Is Life Insurance Protected in Bankruptcy?

To determine what is considered a liquid asset, follow a simple set of rules:

The simple answer is, it depends. Several factors are involved, complicated further because bankruptcy laws vary from state to state. In addition, there are federal laws that apply to bankruptcy. Let's take a closer look at bankruptcy and life insurance policies.

The type of policy matters

When considering life insurance and bankruptcy, the first question is what type of policy you have. There are two primary types of life insurance:

• Term insurance lasts a specific number of years and features a death benefit if you die during the term.
• Permanent insurance, which lasts for your lifetime so long as you pay the premiums, features a death benefit when you pass away, and something called a cash value. The cash value is a savings component in your policy. As you pay into your policy, you slowly build a reserve of money that you can borrow against, if needed. Whole life, variable life, and universal life are all types of permanent policies.

Bankruptcy policy dictates that your creditors can't access an active term insurance policy because there's no cash value; you're only paying monthly premiums, so there'd be a payout before the term expires if you passed away.

However, with permanent insurance, the cash value portion of the policy may be considered part of your assets and therefore available to your creditors as part of the settlement.

Bankruptcy life insurance exemptions

However, you can protect your investment in your life insurance policy by using exemptions, which let you indicate a portion of your assets that won't be included in the bankruptcy. Every state has exemptions, and those cover life insurance in some states. 

It's a good idea to consult an experienced bankruptcy lawyer to determine your state's rules. 

In addition, some states that don't allow a specific exemption for life insurance policies do have something called a wildcard exemption that you can assign to any asset you wish. This type of life insurance bankruptcy exemption may be used to protect the cash value you have built up in your permanent policy. 

There are also federal exemptions that you can use, although you may have to choose between using state or federal rather than picking from both. Note that only some states allow you to use federal exemptions, including Massachusetts, New York, and Michigan. 

Protecting life insurance proceeds during chapter 13

Let's look at another situation. What happens when you're going through bankruptcy and you're the beneficiary of a mature policy? For example, what do you do if your uncle dies the week after you declare chapter 13, and you're the primary beneficiary of his $50,000 whole life policy? Timing is everything in this situation. 

If he died before you declare bankruptcy or within 180 days afterward, the death benefit is considered part of your estate and therefore impacted by the bankruptcy. 

Once again, though, state life insurance bankruptcy laws may play a role. In some states, you may be able to declare an exemption for the death benefit. For others, the type of policy is important. In Ohio, for example, if the death benefit is from a group life insurance policy, the proceeds are exempt. Other policies aren't.

What if the life insurance company goes bankrupt?

Here's one more bankruptcy-related situation that you may encounter: what do you do if it's your insurer who goes bankrupt? Have you lost out on any financial benefit? Will they honor your policy? The first consideration is that you should always purchase your policy from a well-established insurer with high rankings at agencies that monitor financial health, like AM Best and Standard & Poors. These insurers—Ethos policies may be backed by either—are highly unlikely to go bankrupt, and your investment in life insurance with them should be safe.

There are also safeguards in place for bankruptcy and life insurance companies. Required statutory reserves may be used to pay out on policies, and reinsurance regulations allow insurers to share the risk with other companies. If your provider declares bankruptcy, your policy may also be protected by the insurer's membership in a guaranty association, which is mandatory in the U.S. There may be a cap on the amount that a regulatory agency will pay out on behalf of an insurer. In this case, it's often $300,000, with a $100,000 cap on cash value.

Can I get life insurance if I declared bankruptcy in the past?

If you filed for chapter 11 or chapter 13 bankruptcy in the past, you should still be able to purchase a life insurance policy, although you may pay a bit more for it than someone with solid finances. After bankruptcy, getting life insurance will require you to prove to your potential insurer that you're financially stable, with a regular income and good credit history.Get a fast, personalized quote from Ethos today.