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Cash Value Increase in Life Insurance Policy Not Reduced by Debtor’s Pre-Petition Cash Withdrawals

Case: Cohen v. Prudential Insurance Company, et al. (In re Moosman), Adv. Pro. No. 11-1482 ABC (Bankr.D.Colo. 2012).

Discussion: Exemptions allow debtors to protect certain property from creditors or a bankruptcy trustee. Section 522 of the Bankruptcy Code sets forth the federal exemptions for debtors in bankruptcy. These exemptions are available to debtors unless the law of the state that is applicable in the debtor’s bankruptcy case specifically provides that the federal exemptions do not apply. In 1981, the Colorado state legislature opted out of the federal exemptions set forth in 11 U.S.C. § 522.

Sections 13-54-102 and 13-45-104 of the Colorado Revised Statutes contain many of the exemptions available to bankrupt debtors where Colorado exemption law applies. One particular exemption regarding the “cash surrender value” of life insurance policies, provides that “[t]he following property is exempt […]: [t]he cash surrender value of policies or certificate of life insurance to the extent of one hundred thousand dollars [for actions] against the insured; except that there is no exemption for increases in cash value from moneys contributed to a policy or certificate of life insurance during the forty-eight months prior to the [bankruptcy filing].” C.R.S. 13-54-102(1)(l)(I)(A).

In Cohen v. Prudential Insurance Co., Judge A. Bruce Campbell of the United States Bankruptcy Court for the District of Colorado interpreted the portion of the “cash surrender value” life insurance exemption that excludes increases in “cash value” of a life insurance policy during the 48 months prior to bankruptcy. Key to the court’s ruling was its statement that “the language of C.R.S. § 13-54-102(1)(l)(I)(A) prescribes different measures for the exemption and the exclusion from the exemption. It is incorrect to measure the exclusion from the exemption by changes in cash surrender value.” Id. at pg. 5 (emphasis added).

In the case, the debtor’s bankruptcy trustee, Mr. Cohen, sued the debtor’s insurance company, Prudential, for turnover of the cash surrender value of Ms. Moosman’s life insurance policy on the date of her bankruptcy filing in the amount of $1,459.79. The debtor intervened and argued that the cash surrender value was exempt under C.R.S. § 13-54-102(1)(l)(I)(A). In his motion for summary judgment, the trustee argued that the “cash value” of Ms. Moosman’s life insurance policy increased due to premium payments made during the 48 months prior to her bankruptcy filing in the amount of $1,787.75. The trustee’s theory was that the increase in “cash value” during the 48 month pre-petition period was in excess of the “cash surrender value” on the date of the bankruptcy filing and the entire net cash surrender value was non-exempt. In her cross motion for summary judgment, Ms. Moosman argued that during the 48 month period, Ms. Moosman cashed out some paid-up additions (PUAs) to her coverage from dividends and took out loans against the policy. Ms. Moosman argued that during the 48 months prior to her bankruptcy, the “net cash surrender value” of her life insurance policy decreased from $7,841.23 to $1,459.79. Thus, she alleged, there was no non-exempt increase in value that the trustee could recover.

The court sided with the trustee and held that even where a Debtor withdraws money from a life insurance policy prior to bankruptcy, thereby causing a net reduction of the “cash surrender value” during the 48 month period, the Trustee is still entitled to exclude any increases in “cash value” due to contributions made by the Debtor from the otherwise exempt cash surrender value. In other words, neither borrowing nor withdrawing money from the policy will protect any contributions made to the policy from seizure by the bankruptcy trustee if there is any “cash surrender value” on the date of the filing. The court relied heavily on the rationale of the Colorado Court of Appeals in the case of In re Gedgaudas, 978 P.2d 677 (Colo. App. 1999) in finding for the trustee, stating as follows:

Given the explicit language of the statute and the Colorado Court of Appeals’ construction of the statute in Gedgaudas, the Court believes it is also inappropriate, absent an amendment to the statute, to consider a direct withdrawal of cash when computing the exclusion amount. Accordingly, if on the date of the bankruptcy a debtor’s life insurance policy has a cash surrender value equal or less than the amount of her contributions during the prior four years have increased the cash value of the policy, the entire cash surrender value is non-exempt.

Key Quote for Debtors: “Given the explicit language of the statute and the Colorado Court of Appeals’ construction of the statute in Gedgaudas, the Court believes it is also inappropriate, absent an amendment to the statute, to consider a direct withdrawal of cash when computing the exclusion amount.”

Key Quote for Trustees: “In the Trustee’s objection to Debtor’s claim of exemption, the Trustee clearly asserted that there was an increase of $1,855 in the cash value of Debtor’s policy during the 48 months prior to Debtor’s bankruptcy, and that Debtor was entitled to no exemption for the cash surrender value of the policy. Debtor’s default and the Court’s order sustaining the Trustee’s objection to Debtor’s exemption are the law of the case. The preclusion doctrines of res judicata and/or collateral estoppels are additional grounds entitling the Trustee to summary judgment in this case.”

– David J. Warner