was not necessary to support the final holding of taxability. Other more recent cases have, however, followed this philosophy. 5 0 46 For life insurance purposes this amendment generally overrules Helvering v. Hallock, 309 U.S. 106. 46I.R.C., Sec. 811(g). 47 Welliver v. Comm., 8 T.C. 18. 48 See note 38. 4» 278 U.S. 327. so See the curious Bailey litigation, 27 Fed. Supp. 617, 30 Fed. Supp. 184, and 31 Fed. Supp. 778; also Goldstone v. US., 325 U.S. 687.

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51

Under the Treasury Department regulations, based essentially on the Committee Reports heretofore referred to, it is held that the phrase "paid indirectly by the decedent" is intended to be broad in scope and that it includes payments made under such facts as, for example, where the decedent had transferred funds to his wife so that she might buy insurance on his life; where the premiums are paid by a trust whose income is taxable to the insured; where a corporation pays premiums, such corporation being the alter ego of the insured; and where the employer pays premiums which in effect are compensation for services, etc. 52 Apart from the special problems suggested by the foregoing situations, the most important general question today on this subject is what is meant by the word "indirect." How far will the courts go in holding that premiums are indirectly paid by the insured? Is any connection, however remote, to be considered? Probably much litigation will be required to provide an adequate answer but it seems to me that a fair solution, and one which is supported by some case law, is to treat payments as being made indirectly only if they are made by a person as agent for the insured, or if the premium payer was under an obligation to the insured to make such payments. 53 T h e discriminatory aspects of the premium payment test where the insured has no incidents of ownership are such as to give us much concern. T h i s discrimination is apparent when we consider the following simple situation: A buys life insurance, transfers the policy to his wife, but continues to pay premiums by way of gift. His wife has no funds or property of her own. Β follows a similar course but his wife pays all premiums with funds inherited from her father's estate. In the first illustration, the estate tax would apply, but not in the second. T h e consequence is that after the deaths of A and B, the wife of A only, who may need financial support to a greater degree than the wife of B, must pay a substantial tax, at least in theory. One policy is taxed 51 Reg. 105, Sec. 81.27(a). 52 in Welliver v. Comm., 8 T.C. 18, the Tax Court decided that payment of premiums by an employer constituted compensation for services and therefore that such premiums were indirectly paid by the insured. 53 See "Indirect Payment o£ Life Insurance Premiums," The Tax Magazine, Sept., 1943, p. 475; "When Are Life Insurance Premiums Paid Indirectly?" The Tax Magazine, Aug., 1947, p. 726.

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and not the other.®4 Such a result is inequitable and discriminatory. There is also discrimination as between life insurance and other types of property. If the theory of economic origin or source is sound, should it not be applied to other situations? For instance, suppose a husband gives his wife money which she uses to play bridge. If she is lucky, her winnings and the original gift are not taxed to the husband's estate upon his death. Or suppose the husband's money is used by a wife to buy rental real estate which may produce income in the form of rents and perhaps a profit on sale of the property. These economic gains would not, nor would the original money, be taxable to the husband upon his death. As pointed out in a recent article, this discriminatory test may tend to encourage reckless spending as contrasted with investment of funds in life insurance. 55 Moreover, this test affects not only large amounts of life insurance but even small or moderate amounts where the insured otherwise leaves a fairly substantial estate consisting of general property. T h e rule of indirect premium payments also leads to further questionable results and tax avoidance. Suppose an insured buys a single premium endowment policy and at issue designates his wife as owner by way of gift. If the policy should mature while the insured is alive, the wife receiving the insurance proceeds, and then shortly thereafter the husband should die, the proceeds would not be taxable as part of the husband's estate since upon his death the insurance contract was not in existence. But let us suppose the insured is on the verge of death when the contract is about to mature as an endowment. At such time the cash value of the policy may be almost equal to the face value. Under the assumed facts, if the insured should die before the policy matures as an endowment, the entire proceeds would be taxable in his estate. If the wife, however, under her ownership rights, should take the cash value before death, such cash would not in my opinion be taxable as part of the insured's estate under either the incidents of ownership or premium payment tests. By taking the cash value, a loss may be occasioned, but the amount 64 See Harvard Law Review article cited in note 38. BB See discussions by Buist Anderson, Counsel, Connecticut General Life Insurance Company, in American Bar Assn. Ins. Law Proceedings, Sept., 1944, p. 358.

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would perhaps be less than the estate tax that would otherwise be imposed. Possibilities of taxation in cases such as this, and affecting various types of policies, have no doubt induced ownerbeneficiaries at times to surrender policies for cash values rather than allow them to mature by death of the insured. Another important and undecided question is the constitutionality of these new dual premium and ownership tests. I will not venture a prediction as to the outcome. A few writers apparently feel or suggest this question may be decided in favor of constitutionality. 66 Some court decisions support such conclusion, particularly the case of Colonial Trust Co. v. Kraemer,BT where the court sustained these taxing tests as first prescribed by Treasury Decision 5032. Life insurance proceeds payable at death of the insured may also be taxed for other reasons. Section 811(g) of the Code expressly states that a right of reverter is not a taxable incident of ownership. Yet the Treasury Department in its regulations 68 holds that if the insured transfers a policy reserving a right of reverter, the proceeds are fully taxable at his death, presumably as a transfer to take effect at death, even though he has never paid any premiums. The same regulations also hold that taxability will result if any policy, apart from other considerations, is transferred in contemplation of death within the meaning of the statute and decisions taxing such transfers. We should not quarrel with this latter rule, I believe, where a policyholder transfers a policy of long standing purely for tax avoidance motives or other motives associated with death. However, there is a tendency today to support taxation on the questionable theory—at least in some cases—that a transfer of life insurance or the contract is testamentary or inherently testamentary. 69 This doctrine was once rejected by various courts.80 Life insurance as a general rule is procured to protect dependes Michigan Law Review, Vol. 40, 1942, p. 1221; Clark, Taxation of Life Insurance and Annuities, 2nd ed., p. 115; Paul, Federal Estate and Gift Taxation, Vol. 1, pp. 516 and 523. BT 63 Fed. Supp. 866; see also discussion in article, "Life Insurance and the Estate Tax," by William T . Hodge in The Tax Magazine, April, 1947. 58 Reg. 105, Sec. 81.27(2) and Sec. 81.25. 59 See discussions in Clark's Taxation of Life Ins. and Annuities, 2nd Ed., p. 179. eo Walker v. Comm., 83 Fed. (2) 103; Chase Nat. Bank v. US., 28 Fed. Supp. 947, reversed on other grounds. See also Appleman, Insurance Law and Practice, Vol. 19, p. 500.

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ents from loss of support or for investment purposes, and not necessarily with the thought of transferring property. Also, as is well known, the doctrine is not followed for general testamentary purposes. 61 In several recent T a x Court decisions, the testamentary doctrine was followed without much discussion or citation of adequate supporting decisions. In the Cronin case62 the decisions cited are not in point and in essence there is merely a reference to a 1942 House Committee report. T h e earliest decision I can find on this topic otherwise is the first of the Bailey cases,63 when, apparently for the first time, the Court of Claims in 1939 stated the doctrine judicially. However, writers around that period had also suggested the view.64 I cannot believe that the originators of the doctrine sufficiently considered all aspects of the problem and its possible far-reaching effects. Under the facts of the Cronin case, the T a x Court could presumably have decided the issues of taxability without relying upon the testamentary concept. If this doctrine is sustained and generally applied, perhaps under no circumstances could life insurance, issued for the most legitimate purposes, including business purposes, be made tax-free as other property might be exempted from tax. I hope the doctrine in time will be repudiated or limited to most unusual facts. T h e Supreme Court will eventually have to pass on it. 64a T h e unfairness of most of these insurance estate tax rules has been recognized by various organizations. Recently the American Bar Association made recommendations that the statutory provisions be changed so as in effect to apply only the incidents of ownership test. 65 One might also recommend allowing a reasonable 61 C. J. Secundum, Vol. 46, p. 41, C.C.H. Insurance Law Journal, 1945, p. 707. «2 Cronin v. Comm., 7 T.C. 1403; Garret, 8 T.C. 492. See also Liebmann v. Hassett, 148 Fed. (2) 247, on question of determining amount of taxable proceeds where transferee takes over payment of premiums; for procedure approved by Tax Court, see footnote in Cronin case on page 1411. 63 27 Fed. Supp. 617; Chase Natl. Bank v. U.S., 116 Fed. (2) 625. 64 See annotations in Clark's Taxation of Life Insurance and Annuities, 2nd Ed., p. 181. 64a Since this lecture was delivered the Tax Court appears to have decided to permit exceptions to this testamentary doctrine. See Estate of Ruthrauff, 9 T.C., 59. 65 American Bar Assn., Program ir Comm. Reports, Taxation Section, Oct. 27-29, 1946, pp. 12 and 15.

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life insurance exemption, but not necessarily in the forty-thousand-dollar amount which prevailed before the Revenue Act of 1942. Whatever the amount might be, specific exemption would serve to minimize such questions as have been discussed and to promote more orderly administration of the law. The increased estate tax burden on life insurance, particularly under the federal law, has resulted during recent years in a number of serious questions of estate tax liability and collection. Who is to bear the burden of the tax on life insurance proceeds, the estate or the beneficiary? When insurance proceeds are retained by the insurance company under an interest option or for payment in installments, and the beneficiary or the insured's estate cannot meet the tax, can the company be required to release funds to the estate or to the Government to satisfy the tax liability? Another novel question now being litigated in New York State is the liability of the insurance company for tax reimbursement on a lump sum policy, the proceeds having been paid in good faith to a beneficiary who later died insolvent. 66 An examination of the federal estate tax laws discloses several provisions having a bearing on the above questions. Section 827 of the Internal Revenue Code provides that the estate tax shall be a lien for ten years upon the gross estate of the decedent. T h e same section also imposes liability for tax upon certain "transferees." T h e primary liability for tax is, however, under Code Section 822, imposed upon the executor. As for life insurance proceeds, Code Section 826(c), briefly speaking, provides that the executor, in the absence of a provision in the decedent's will to the contrary, may collect the tax on such insurance from the beneficiary. Under these provisions, then, it would appear the payment and collection of estate taxes is no concern of the insurance company. T h e litigated cases support the foregoing conclusion. Beneficiaries may be sued successfully by the Federal Government for estate taxes, but not the insurers. As to beneficiaries,87 the Board of Tax Appeals has held them liable as transferees and in one 66 Matter of Zahn, Surrogate's Court, N.Y. County—New York Law Journal, Dec. 14, 1946, p. 1794; decision adhered to on rehearing, New York Law Journal, April 8, 1947, p. 1359. 67 Hays' Estate, 34 B.T.A. 808; Lansburgh Estate, 35 B.T.A. 928.

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case*8 involving two beneficiaries has further held that the liability of a specific beneficiary did not merely extend to his proportionate part of the tax but rather to the whole tax on all the insurance on the life of the decedent. No attempt apparently has ever been made by the Federal Government to hold the insurer liable for the estate tax when it pays policy proceeds in a lump sum.69 The theory appears to be that the company, having a contractual obligation, must discharge its duties as to payment and that the lien of the tax extends to the proceeds in the beneficiary's hands. When the company retains the proceeds under an optional mode of settlement, the Federal Government likewise cannot require the company under Federal laws to release funds for payment of estate taxes. The case of John Hancock Mutual Life v. H elvering10 involved an insured's election and the court decided the insurance company was not a "transferee" for purposes of tax collection. The same result was reached by the Board of Tax Appeals in the. case of Equitable Life Assurance Society v. Commissioner,"'1 where the beneficiary had filed an election of a deferred settlement. The most recent developments respecting tax collection or reimbursement, especially in New York State, relate chiefly to attempts by executors to secure insurance proceeds held by life insurance companies under optional modes of settlement. Normally the executors under state laws must use funds in the residuary estate to pay federal and local estate or inheritance taxes, even on property such as life insurance not coming into their possession.72 But this rule does not apply to those states, including New York, Pennsylvania, and others, which have enacted special laws for apportionment of federal and state estate or inheritance taxes, unless the decedent otherwise directs in his will.73 Under such statutes the taxes as a general rule must β8 Lansburgh Estate (see preceding note). β9 But see discussion on following pages. 70 128 Fed. (2) 745. 71 46 B . T A . 586. 72 See cases cited in pars. 24522A and 24574 of Prentice-Hall, 1941 Federal Tax Service. 73 See par. 24522B, Prentice-Hall, 1947 Federal Tax Service.

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be equitably allocated among all the estate heirs, and also among recipients of taxable property not passing by will. Insurance beneficiaries have, no doubt, on numerous occasions been required to contribute to the tax burden in these states. Statutes of this nature, in so far as property passes through the executors' hands, have been held constitutional on the theory that the states have the final voice as to the distribution of the tax burden. 74 T h e Pennsylvania proration statute, however, in the case of Estate of Moreland was held not to apply to an insurance company holding funds under supplemental agreements. 75 T h e court also held that the insurer could not be required to account directly to the estate for the tax and that the remedy of the estate is to garnishee installment payments as they come due. In the State of New York, however, the rule is different. There, in the Scott decision, it was held that under the New York apportionment statute an insurance company could be lawfully required, when it retains proceeds under options, to pay a portion of the proceeds to the executor by way of reimbursing him for estate taxes paid on the insurance.7® T h e company, however, does not directly assume the tax burden but is permitted to revise the supplementary agreements or contracts and deduct the principal amount paid out pursuant to court decree, scaling down the payments actually to such proportionate amounts as the remainder of the retained proceeds would provide. Since apportionment statutes are being enacted from time to time in various states, it seems that the problems of an insurance company from the viewpoint of tax collection or reimbursement will constantly increase. T h e major problem concerns those cases where companies hold the insurance funds for installment payments. In those instances where as a practical matter the beneficiaries and estate cannot pay the taxes, possibly the collection from the insurance company without any loss to it may be justifiable. Nevertheless, the states of Massachusetts and New Hampshire expressly provide in their apportionment laws that either insurance companies are not liable for tax contributions M Riggs v. Del. Drago, 317 U.S. 95. 78 42 Atl. (2) 63. ™ Frank L. Scott Estate, 286 N.Y. Supp. 138, 249 App. Div. 542, 274 N.Y. 538, Cert, denied by Sup. Ct. of U.S.

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or life insurance contracts are not subject to tax allocation." Under the New York apportionment law, the question of tax liability on the part of the insurance company has arisen even in connection with lump sum payments. In the Sullivan case, decided by a Surrogate in Kings County, New York, it was held that the New York statute did not prevent the company from paying promptly pursuant to its contract and that it was not liable to the executor for the federal estate tax on the policy proceeds. 78 In the Zahn case, already mentioned, 7 9 a different conclusion, believed by many to be unsound, was reached. T h e company was held responsible for the federal estate tax without any opportunity for reimbursement. However, the case is being appealed. If the adverse decision should be affirmed by the highest courts, no doubt remedial legislation will be needed so as to permit companies to pay claims promptly and without incurring additional liability for these taxes. FEDERAL G I F T T A X T h e federal gift tax—a tax chiefly designed to offset loss of estate taxes because of inter vivos transfers—is, I believe, not very important these days with respect to life insurance transactions. Its impact now is felt principally by insureds who pay premiums on policies which were assigned by way of gift before the estate tax base for life insurance was extended. T h i s tax under the law applies to any transfer of property, 80 including life insurance policies 81 transferred without adequate consideration in money or money's worth, and notwithstanding that later the same property may clearly be subject to estate tax also in the estate of the transferor. Where both gift and estate taxes apply, a credit may be allowed against the estate tax for the gift tax paid. 82 Under the Treasury Department regulations it is held that 77 Massachusetts, Gen. Stats., c. 65A, Sec. 5A; N e w H a m p s h i r e Laws 1943, c. 175, Sec. 1. 78 Sullivan's Estate, 55 N.Y. Supp. (2) 702. 79 See n o t e 66. 8 0 I . R . C . , Sec. 1000(a). See also I.R.C. Section 1000(d) applicable to gifts of c o m m u n i t y property; and also f o o t n o t e 40a. 81 R e g . 108, Sec. 86.2(a)(8). 82 I.R.C., Sec. 812(c).

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a transfer of a policy without retention of any economic benefits is a gift of the policy even though the assignor insured retains a right of reverter.83 Several years ago, when such right was reserved, the Treasury Department attitude was that only a partial gift of the policy was made. Now in either case, that is, complete assignment, or assignment or irrevocable designation of a beneficiary with a reversionary interest, the measure of value is the same. The regulations also hold that premiums paid on policies which have been conveyed by way of gift are additional gifts. For purposes of valuation the regulations require, 84 and the courts have agreed,85 that policies transferred by way of gift should generally be valued on the basis of replacement cost. This rule in the case of new single premium or paid-up policies requires a valuation on the basis of the premiums paid or currently charged by the insurance company for the protection given by the contracts. In the case of other policies on which- further premium payments are contemplated, the regulations permit the use in valuation of the insuring company's interpolated reserve for the policy plus the proportionate part of the last premium paid before the date of the gift. The value secured by the interpolated reserve method is slightly higher as a rule than the policy cash value usually available. Although the foregoing methods of valuation are generally applied, they do not, I believe, preclude other methods. Suppose a policy on the life of A, owned by B, is given by Β to C while A, the insured, is very ill or perhaps on the verge of death. In such a case the gift tax value may properly be the anticipated amount of the proceeds payable on the death of A, the insured. Somewhat liberal gift tax exemptions are permitted by statute. T h e larger of these, technically a deduction, amounts to thirty thousand dollars.86 It is cumulative and may be spread, if necessary, over the donor's lifetime. The second exemption, properly an exclusion, permits gifts free of tax in the amount of three thousand dollars or under per person per calendar year.87 When 83 See note 81. 84 Reg. 108, Sec. 86.19(i). 85 See cases cited in Prentice-Hall, 1947 Federal Tax Service, par. 26267. 8β I.R.C., Sec. 1004(a). 87 I.R.C., Sec. 1003(b)(3).

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the three-thousand-dollar amount is exceeded, the general exemption of thirty thousand dollars is applicable to the excess if it has not already been used up. But even after the larger exemption is exhausted, the smaller one is still permitted. These exemptions were more liberal prior to 1942. T h e three-thousand-dollar exclusion is not available in connection with gifts of a so-called future interest, 88 that is, an interest which, as to a particular doneee, takes effect at a subsequent date. This future interest rule under the Treasury Department regulations, however, does not generally apply to interests in a transferred policy of life insurance, such interests being deemed to take effect immediately. 89 For instance, the interest of an irrevocably designated beneficiary is not to be deemed a future interest simply because he or she must await the death of the insured in order to collect the face value of the policy. Under the gift tax statutory provisions, 90 the donor or the representatives of his estate are liable for payment of gift taxes. When the taxes are not paid by such persons the donee has a liability. 91 In fact, a donee was held by the T a x Court to have a liability for gift tax on a transfer of an annuity contract where no attempt apparently had been made to secure the tax from the donor. 92 Moreover, in that case the liability of the donee was not limited to the tax due and unpaid on the transfer to her; rather she was held liable for the full amount of the unpaid donor's tax liability arising on account of numerous gifts, but not in excess of the value of the transferred contract. 93 I am not aware of any attempt by the Government to collect gift taxes by recourse to an insurance company or to contracts it has issued. But collection from policy cash values might be possible in theory under Section 3678 of the Internal Revenue Code authorizing civil actions to enforce liens on property, which section has 88 Reg. 108, Sec. 86.11; Code Sec. 1003(b)(3). 89 Reg. 108, Sec. 86.11. But see also Tax Court decision apparently to the contrary; George B. Caudle, Prentice-Hall BTA Memo Service, par. 45100. 90I.R.C., Sec. 1008; Sec. 518, Revenue Act of 1934; Reg. 108, Sec 86.34. »11.R.C., Sec. 1009; Reg. 108, Sec. 86.35. 92 Clara Ream and Capitola A. Perry, in Prentice-Hall, BTA Memo Service, par. 43501. 93 See also other decisions cited in par. 26523, Prentice-Hall, 1947 Federal Tax Service.

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heretofore furnished a basis for collection of unpaid income taxes from policyholders' cash values.94 STATE TAXATION A survey of life insurance taxation would not be complete without some reference to taxes imposed by the various states. Although the tax burden on life insurance proceeds under state laws generally is not oppressive, such taxes deserve careful consideration. Income Tax. Of the states imposing income taxes, that is, about three-fifths of all states, practically every one has life insurance provisions patterned after the Federal law. However, in any jurisdiction the law, regulations, rulings, and court decisions, if any, must be examined to determine definitely the answer to any specific question.95 Inheritance or Estate Tax. Under the various state inheritance or estate tax laws, life insurance death proceeds are given far from uniform treatment. There has been a tendency, however, during recent years for some states to follow Federal practices. In all states, with possibly one or two exceptions under special circumstances,96 proceeds payable to an executor or administrator of the insured's estate are taxable as part of such estate. Proceeds payable to specific persons, such as, for instance, wives and children, are exempted from tax in a majority of states, the reasons usually being lack of taxing provisions and judicial or administrative interpretation, or express exemptions. The State of Pennsylvania, for example, is included in this group of states.97 In the remaining states death proceeds are subject to tax with, as a rule, fairly liberal exemptions. Apart from the question of statutory exemptions, life insurance proceeds in this minority group are usually not taxable where the insured in good faith has relinquished incidents of ownership. A few states 8< For discussion of seizure of life insurance policies and equities therein to satisfy unpaid income taxes, see Howard C. Spencer, "Rights of Creditors in Life Insurance," pp. 80 to 82, of this volume. es See Prentice-Hall and Commerce Clearing House state and local tax services. eesee exceptional Maine Inheritance Tax Law, Sec. 2-1, 1944 Maine R. S. In community property states special rules may also prevail. »T Purdon's Stat.. Title 72, Sec. 2301(d).

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apply premium payment and/or incidents of ownership rules similar to the Federal tests.98 Gift Tax. Twelve states, not including Pennsylvania, now impose gift taxes similar to the Federal gift tax. Although it would appear that for life insurance purposes the tax bases and to some extent the valuation methods employed by the states are the same as those employed by the Federal Government, exemptions and rates of tax vary considerably. Personal Property Taxes. In all states imposing personal property taxes, the legislative and administrative custom for many years has been to exempt unmatured life and endowment insurance policies from property taxation. T h e exemption is in part based on social policy and in part on administrative difficulty." Such liberality, however, is not always extended to the proceeds of matured policies, whether maturing by reason of the death of the insured or as endowments. In a few states, for instance, Ohio, 100 Michigan, 101 and Oklahoma, 102 by virtue of statutory provisions, court decisions, or administrative rulings, the policy proceeds, if left with the insurance company under one of the optional modes of settlement, are regarded as taxable property in the nature of annuities or deposits and must be reported for assessment. One state, North Carolina, 103 requires the insurance company to pay taxes on certain retained proceeds, such taxes being charged to the beneficiaries' accounts. It is difficult to justify these conflicting practices. If social feeling dictates freedom from tax before maturity of a policy, say when the father and supporter of the family is alive, similar immunity from tax ought to be extended to the policy proceeds subsequently used as a substitute for the support previously provided by the insured. In fact, after maturity of a policy by reason of death, the need for freedom from a tax burden often is greater. In this respect I am glad that the State of Pennsyl98 See, for instance, New York Estate T a x Law, Art. 10C, Sec. 249-q, and Sec. 249r9. »9 "Must the Policyholder Pay Taxes on the Cash Surrender Value of His Life Insurance," Assn. of L. Ins. Counsel Proceedings, Dec., 1914. 100 Prentice-Hall, State and Local Property Tax Service, Ohio, par. 31370. 101 Michigan Intangible Tax Act, P.A. 1939, Act. 301, Sec. 1. 102 Wilkin v. Board of Com'rs, 186 Pac. 474. 103 N.C. Rev. Act of 1939 as amended, Art. VIII, Sched. H. Sec. 707.

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vania, with a proper understanding of the problem, frees policies and proceeds both before and after maturity from its county property tax. 104 CONCLUSION The foregoing survey shows that, in most respects, the taxation of life insurance proceeds is rational and fair. The peculiar and harsh treatment presently given such proceeds under the Federal Estate T a x Law requires correction; and probably amendments will eventually be secured, putting Federal life insurance estate taxation on a more reasonable basis. Life insurance, it must be remembered, is still more than ordinary property. It is a social institution. T h e late Judge Cardozo has said: "Insurance for dependents is today in the thought of many a pressing social duty. Even if not a duty, it is a common item in the family budget, kept up very often at the cost of painful sacrifice, and abandoned only under dire compulsion." 105 104 Prentice-Hall, State and Local Property Tax Service, par. 34395. 106 Burnet v. Wells, 289 U.S. 670.

PROGRAMMING TO MEET BENEFICIARY NEEDS By John O. Todd, C.L.U.*

A s LIFE insurance has developed over the years to its present mature stature, the ultimate purpose of serving the needs of the beneficiaries has always been recognized. W i t h each year— during the last forty years in particular—has come additional realization of how life insurance can meet more and more the complex needs of beneficiaries, and do it better than any other medium. In addition to the lawyers, the actuaries, the doctors, the financial men, and all the others associated with life insurance companies w h o devised contracts, computed rates and reserves, selected risks, administered investments, and handled the receipt and disbursement of policyholders' funds, there was need for an underwriter whose function it was to put life insurance to practical use for human welfare. Research in the scientist's laboratory may produce knowledge of infinite value to mankind, but it will serve no human need until the practicing doctor in the field tests that knowledge and puts it to use. T h u s does the underwriter serve to put the accumulated knowledge and services of life insurance trusteeship 1 to use in the field. It is my aim to explain in some measure how the underwriter functions in the task of planning, not only to bring needed capital into being through life insurance, but also to apply that capital to an insured's objectives in such a way as to serve beneficiaries' needs. A n d don't forget that the insured actually • General Agent, Northwestern Mutual Life Insurance Company, Chicago. ι T h e expression "trusteeship" as used by the author at a number of points is given a broad popular meaning rather than its normal legal meaning. 212

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may become the beneficiary, if he lives to use his insurance for himself. Every life insurance policy must some day be measured against the job that it must perform for beneficiaries. The trouble is that if it is not measured until it becomes a claim and then falls short of doing the job, there is nothing that can be done to remedy the situation. Therefore, the first function of the underwriter is to forecast the needs. FORECASTING T H E NEEDS There are two reasons why men seldom own as much life insurance as they ought to have. T h e first is the natural conflict between present and future needs for money, in which it is human nature to favor the present over the future. T h e second is that most men can no more build a program without expert help than they can draw a detailed set of plans for a house. In the case of the house they seek an architect; for their financial plans they need to seek an underwriter. T h e difference is that most people know when they need and can afford a house, but a life insurance program never appears to them as a problem. Getting the Facts. T h e first function of the underwriter in forecasting needs is to elicit all of the facts. If he is to be certain that his work is right, he must secure every pertinent piece of information about the man who wishes to plan for his beneficiaries. Let us consider then for a moment exactly what the underwriter ought to know about a given individual: 1. T h e names and dates of birth of the members of the family, including the breadwinner, as well as any dependents, present or future. 2. Does he own or rent his home; if rented, how much rent; if owned, in whose name—his, his wife's, or joint tenancy; what is the home worth; what are the terms and amount of any mortgage? 3. What other property does he have—real estate, stocks and bonds, cash, interest in his own business? What is the current value and incomeproducing capacity? Does he have a will, and if so, where and how does it dispose of the aforementioned property? Are there any trusts that he or others have created; if so, what are the details? As to his business, is he stockholder, partner, proprietor, or employee? Does his company provide him any pension or group insurance benefits? Is he eligible for Social Security, and if so, since when and at what rate of earnings? If he is a veteran of either World War I or II, what, if any, government benefits are available to him or his dependents?

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4. What is his earning power in terms of income, and is it expected to increase? What are his spending habits—how much does it cost to live, and what spread, if any, is there between his income and expenses? What are the possible inheritances from other sources for him or his dependents? Exactly what life insurance does he own—what kind, and to whom and how is it payable? 5. How much money does he owe on either long or short term commitments, and what further liabilities, such as taxes and administration expenses, will his estate have to meet before the beneficiaries will know what is left for their benefit? 6. And most important of all, what are his ideas as to what constitutes financial success for him under all circumstances; in other words, what is his ambition and what are his minimum objectives in behalf of himself and his dependents? Specifically, how much money will his family require each month through the years to meet the gradual rise in expenses while the children are growing up and until they are finally ready for college? And does he want to provide the children with a college education?

Not until the underwriter is armed with all of this information is he prepared to do a reasonably scientific job of forecasting the needs of beneficiaries. Like the medical specialist, who takes down every possible item of history so that he can diagnose and prescribe, the underwriter equipped with this information is now ready to go to work. Discovering and Clarifying the Problem. It is axiomatic that the first step in solving any problem is to recognize that it exists. Foresight is often no more than looking ahead into the future with imagination, through the glasses of past experience. Now, with all of the facts properly marshalled in front of him, the underwriter applies that imagination and experience to discover and set down the problems of the future, problems which may be prevented from becoming insoluble by action taken in the present. T h e fundamental problem of life is the need for income. As long as human beings must be fed, clothed, and sheltered, the bills arrive with unfailing regularity, and they must be met by income. There are only two sources of income—men at work, and money at work. Men can work only while they have life and health. Money at work, properly invested, will endure without regard to health or sickness, life or death. Hence, for practical

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purposes, personal earnings are temporary income; money at work is permanent income. The family unit is in one sense a business partnership, and in most cases each partner has his or her share of the work to do. But the division of labor is such that one partner is the "outside man" whose work brings in the income that supports the business, while the other partner is the "inside man" who runs the home, cares for the children, and in general makes it possible for the "outside man" to devote his full time and attention to producing that needed income. Moreover, if ultimate security is to be provided, as the normal depreciation of human life takes place, there must be a reserve set aside from every dollar of personally earned income, so that when the human machine is worn out, there will be capital to substitute permanent income for the temporary income of personal earnings. Therefore, it is obvious that the two basic questions from which all others stem in meeting the fundamental income problem of beneficiaries are: a. Will there be time enough in which to build capital enough to produce income enough when the moment arrives at which money at work must substitute for a man at work? b. If there is money enough, will it be secure against hazard and human frailty long enough to meet the needs of the beneficiaries dependent upon it?

Thus we study the facts to discover the ramifications of these two basic questions, in order to determine exactly what the problem of a particular individual may be. This brings the underwriter logically to the next step, which is solving the problem. SOLVING THE PROBLEM We have spoken of income from capital as being relatively permanent when compared with the temporary nature of personal earnings. But the grinding effect of taxes, which prohibit successive inheritance, combined with the low interest rates available from safely invested funds, make it impossible for the vast majority ever to hope to conserve their capital from one

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generation to another. Thus in most cases capital must be built up during the accumulative period of each generation, and dissipated during the dependency period. T h e underwriter's first test in planning for the beneficiaries' needs must be to determine the income that may be expected from the capital available, and if that should be inadequate, then the extent to which it must be supplemented from principal. For example, if we assume a given beneficiary has $25,000 of capital, after creditors' claims and taxes have been paid, we know that at 3 per cent interest the capital will produce $750 per year, or $62.50 per month. If we find that the beneficiary must have $200 per month to live upon, then we must take part from capital. Assuming interest to be at 3 per cent, we learn that at $200 per month, $25,000 will last for approximately twelve and a half years. Immediately the question arises as to whether the capital will then last as long as we need it. In this way do we promptly discover whether the funds are adequate to meet beneficiary needs. T h u s far we have talked about correlating all of the factors in an estate, but our primary concern here is the specific method by which we can apply the services of one kind of capital, namely, life insurance. For no other form of property is as secure or as ideally suited to the individual, and since life insurance has recognized its responsibility to provide the same security and trusteeship for the beneficiary as it has always had for the insured, it is the one means by which a plan can be made that is certain of fulfillment. Let us now turn our attention to the mechanics on the basis of which this marvelous device can be put to practical use through the application of the tools available, thereby providing trusteeship by contract. We will ignore all other items of estate, and assume that our planning is concerned only with Social Security benefits and with life insurance. OPTIONS OF S E T T L E M E N T Elsewhere in this volume 2 the history and development of the 2 See Richard C. Guest, "Development of Provisions for Optional Modes of Settlement," pp. 109 to 125. A larger number of options are described there, but some of them are not to commonly used.

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trusteeship options available in virtually all life insurance policies have been discussed. So let us here merely summarize the several fundamental options of settlement available as the tools in planning for beneficiary needs. T h e n we will study their application. T h e principal options are: 1. Interest Option: T o leave principal intact, paying to the beneficiary the interest income in monthly, quarterly, semiannual, or annual installments. A minimum rate is usually guaranteed, and in mutual companies will be increased by participation in any interest earnings of the company over the minimum guarantee. By common practice, money may be left for the lifetime of the primary beneficiary, or thirty years, whichever is the longer, and the beneficiary may either be prohibited from drawing principal or given full leeway. 2. Fixed Period Option: T o distribute principal, and the interest on the remaining undistributed principal, in regular installments over a stipulated period of time. Here again there is a guaranteed rate of interest included, and in mutual companies participation in any excess interest. T h e period of time may be anywhere from twelve months to thirty years. 3. Fixed Installment Option: T o distribute a specific amount in regular installments of both principal and interest, until the proceeds are exhausted. This is virtually the same as the second option, but makes the amount the constant and the time the variable. 4. Lije Income Option: T o distribute both principal and interest in such an amount as will pay income to the beneficiary for life. T h e rate depends upon the beneficiary's age and sex. The option may provide for termination of payments at the beneficiary's death, or for their continuation from original date through a minimum period of five, ten, fifteen, or twenty years, as may be elected. 5. Dual Life Income Option: T o distribute both principal and interest as in life income option above, but for the longer of two lives. A variation of this option, sometimes available, is to provide for continuation of three-fourths or one-half of the original amount of income to the last survivor of the two beneficiaries. Both of these life income options in mutual companies participate in excess earnings during the period certain. It is obvious that either through one or a combination of these options almost any conceivable need can be met. T h e only limitations are (1) that if any discretion is to be exercised, it must be the discretion of the beneficiary, as the insurance company

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cannot make changes in a contract when one party to the contract has died, and (2) such limitations as various companies may place upon even the beneficiary's discretion when it is deemed that such exercise might be inimical to the best interests of the company. Before we can complete our brief examination of the tools that are available, we must consider the death benefits under Social Security. Not all people are covered, but there are enough to make Social Security a factor in a large percentage of cases. Death benefits are so substantial that they must be taken into account when planning for the beneficiary. Let us therefore consider them briefly. SOCIAL SECURITY Neither the insured nor his beneficiary directly controls the benefits from Social Security. At death, the family of any person covered will receive an income only as follows: a. T o the eighteenth birthday of the youngest child. During this period the benefit is payable in part to the widow, and in part to the child, but even the part to the widow is contingent upon the child's age. b. T o the widow after she has reached her sixty-fifth birthday. In each instance, benefits are payable only if the person entitled to them is not working in covered employment.

These dependency benefits, in general, are based upon the average earnings and the number of years in which earnings were taxed before the death of the worker. The amounts, however, are heavily loaded in favor of low wage or salary workers. For example, if average earnings of a worker over a ten-year period had been $150 per month, a widow and one child surviving would receive benefits of $41.25 per month. If earnings had been $250 or over per month, the same family would receive $55.00 per month. Tables are available from which actual amounts can readily be calculated. When the youngest child reaches eighteen, the income ceases, not to begin again until the widow reaches sixty-five, when she will again receive an income for life equal to the same amount that she received for her part of the benefit during the period that the children were under age eighteen. For our purposes we now have the raw materials. Let us next

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examine the factors which constitute the problem for the solution of which we propose to use these tools. FAMILY INCOME PERIODS In planning to underwriter must "outside man" in nificant periods to

meet the future needs of beneficiaries, the recognize that in case of the death of the the family partnership, there are three sigbe considered. These are:

1. The readjustment period during which the family rearranges its life to a lower income than existed while the insured lived. This may be accomplished in a year or two, but seldom should be shorter. Going down a flight of stairs is slower but safer than jumping down an elevator shaft. 2. The dependency period, during which the children are at home or completing their education, and the family unit must be maintained with the advantage of the mother's care and guidance. The larger the family, and the greater the equipment in educational advantages to be given the children, the greater will be the amount of money required. 3. The widow's life income period, which in turn has two divisions: (1) The "youth of old age"—that period from a widow's early fifties into her sixties, when ordinarily her children have married and left home. She is still very active physically, yet she is relieved of the responsibility of maintaining the home for her children. During this period she may well seek outside employment, not only to supplement her income, but also to occupy her time. (2) The "old age period," after which the physical being slows down, gainful employment is no longer open, and although financial needs may be smaller, illnesses and the need for care, together with the inability to supplement income, may well make the need for income from capital greater than in the earlier years.

Throughout any of these periods, life is always subject to the hazard of unexpected emergencies, and if tragedy is to be avoided, emergency funds must be available. When an underwriter is helping a client to make financial plans for himself and his family, he brings these fundamental income needs to the client's mind. Together they determine what kind of a "house of protection" they wish to build. It then becomes the underwriter's function to define the exact mechanics through which the plan will be carried out. We have seen the tools that are available. We have seen the fundamental needs that must be filled. Let us now break down the problem into its component parts:

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1. We must determine exactly what the needs are within our general pattern. 2. We must determine how much capital is required to meet these needs. 3. We must determine the method by which this capital is to be made available. 4. We must arrange the mechanics of trusteeship through which the capital is to be converted into income at the time it is needed. 5. We must do all of these things in the face of the fact that we do not know whether the plan will have to go into effect tomorrow, or many years hence. Obviously, figures will differ in every case because of the variations in all of the factors affecting any individual family. It may, however, be easier to illustrate the mechanics of attaining the plan desired by taking a specific case than by any other method. D E M O N S T R A T I N G T H E PROCEDURE As an example, then, let us take an hypothetical set of facts: Assume a man age 35 with a 34-year-old wife, a son age 7, and a daughter age 5. He earns over $7,500 per year, has worked in "covered employment" for ten years at $200 per month average; he has no capital other than life insurance, and has determined the needs of his family if he were to die tomorrow to be: Cash to pay current bills—$3,000 An emergency reserve for unexpected contingencies—$5,000 An income while both children are at home of $270 per month An income after the son reaches 18, but while the family is still a unit, of not less than $250 per month Additional funds to educate his children through high school and college in the amount of $4,000 for each An income during his wife's "youth of old age," after the children are educated, of $100 per month An income for life after his wife is in old age, starting at 65, of $130 per month. Let us see how these needs look when put down on a work sheet which will allow us to determine not only how much money will be needed, but also the mechanics of arranging to meet the needs. Determining the Need. On the accompanying work sheet we first trace the ages of our beneficiaries to determine how many

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years are represented by each period of need. T h e dependency period is broken into as many columns as are needed to reflect variations that will occur in the amount of income available from various sources. Now we are prepared to insert the amounts of money desired in each of these periods, as well as the special-purpose capital wants. From these we then subtract the funds provided by Social Security in order to determine the needs that must come from capital. Now we know exactly what our capital must provide. T h e fact that income needs are larger in the early period means, of course, that during this period we propose to use up some principal. We are already committed to the theory that our purpose is to use up all of our principal in the course of the generation for which we are planning, but to do so on a scientific basis, so as to be assured that it will last as long as the need lasts. If this were not so, if, in other words, there were enough money to provide all needed income from interest on capital, we would have no problem at all. Determining the Amount of Capital Needed. Our problem is, first, to determine how much principal is needed; second, to set up the machinery by which the determined amount will actually meet the desired objectives. How then to proceed? We discover from our work sheet that the income to the wife from capital during the period after the dependency period must be $100 per month. Annuity tables show us that for a life income ten years certain to a woman at or near 50, income approximates $4.50 to $5.00 per month for each $1,000 of capital. So we know that by the time the widow reaches this age we must still have in the neighborhood of $20,000 of capital intact. In the interim, this capital will earn interest, if at 3 per cent, of about $2.50 per month for each $1,000. So in the instant case we discover that the increase in income when changed from the interest only to the annuity option will approximate the decrease when Social Security incomes cease. Noting that the wife is age 47 when Social Security stops, we decide to plan this increase to coincide. Thus, by planning for $22,000 of insurance in the "A" Life Insurance Co. to be held at interest for a period of thirteen years, then changed to an annuity,

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we have provided $55 per month of income in the first two columns and $100 per month for life thereafter. The remaining deficiency then approximates $145 per month for the sixteen-year dependency period. Consulting option settlement tables, we learn that it takes $23,000 to produce this income. The income part of our plan is then complete. Cash, readjustment, emergency and educational funds are entered in the first column to give the total of capital needed to complete the plan. Determining the Method of Acquiring the Capital. In the instant example, for purposes of simplicity, we have assumed insurance available from three different companies. In the left hand column we have entered the contracts available in those companies in the several groups in such a way as to utilize the policies with highest guaranteed interest factors for the longest deferred benefits. The Mechanics of Converting the Capital to Income. We now know how much capital we must have in each block to complete the plan, and must instruct the various insurance companies to prepare amendments to their contracts by virtue of which the plan will be in effect. The work sheet was the means by which we were able to determine the correct amounts. Let us see next how we want the composite plan to look when it is finished, and then see exactly how the insurance companies should be instructed. It will be easier to understand how instructions are to be given if we take the work sheet figures and move them over onto a simple diagram that shows the result of our plan. In the accompanying diagram we are dealing with the family as a unit, assuming the widow will survive. We will take up separately the arrangements for the children as contingent beneficiaries if the wife should not live. Total Principal Item 1. Cash for final expenses Item 2. Reserve for emergency. Balance

$61,000

$3,000 5,000

8,000 $53,000

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BENEFICIARY IN U F E INSURANCE Distributed as follows: A

B

C

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T h e following is a digest of how the companies would be instructed: Item 1. $3,000 cash for expenses, payable to wife, to be held under interest option with right to withdraw all or any part at any time. Item 2. $5,000 emergency funds, payable to wife, to be held under interest option with right to withdraw or to convert to any other option, all or any part at any time. Block A. $22,000 life income funds, payable to wife, to be held under interest option with or without the right of withdrawal (depending upon the attitude of the insured) and with the privilege to convert to the annuity option in such number of installments certain as the beneficiary may elect, at any time after attaining the age of 47. Interest on the principal produces not less than $55 per month, and if the principal is converted to an annuity at 47, the income will be $100 per month. Block B. $23,000 dependency period extra income needed, payable to wife, to be held at interest with privilege to beneficiary to convert to fixed installment option in such number of installments as will not exhaust proceeds before the year in which she attains age 50, and with further privilege to convert any unused portion to the annuity option at 50. Thus, if the plan comes into operation this year, the period will be sixteen years and the widow's income will be $145 per month. If the plan should commence to operate eight years from now, the widow could still get her $145 per month for the remaining eight years without exhausting anywhere nearly as much as one-half of the principal. Any portion remaining could serve either to leave a larger estate to the children, or to increase the widow's income after the dependency income is exhausted. Block C. $8,000 educational funds, payable to wife to avoid complication of guardianship for the minor children, to be held at interest until each child reaches college age, then to be paid as wife may elect over a period of not less than four years for each child. Providing for Contingent Beneficiaries. Sound practice requires the naming of contingent beneficiaries wherever possible, and great care should be exercised to avoid inadvertent maladjustments. With such funds as are intended to meet expenses of

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the estate, it may be well to have the estate itself be contingent beneficiary (to prevent complications with the probate court if children are minors), but as to other funds, it is perhaps even more important to have the advantage of trusteeship than it was for the wife if living. Where there are children, or where there may be children in the future, unless prevented from doing so by company practice or by some other cause, it is always well to include hereafter born children along with those existing. Again, since it may be in the distant future that final settlement is made under these option agreements, generally speaking it is well to provide for settlement to children on a share and share alike or survivor basis, except that if any child dies leaving children, his children should receive his share. W i t h these thoughts in mind, we would include in our instructions to the insurance companies, in the case being used as an example, that in the event of the wife's death either before or after the insured, while there are still funds on deposit with the company, the following should prevail: Item 1. $3,000 cash expense fund, to go to the estate of the last survivor of the insured and his wife. This is money for expenses that we want to keep out of the hands of minor children. Item 2. $5,000 emergency fund, to go to children, share and share alike or survivor, but if any dies leaving issue, then his share to his issue, entire sum to be held at interest with right to withdraw. Block A. $22,000 life income fund—same sequence as Item 2. If wife should survive and convert to annuity option, the income should continue to children until the period certain expires. If funds are still on interest when the wife dies, then the interest should be continued in the same manner to children, possibly allowing withdrawal of one-half the principal at 25, the balance at 30. Block B. $23,000 dependency income fund—same sequence as Item 2. If funds on interest option, the same privileges of conversion should be provided to the children as to the wife. If the wife has already converted, the income should be continued on the same basis to the children. Block C. $8,000 educational funds, to go specifically one-half

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to each child, or all to survivor, and to be held at interest until age 17 or 18, at which time, upon proof of matriculation in an accredited college or university, the proceeds should automatically be paid in monthly installments over the succeeding four years. Here, then, we have demonstrated the simplicity, flexibility and certainty of the marvel of trusteeship by contract, made possible through no other means than life insurance, for the purpose of serving the most fundamental of human needs. Here, too, we have shown how important is the function of sound planning in advance for the beneficiaries' needs. Guesswork is reduced to a minimum and men can say with certainty, "There, at least that much is done." Furthermore, it is clear that only by such advance planning is it possible to determine the correct amounts of principal that are needed. Certainly it is shown that capital, in itself, is of no consequence. W h a t really matters is, what the capital will do in terms of income. PROBLEMS IN A R R A N G I N G O P T I O N S It is not possible here to do more than suggest some of the problems that the underwriter must solve in attaining these apparently simple results. They fall generally into the following categories: 1. A full recitation of the order of descent desired in case of the death of any beneficiary. 2. Avoidance of accidental inequities and failure of intent through the possibility of loans against, or lapse of, particular policies, thereby unintentionally changing the amounts in various blocks. 3. Search for the most liberal options for the funds intended to be distributed over the longest periods of time. 4. Reconcilement and coordination of the differences in practice among various companies where the same insured owns contracts in several companies. 5. Consideration of the effect of taxation upon insurance proceeds settled under various options. In all of these problems except the last, the mere suggestion that there is a problem will usually show the way to its correct solution. In each such problem, the facts of the individual case

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will control, so it would not be worthwhile here to spend more time on them. But the tax problem, though a constantly changing one, does have a general effect and should be considered. T H E EFFECT OF TAXES 3 There are only three principal taxes which may directly affect the life insurance policyholder or his beneficiaries: The Estate and/or Inheritance Tax—whether Federal or State The Federal Gift Tax The Federal Income Tax

The Estate and/or Inheritance Tax. Only a few states levy either an estate or an inheritance tax upon the proceeds of life insurance when made payable to a named beneficiary other than the estate. But the Federal Government includes life insurance as a taxable item, even though the proceeds are payable to a named beneficiary and hence do not pass through the probated estate. The tax is imposed as a capital levy against all property, including life insurance, to the extent that the total value exceeds sixty thousand dollars. Virtually the only circumstances where this tax does not apply is in cases where the insurance is bought, owned, and paid for by someone other than the insured. Ordinarily the tax is levied against the general estate, but in most cases the executor can call upon the insurance beneficiaries for their share of the tax. Here, again, is a need for flexibility, because an airtight selection of options may cause some embarrassment to the beneficiaries. Moreover, insurance companies have in certain circumstances been required to release such portion of the proceeds as are necessary to pay the tax. 4 It is important, therefore, to have this tax definitely in mind when planning an estate that exceeds the exemption. The Gift Tax. The federal gift tax (some states also have such a tax) is imposed on any transfer over certain limits between two living people. Under it, an insurance policy transferred from one person to another may be the subject of tax if the value when transferred exceeds the allowed limits. Gift tax rates are seventy3 For a fuller discussion of the tax situation, see Bernard G. Hildebrand, "Taxation of Life Insurance Polio· Proceeds," pp. 186 to 211. * Supra. See pp. 203 to 206.

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five per cent of estate tax rates, but usually the actual tax payable is much less, primarily because a gift comes off the top of the estate tax brackets and into the bottom of the gift tax brackets. But the "premium payment" test currently applicable under the federal estate tax materially restricts any tax advantages which might be derived from a gift of life insurance.5 Unintended liability for gift tax on insurance proceeds may arise where a wife owns insurance on her husband's life but makes the policy payable to her children. In this case, when the insured dies, the face of the policy becomes a gift from the mother to the children at the instant of her husband's death. Thus, an inadvertent tax might be due in a case where the owner is other than the insured and a third person is the beneficiary. The Federal Income Tax. The federal income tax (some states also have such a tax), formerly a problem only of the wealthy, now touches the pocketbooks of almost all ordinary policyholders and their beneficiaries. It is noteworthy that proceeds of an insurance policy, whether paid in one sum or installments, are not considered taxable income to the beneficiary. When proceeds are held at interest only, the interest income is considered taxable, but payments under other income options are not. Therefore, the use of these latter options often produces substantial tax economies. All three of these taxes are complicated subjects in themselves, with too many ramifications in their effect upon the beneficiary to include within the scope of this discussion. They are covered in detail elsewhere, and mentioned here in passing only to show that no planning can be complete without considering their effect. T H E INSURED AS A BENEFICIARY OF LIFE INSURANCE So far, our discussion has been entirely devoted to the death beneficiaries of life insurance. It is natural that the dependents at death should be thought of as the only beneficiaries, because life insurance produces over eighty per cent of the funds available to provide for the support of surviving dependents. But 5 Supra. See pp. 194 to 209.

230

BENEFICIARY IN LIFE INSURANCE

statistics show that American life insurance companies have paid at least a dollar to living insureds for every dollar they pay in death benefits. Therefore, it is a mistake not to include the insured in considering the beneficiaries of life insurance. He may, in fact, be an important beneficiary of his own insurance. Physical life often extends beyond economic life. T h e insured must therefore make his plans so that if he lives his insurance capital will do for him what he expects it to do for his family if he does not live. He will be as much of a dependent when he runs beyond his period of earnings as will be his family if he dies before that. T h e same options of settlement available to death beneficiaries are usually also available to the insured with respect to the cash values he has built during his lifetime. Therefore, to make his planning complete, he must arrange to have his values, if he should survive, attain a sum sufficient to meet his needs at retirement. Furthermore, he is confronted by the impossibility of having adequate income at retirement from interest alone. Even at 3 per cent it takes $80,000 to yield as little as $200 per month, while if the captial is annuitized, starting at age 65, only a little over $30,000 would produce $200 per month. T o complete our planning for the beneficiary if, in the case we have heretofore used as an example, he were to establish the objective of having an income of $200 per month for his own lifetime after 65, he would need to own insurance that would have cash values of approximately $30,000 available for use under the annuity option at his age of retirement. SIGNIFICANCE OF G U A R A N T E E D INCOMES By reason of its self-completing feature, life insurance has become well accepted as the only means by which men can be sure that shortness of time will not defeat their plans. But of equal importance to assure completion of plans is the factor of guaranteed income. Life insurance options of settlement are the only known means of guaranteeing income. Even government bonds may be recalled or reach maturity without a corresponding security being offered in their stead. Only through life insurance is it possible

PROGRAMMING T O MEET NEEDS

231

to procure an assured income geared to the convenience of the buyer instead of the seller. Why is this so important? And is its significance not minimized by fluctuations in the buying power of the dollar? During a man's normal earning years, his chief source of income is his personal earning power. As long as he has that, if his investment plan ceases for a time to pay him income, he can live on what he earns. But when, because of death or retirement, that earning power is gone, the return on his capital becomes essential. Income must be there every month on time. At this point, then, a guarantee of income is all-important, even though its buying power does not remain constant. And there are times when the guaranteed income may be both an inflation and a deflation hedge. For example, let me mention an actual case. A man died in 1918, leaving a widow and four young children. He had accumulated a fair sized estate in various equities, and had buttressed this estate by establishing guaranteed incomes for life from his insurance, in an amount sufficient to provide minimum living needs. From 1918 through 1929 these insurance dollars represented no more than twenty-five per cent of the total income from the estate. Through those years they were nice to have but not vital. T h a t was a period of high prices. T h e n from 1930 to 1940, as the nonguaranteed income from equities disappeared, the same number of dollars from the guaranteed life insurance incomes became eighty per cent of the total income to the family. Those dollars then became vital living dollars. But here is the significant point: Because those dollars were adequate to meet the minimum needs, it was not necessary to liquidate equities at the low point of the market, selling perhaps five dollars worth of property to procure a dollar to live on. In consequence, as income has again returned on the equity dollars, the family involved still owns those equities which otherwise would have been sold. Hence it is clear that the factor of guarantee in life insurance options is almost as important in planning for the needs of beneficiaries—be they death beneficiaries, or the insured as an old man—as is the principle of the life insurance method of creating capital itself.

232

BENEFICIARY IN LIFE INSURANCE T H E NEED FOR T H E U N D E R W R I T E R IN PLANNING FOR BENEFICIARIES

Throughout our discussion we have made frequent reference to the underwriter as the architect of plans for life insurance beneficiaries. T h e question may properly be asked as to why it is necessary for an underwriter to serve in this capacity. Why couldn't the insurance owner ponder these simple principles himself, making and executing his own plans by use of the tools which are readily available to him? T h e same question could be asked of any other professional man—the doctor, the lawyer, the architect, or the engineer. There is little of human knowledge that is not already written down on paper for those to acquire who would learn. But the sum total of human knowledge is far beyond the capacity of any one mind to encompass. T h e man who is sick could die before he could find the book that would tell him what his malady and the cure for it might be, while the trained physician, through his specialized experience, could recognize and cure it in a matter of hours or days. So it is with man's financial plans; life is too short for each person to find the right way by trial and error. Indeed, the symptoms of financial illness are frequently not even manifest to the untrained eye until too late to effect a cure. Often the competent underwriter must not only be skilled in the methods of solving problems, but must also be able to take men in their imaginations into the future, to foresee risk, and by proper planning to prevent catastrophe. A risk is the danger that some misfortune may occur; a catastrophe is the actual happening of the event. No man has the final power over the risk of death— either physical or economic—but thoughtful planning can prevent economic death from occurring without a substitute source of income.

Appendix A ATTITUDE OF STATES TOWARD ASSIGNMENT*

1. Right of assignee under a Collateral Assignment made without the consent of the beneficiary is superior to that of the beneficiary (majority rule): Alabama: Taylor v. Southern Bank and Trust Company, 227 Ala. 565, 151 So. 357 (1933). California: Morrison v. Mutual Life, 15 Cal. (2d) 579, 103 P. (2) 963 (1940), Sec. 10173 of California Insurance Code. Florida: Moon v. Williams, 102 Fla. 214, 135 So. 555 (1931); Rawls v. Penn Mutual, 253 Fed. 725 (1918). Georgia: Baldwin v. Atlantic Joint Stock Land Bank, 189 Ga. 607, 7 S.E. (2) 178 (1940). Illinois: Equitable Life v. Mitchell, 248 111. App. 401 (1927). Iowa: Potter v. Northwestern Mutual, 216 la. 799, 247 N.W. 669 (1933). Kansas: Elmore v. Continental Life, 131 Kan. 335, 291 Pac. 755 (1930). Michigan: Lalonde v. Roman Standard Life, 269 Mich. 330, 257 N.W. 834 (1934). Minnesota: Janesville State Bank v. Aetna Life, 200 Minn. 312, 274 N.W. 232 (1937). Mississippi: Bank of Belzoni v. Hodges, 132 Miss. 238, 96 So. 97 (1923). Missouri: Missouri State Life v. California State Bank, 202 Mo. App. 347, 216 S.W. 785 (1919); McKinney v. Fidelity Mutual Life, 270 Mo. 305, 193 S.W. 564 (1917). New Hampshire: Barbin v. Moore, 85 N.H. 362, 159 Atl. 409 (1932). New York: Davis v. Modern Industrial Bank, 279 N.Y. 405, 18 N.E. (2) 639, 135 A.L.R. 1035 (1939). Pennsylvania: Lemley v. McClure, 122 Pa. Super. 225, 185 Atl. 878 (1936); Shay v. Merchants Bank ir Trust Company, 335 Pa. 101, 6 A. (2) 536 (1939). South Carolina: Antley v. New York Life, 139 S.C. 23, 137 S.E. 199 (1927). Texas: Farracy v. Perry, 12 S.W. (2) 651 (1929). • In states for which no case is cited, none was found which clearly supports the proposition. In some states additional cases supporting the same point have been omitted.

233

234

BENEFICIARY IN LIFE INSURANCE

Vermont: Belknap v. Northwestern Mutual, 108 Vt. 421, 188 Atl. 897 (1937). Washington: Massachusetts Mutual v. Bank of California, 187 Wash. 565, 60 P. (2) 675 (1936). See also Revised Statutes, Sec. 7230-1, Subsec. 2. West Virginia: Act approved March 13, 1947 (Senate Bill 226). This Act, I believe, was intended to cover not only Collateral but Absolute Assignments; but, in my opinion, its application is limited by its wording to Collateral Assignments. Wisconsin: Beck v. First National Bank, 238 Wise. 346, 298 N.W. 161 (1941); Oldenburg v. Central Life, 242 Wise. 620, 9 N.W. (2) 113 (1943). 2. Right of absolute assignee without change or consent of beneficiary held superior to that of beneficiary: Iowa: Petty v. Mutual Benefit Life, 235 la. 455, 15 N.W. (2) 613 (1944). Kentucky: Lockett v. Lockett, 26 Ky. L. 199, 80 S.W. 1152 (1904). 3. A Collateral Assignment is a change of beneficiary to the extent necessary to protect the collateral assignee: Florida: Moon v. Williams, 102 Fla. 214, 135 So. 555 (1931). Georgia: Baldwin v. Bank, 189 Ga. 607, 7 S.E. (2) 178 (1940). Illinois: Penn Mutual v. Forbes, 200 111. App. 441. Iowa: Potter v. Northwestern Mutual, 216 la. 799, 247 N.W. 669 (1933). Mississippi: Bank of Belzoni v. Hodges, 132 Miss. 238, 96 So. 97 (1920). 4. An Absolute Assignment is a change of beneficiary: Kansas: Turner v. Prudential, 150 Kan. 899, 96 P. (2) 641 ( 1 9 3 9 ) - ( b u t beneficiary was the insured's estate). Kentucky: Lockett v. Lockett, 26 Ky. L. 199, 80 S.W. 1152 (1904). 5. Minority Rule—An assignment without a change of beneficiary or consent of the beneficiary does not affect the interest of the beneficiary: Colorado: Johnson v. New York Life, 56 Colo. 178, 138 Pac. 414 (1913); Muller v. Penn Mutual, 62 Colo. 245, 161 Pac. 148 (1916). Louisiana: Citizens Bank v. Knight, 15 La. App. 62, 130 So. 270 (1930); Douglass v. Equitable Life, 150 La. 519, 90 So. 834 (1922). Massachusetts: Finegan v. Prudential, 300 Mass. 147, 14 N.E. (2) 172 (1938); Goldman v. Moses, 287 Mass. 393, 191 N.E. 873 (1934). See also 130 A.L.R. 1040; 60 A.L.R. 191; 38 A.L.R. 109; 6 Couch, Cyclopedia of Insurance Law, Sec. 1458 (p); and 2 Appleman, Insurance Law and Practice, Sees. 1196 and 1211. As to right of beneficiary to subrogation against insured's estate where policy has been assigned as collateral, see 83 A.L.R. 77; Barbin v. Moore, 85 N . H . 362, 159 Atl. 409 (1932); and Smith v. Coleman, 184 Va. 259, 35 S.E. (2) 107 (1945). 6. U n d e r both the majority and minority rule, the assignee prevails over the beneficiary if at the time of the assignment the beneficiary is the insured or his estate:

APPENDIX A

235

Connecticut: Neary v. Metropolitan Life, 92 Conn. 488, 103 Atl. 661 (1918). Indiana: Oleska v. Kotur, 113 Ind. App. 428, 48 N.E. (2) 88 (1943). Kansas: Shawnee State Bank v. Royal Union Life, 127 Kan. 456, 274 Pac. 132 (1929). Maryland: Reliance Life v. Bennington, 142 Md. 390, 121 Atl. 369 (1923). Massachusetts: Abbruzise v. Sposata, 306 Mass. 151, 27 N.E. (2) 722 (1940). Nebraska: Dvorak v. Kucera, 130 Neb. 341, 264 N.W. 737 (1936). New Jersey: Metropolitan v. Poliakoff, 123 N.J.E. 524, 198 Atl. 852 (1938). South Carolina: Cook v. Commercial Casualty, 160 F. (2d) 490 (C.C.A. 4, 1947).

Appendix Β ASSIGNMENT OF LIFE INSURANCE POLICY AS COLLATERAL (Form approved by the Bank Management Commission of the American Bankers Association.—See page 36.

A.

For Value Received the undersigned hereby assign, transfer and set over to of its successors and assigns, (herein called

the "Assignee") Policy No. issued by the

(herein called the "Insurer") and any supplementary contracts issued in connection therewith (said policy and contracts being herein called the "Policy"), upon the life of of and all claims, options, privileges, rights, title and interest therein and thereunder (except as provided in Paragraph C hereof), subject to all the terms and conditions of the Policy and to all superior liens, if any, which the Insurer may have against the Policy. T h e undersigned by this instrument jointly and severally agree and the Assignee by the acceptance of this assignment agrees to the conditions and provisions herein set forth. B. It is expressly agreed that, without detracting from the generality of the foregoing, the following specific rights are included in this assignment and pass by virtue hereof: 1. T h e sole right to collect from the Insurer the net proceeds of the Policy when it becomes a claim by death or maturity; 2. T h e sole right to surrender the Policy and receive the surrender value thereof at any time provided by the terms of the Policy and at such other times as the Insurer may allow; 3. T h e sole right to obtain one or more loans or advances on the Policy, either from the Insurer or, at any time, from other persons, and to pledge or assign the Policy as security for such loans or advances; 4. T h e sole right to collect and receive all distributions or shares of surplus, dividend deposits or additions to the Policy now or hereafter made or apportioned thereto, and to exercise any and all options contained in the Policy with respect thereto; provided, that unless and until the Assignee shall notify the Insurer in writing to the contrary, the distributions or shares of surplus, dividend deposits and additions shall continue on the plan in force at the time of this assignment; and 5. T h e sole right to exercise all nonforfeiture rights permitted by the terms of the Policy or allowed by the Insurer and to receive all benefits and advantages derived therefrom. C. It is expressly agreed that the following specific rights, so long as the

APPENDIX Β

237

Policy has not been surrendered, are reserved and excluded from this assignment and do not pass by virtue hereof: 1. The right to collect from the Insurer any disability benefit payable in cash that does not reduce the amount of insurance; 2. The right to designate and change the beneficiary; 3. The right to elect any optional mode of settlement permitted by the Policy or allowed by the Insurer; but the reservation of these rights shall in no way impair the right of the Assignee to surrender the Policy completely with all its incidents or impair any other right of the Assignee hereunder, and any designation or change of beneficiary or election of a mode of settlement shall be made subject to this assignment and to the rights of the Assignee hereunder. D. This assignment is made and the Policy is to be held as collateral security for any and all liabilities of the undersigned, or any of them, to the Assignee, either now existing or that may hereafter arise in the ordinary course of business between any of the undersigned and the Assignee (all of which liabilities secured or to become secured are herein called "liabilities"). E. T h e Assignee covenants and agrees with the undersigned as follows: 1. That any balance of sums received hereunder from the Insurer remaining after payment of the then existing Liabilities, matured or unmatured, shall be paid by the Assignee to the persons entitled thereto under the terms of the Policy had this assignment not been executed; 2. That the Assignee will not exercise either the right to surrender the Policy or (except for the purpose of paying premiums) the right to obtain policy loans from the Insurer, until there has been default in any of the Liabilities or a failure to pay any premium when due, nor until twenty days after the Assignee shall have mailed, by first-class mail, to the undersigned at the addresses last supplied in writing to the Assignee specifically referring to this assignment, notice of intention to exercise such right; and S. That the Assignee will upon request forward without unreasonable delay to the Insurer the Policy for endorsement of any designation or change of beneficiary or any election of an optional mode of settlement. The Insurer is hereby authorized to recognize the Assignee's claims to rights hereunder without investigating the reason for any action taken by the Assignee, or the validity or the amount of the Liabilities or the existence of any default therein, or the giving of any notice under Paragraph E (2) above or otherwise, or the application to be made by the Assignee of any amounts to be paid to the Assignee. The sole signature of the Assignee shall be sufficient for the exercise of any rights under the Policy assigned hereby and the sole receipt of the Assignee for any sums received shall be a full discharge and release therefor to the Insurer. Checks for all or any part of the sums payable under the Policy and assigned herein, shall be drawn to the exclusive order of the Assignee if, when, and in such amounts as may be, requested by the Assignee. The Assignee shall be under no obligation to pay any premium, or the principal of or interest on any loans or advances on the Policy whether or not obtained by the Assignee, or any other charges on the Policy, but any such amounts so paid by the Assignee from its own funds, shall become a part of the Liabilities hereby secured, shall be due immediately, and shall draw interest at a rate fixed by the Assignee from time to time not exceeding 6% per annum. T h e exercise of any right, option, privilege or power given herein to the Assignee shall be at the option of the Assignee, but (except as re-

238

I.

J.

K.

BENEFICIARY IN LIFE INSURANCE tricted by Paragraph E (2) above) the Assignee may exercise any such right, option, privilege or power without notice to, or assent by, or affecting the liability of, or releasing any interest hereby assigned by the undersigned, or any of them. T h e Assignee may take or release other security, may release any party primarily or secondarily liable for any of the Liabilities, may grant extensions, renewals or indulgences with respect to the Liabilities, or may apply to the Liabilities in such order as the Assignee shall determine, the proceeds of the Policy hereby assigned or any a m o u n t received on account of the Policy by the exercise of any right permitted under this assignment, without resorting or regard to other security. In the event of any conflict between the provisions of this assignment and provisions of the note or other evidence of any Liability, with iespect to the Policy or rights of collateral security therein, the provisions of this assignment shall prevail. Each of the undersigned declares that no proceedings in bankruptcy are pending against him and that his property is not subject to any assignment for the benefit of creditors.

Signed and sealed this

day of

, 19.

_(L.S.)

Witness

Insured

or

Owner

Address .(L.S.) Witness

Beneficiary Address

Appendix C SUMMARY OF CASES In preparing this lecture the writer has examined (all too superficially, to be sure) about eight hundred cases. Of these, about 250 are cited. T h e distribution of the cases examined, by jurisdiction and period in which decided, is shown in the following table: Jurisdiction N.Y. Pa. Mass. Ohio Tenn. Ky. 111. Ala. Ia. Miss. Calif. La. Wis. Mo. Minn. N.J. Ark. Fla. Tex. Wash. Ga. Md. N. H. N. C. All others 1 Total

1847 1896 41 6 7 9 2 1 7 6 1 5 1 0 0 0 3 3 0 3 1 1 2 2 3 2 15 121

1897 1906 16 5 2 1 5 6 3 2 7 4 4 1 4 3 1 1 0 0 0 1 4 2 0 2 22 96

1907 1916 13 10 6 4 5 7 1 8 1 3 0 3 2 2 1 1 1 2 0 4 0 1 2 0 7 84

1917 1926 11 5 4 1 2 5 0 0 4 4 4 3 1 5 6 2 1 4 0 1 3 2 0 3 28 99

1927 1936 58 22 7 5 9 4 7 4 8 5 6 5 6 3 3 4 11 6 10 3 2 3 4 3 35 233

1937 1946 75 10 4 8 3 3 7 2 1 0 6 7 4 4 2 5 2 0 2 3 1 1 1 0 19 170

Total 214 58 30 28 26 26 25 22 22 21 21 19 17 17 16 16 15 15 13 13 12 11 10 10 126 803

ι The other jurisdictions were Kans. 9, Neb. 9, Okla. 9, Va. 9, Ind. 8, Me. 8, S.C. 8, S.D. 8, Mich. 7, Colo. 6, Conn. 6, N.D. 5, Ore. 4, R.I. 4, Dist. of Col. 3, Nev. 3, Del. 2, Utah 2, W.Va. 2, Ariz. 1, Ida. 1, Mont. 0, New Mex. 0, Vt. 0, and Wyo. 0, Tax Court, Court of Claims, etc. 12.

T h e search for cases has not been exhaustive nor has the basis of selection been wholly consistent. But while no great significance can be 239

240

BENEFICIARY IN LIFE I N S U R A N C E

claimed for these figures, it is interesting to note the concentration of cases following the 1929 collapse paralleling a similar concentration in the enactment of "55-a" statutes (see note 38 of preceding lecture). The number of cases for the 1927-36 decade was: 1927-14; 1928-20; 1929-18; 1930-12; 1931-16; 1932-28; 1933-25; 1934-36; 1935-33; 1936—31. The number continued relatively high well into the next decade largely because of the volume of New York cases, perhaps resulting from the enactment there of Sec. 55-b in 1934, Sec. 55-c in 1935, and Sec. 166 in 1939. But the average number of reported cases each year during the last four years of the 1937-46 decade was down again to 12, approaching the predepression level.

Appendix D BLANK LIFE INSURANCE COMPANY

PLANNED SECURITY Policy Number Insured The death benefits of the above numbered policy or policies shall be settled as provided in this agreement. Q Pay clean-up fund $ to primary beneficiary designated below, if living, otherwise to (Do n o t designate m i n o r s )

the insured's executors or administrators, and settle the remaining death benefits as follows. Designation of Beneficiary Primary Beneficiary (In accordance with Section I below) First Contingent Beneficiary (In accordance with Section I I below) Second Contingent Beneficiary (In a single sum) Final Beneficiary—The execu- Q last to die among the insured and beneficiary hereunder in a tors or administrators of the: single sum.

•

Section I Settle with primary beneficiary as follows: 1. • Option Β until and thereafter as indicated in 2 below. During said period: f~| the company shall pay the beneficiary •

the beneficiary may elect settlement under any monthly installment option, the monthly payment elected not to exceed

?

_

__

_·

2. Q Option A, the primary beneficiary to have the right to elect: [ j Any other option Q Only option Q T h e monthly payment under any elected option shall not exceed $ I I Option C years. I I Option D $ per mo. • Option E years certain. 241

242

B E N E F I C I A R Y I N LIFE

INSURANCE

3. T h e primary beneficiary may Q Increase monthly payments hereunder up to $ • Make withdrawals up to 5

per mo.

Section II Settle with first contingent beneficiary as follows: 1. • Option Β until and thereafter as indicated in 2 below. During said period: Q the company shall pay each beneficiary

2. •

Q each beneficiary may elect settlement under any monthly installment option, the monthly payment elected not to exceed $ · Option C years.

Π Option D § per month to Q each beneficiary Q beneficiaries as a group. f~] Option E years certain. Q Pay in a single sum. Q If the primary beneficiary dies after the insured while the plan of settlement hereunder is Option C, D or E, pay to beneficiary the remaining installments certain as they fall due, in lieu of plan provided in this Section II. 3. A first contingent beneficiary may: Q Increase monthly payments hereunder up to $ per mo. Q Make withdrawals up to $ DEATH BENEFITS Death benefits, sometimes referred to herein as "benefits," are all the proceeds of a policy, including any dividends, due upon proof of the death of the insured, increased by any accidental death benefits, but shall not include benefits payable under a premium paid in advance agreement or under a mortgage retirement or family security agreement. The term "benefits" shall include interest added to the original principal. SETTLEMENT OPTIONS T h e options referred to in this agreement are described as follows: Option A. Pay interest for life of the beneficiary. Option B. Interest for fixed period. Unless otherwise provided herein, interest and excess interest under this option shall be added to the principal. Option C. Pay principal and interest in equal monthly installments for fixed period. Option D. Pay a fixed amount monthly until interest and principal exhausted. Option E. (Referred to as Option 2 in policies numbered below 175,000.) Pay monthly income for life of beneficiary 10, 15 or 20 years certain at rate in policy for beneficiary's age on due date of first payment. BENEFICIARY T h e term "beneficiary" as used herein shall include the plural as well as the singular. The term "children" shall not have the broad meaning of descendants. Each class of designated beneficiary shall receive settlement hereunder

APPENDIX D

243

in the order of their designation. Unless otherwise provided by fractions after the designation of each beneficiary of a class, beneficiary of a class shall share equally. Except as otherwise provided in the provision "Payment to Children of Deceased Children" if elected, the unpaid share of a deceased beneficiary shall be apportioned and settled with the living beneficiary of such deceased beneficiary's class, if any, otherwise the living beneficiary of the next class of beneficiary designated; the apportionment to be in the same proportion as the original shares of the living beneficiary bore to each other. A share thus apportioned shall be settled with each beneficiary in the manner provided for such beneficiary's original share, but the company reserves the right to pay such a share to the beneficiary in a single sum. In the event of the death of a beneficiary any interest or installment accruing to said beneficiary's share since the last payment shall be settled with the next beneficiary entitled to settlement of the deceased beneficiary's share. The right to change this agreement or the beneficiary designation herein is reserved. WITHDRAWALS The right of withdrawal, if granted, may be exercised by a beneficiary not more often than three times in any calendar year. Withdrawals shall be in multiples of $50. The company reserves the right to require not to exceed 1 90 days written notice as a condition to the granting of a withdrawal request. The right of withdrawal may not be exercised with respect to proceeds being settled under Option £. If a withdrawal is made while settlement is under Option C the amount of the original installment shall be continued until the remaining benefits are exhausted. The right to withdraw a fixed amount per "year" shall mean "calendar year." The right to withdraw at stated intervals ' shall be noncuraulative. INTEREST AND INSTALLMENT PAYMENTS ¡Interest and installment rates hereunder shall be those specified in the death benefit settlement options of the policy or policy rider from which the bene¡ fits are derived. In the case of any policy which does not contain policy settlem e n t options the death benefit option rates appearing in policies issued by the company prior to January 1, 1938, shall apply. Interest hereunder shall i be payable monthly. Any excess interest or earnings shall be paid when due ito the beneficiary then entitled to receive payments hereunder. Any payment thereunder shall be charged against the benefits and shall relieve the com]pany of further liability to the extent of such payment. If payments of princ i p a l or interest hereunder shall amount to less than $20.00 each, the company : reserves the right to make such payments at such intervals (quarterly, semia n n u a l or annual) as will make each payment amount at least to $20. If the : amount apportioned to a beneficiary is less than $1000, or if any benefit being 'held at interest for a beneficiary becomes less than $1000, the company resserves the right to immediately pay such amount in a single sum to said beneIficiary. Subject to the company's agreement a beneficiary entitled to payments