Creditor Proof Status Of Life Insurance Company Products

If you heard a loud sigh of relief on February 22, 1996, you needed to look no further than to the life insurance industry to discover the source. It was on that day, that the Supreme Court of Canada unanimously confirmed the preferred status of life insurance products regarding protection from seizure by creditors. By upholding the decision of the Saskatchewan Court of Appeal in the Ramgotra case, and rejecting the appeal of the Royal Bank, the Supreme Court of Canada became the third court to rule against the leader's attempts to seize an insurance company RRIF from the insolvent Dr. Ramgotra.

The Ramgotra case was significant in the lower courts as decisions contradicted the findings of the Klassen case, which had hung like a pall over the insurance community since 1990. Under Klassen , the court ruled that the trustee in bankruptcy designed. While the circumstances of Klassen and Ramgotra were different, the decision of the Supreme Court of Canada in Ramgotra. would appear to provide a clearly defined conclusion as well as offering the Court's insight into the interaction of the federal Bankruptcy and Insolvency Act (BIA) and the provincial insurance acts.

Klassen raised doubts as to the creditor proof status of life insurance deposits where a policy owner (Klassen) became bankrupt within a year of depositing money into an insurance contract (RRSP) that named an immediate family member (his wife) as beneficiary. Even before Klassen, while the courts looked upon the creditor proof status of life insurance products favourably, they had assumed that there was a conflict between the creditor protection afforded by insurance law and the BIA which, under section 91, set out three instances where settlements would be "void against trustee". These three settlements are:

• within one year before becoming bankrupt;
• within five years, either where the bankrupt was insolvent at the time of the settlement, or
• within five years, where "the interest of the settlor in the property did not pass".

The Supreme Court ruling found that, in Ramgotra., the RRIF remained legally out of reach of the creditors despite the timing of the investment. The ruling also concluded that federal bankruptcy laws of gives a trustee in bankruptcy no special right to seize assets that are protected from creditors under the insurance laws of Canada's provinces. In writing the Courts decision, Mr. Justice Gonthier concludes that the Bankruptcy and Insolvency Act tells us to look to provincial insurance law to find out what is protected from creditors.

The provincial insurance laws of all provinces (except Quebec) maintain that the proceeds of insurance contracts which are left to certain family members (spouse, child, parent or grandchild) of the life insured are exempt from seizure by creditors of the insured. It is important to note that it is the relationship to the insured which is paramount. This differs from Quebec, where the insurance act stipulates the relationship to the policy owner. Quebec also affords wider protection in that the protected class includes any ascendant or descendant of the policyholder. In all provinces, the designating of a beneficiary as irrevocable affords creditor protection.

By ruling that the Bankruptcy and Insolvency Act defer to provincial insurance statues on the question of creditor proof status, the Supreme Court of Canada rendered a decision that went beyond the expectations of the insurance community. The industry anticipated merely an upholding of the lower courts' decision in Ramgotra. What they got was a clarification of the confusion that had existed for almost 25 years due to the assumed overlapping of section 91 of the BIA and the provincial insurance laws.

What should be apparent, however, is that carte blanche has not been given to sidestep an insolvent's creditors by merely transferring assets to an insurance company. The issue will be one of intent. What was the intent of the individual in transferring or depositing assets with an insurance company? If the intent can be construed to be the defrauding of one's creditors, then the transaction may still be overturned under the Section 91 of Bankruptcy and Insolvency Act. What the Supreme Court decision has done is clear up some of the confusion regarding the subject and leave us with the following considerations:

• Life insurance products, generally, offer better creditor protection for both registered and non-registered contracts than do other investment vehicles.
• Bankruptcy alone cannot strip away life insurance creditor protection.
• The courts will look more closely at the issue of the intention of buying an insurance product or the naming of a beneficiary when dealing with creditor proof issues.

It is the opinion of some that the level of protection afforded also depends on the type of insurance product. Notwithstanding the above, there are still some additional cases where the lower court has ruled that some annuity contracts issued by insurance companies and differing very little from guaranteed investments certificates or term deposits should by their nature not enjoy preferential treatment. These cases have not, as yet, been dealt with at the Supreme Court level. That court's decision in Ramgotra., however, may influence future judicial decisions if not provide a precedent.

Given this specific area of uncertainty, however, the following is a list of insurance company products, rated in descending order as to their potential creditor proof status:

• Death benefits of life insurance policies with a named beneficiary.
• Cash values of life insurance policies with a named beneficiary who is of specified family class (i.e. preferred beneficiary).
• Life annuities, on a registered or non-registered basis.
• Segregated funds, which are basically mutual funds sold by life insurance companies. These plans also afford protection from the creditors of the life company as funds are "segregated" and kept separate from the general assets of the company.
• Term certain annuities, including RRIF contracts.
• Deposit annuities similar in nature to a guaranteed investment certificate or term deposit offered by a bank or trust company. These types of investments should still be strongly considered over alternate types given the additional argument provided by the February 22, 1996 Supreme Court decision.

As shown by the above it is products unique to the life insurance industry and element of mortality risk which affords the additional creditor proof status. For example, trust companies are prevented from selling life annuities. By contrast, term deposits sold as annuities contracts by life companies are deemed to be life insurance policies by virtue of the fact that the proceeds may be withdrawn in form of life annuities.

In summary, as long as the intent of the depositor cannot be construed as an avoidance of creditors specifically, (i.e. as long as the depositor was not insolvent at the time of the transaction), insurance company products will afford more protection from creditors that other investments. This is an important consideration to bear in mind as we approach the RRSP season. Given that many insurance products equal or outperform alternative, similar investments, creditor proofing is an additional factor in determining your investment mix.