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In re Bowen: Bankruptcy Trustee Cannot Reach Cash Value of Private ROP Disability Policy

In the Illinois bankruptcy case In re Bowen, No. 11-71289 (C. D. Illinois)(Order entered September 23, 2011) the bankruptcy court held that the cash value of a private disability policy owned by a debtor was exempt from the claims of the debtor’s creditors, not as life insurance, but under the provision of Illinois law exempting the debtor’s right to receive disability payments, even if the debtor was not currently receiving disability payments.

All states exempt certain assets from the claims of creditors. Many states exempt disability payments to a debtor as part of their statutory exemption scheme. For example, North Carolina exempts “compensation for personal injury, including compensation from private disability policies or annuities…” Illinois exempts a “debtor’s right to receive a disability, illness, or unemployment benefit.”

In 1990s disability insurance carriers introduced a return of premium (“ROP”) disability policy. By paying for a ROP rider, the insured had the potential to receive a portion of the premium back five or ten years down the road, depending on claims experience. Many of these policies provided that if the insured died without making a claim, the premiums would be returned to the insured’s beneficiary. ROP disability riders were not cheap, typically costing an additional 40% to 60% of the base premium. Given this increased cost, ROP disability insurance is rarely if ever a wise purchase (you are essentially making an interest free loan to the insurance company of 40% to 60% of the base premium in the hope of getting 50% to 80% back in five to ten years). As a result,the ROP disability insurance market has all but dried up, with only a couple of carriers offering this type of rider today.

For Steve Bowen, however, this proved to be a wise decision, at least from an asset protection standpoint. When Mr. Bowen filed bankruptcy he listed not one but two ROP disability policies, which at the time had a combined cash value of $7,777, as exempt. Illinois is an opt-out state, so Mr. Bowen’s exemptions were based on Illinois’ statutory exemption scheme.

Mr. Bowen claimed the policies were exempt on two grounds. First, because the policies had a cash value component which could be paid to his beneficiaries if he died without making a claim, the policies were life insurance policies, which were exempt. Second, because the policies were disability policies, the policies constituted Mr. Bowen’s “right to receive a disability…benefit.”

The bankruptcy trustee objected on two grounds. First, the policies were not life insurance policies and, therefore, were not exempt. Second, because Mr. Bowen was not currently receiving disability payments, the cash value of the ROP disability policies was not a “right to receive…disability benefits” as that term is used in the Illinois statute.

The Court agreed with the trustee on the first point, finding that any death benefit was merely “incidental” to the policy. As a result, the ROP disability policy was not life insurance. Turning to the second point, the bankruptcy court first observed that exemption statutes, including the one in question, are to be liberally construed in favor of the debtor. If an exemption statute is capable of being read two ways, one that would favor the debtor and one that would not, it should be read to favor the debtor.

The Bowen court went on to rule that even a debtor’s contingent right to receive payment at some uncertain point in the future was also protected. For that reason, the debtor’s “right to receive” disability payments was not limited to benefits being currently received, but extended to include the accumulated cash value in each of the ROP disability policies. The court went on to note that although the statute in question was silent on this issue, there is no distinction for purposes of the exemption statute, between public disability benefits, such as SSDI, and private disability such as the policies owned by Mr. Bowen.

Are ROP disability policies a wise purchase? Normally no. Will a ROP disability policy keep the cash value away from the policy owner’s creditors? Yes, at least in Illinois.