Life insurance agents should take note of a ruling handed down by the U.S. Supreme Court a month ago. It involved one of an insurance agent's worst nightmares: The divorce of married clients. The dispute pitted a former spouse against her step-children and revolved around a relatively new law. The outcome has implications for life insurance policyholders in New York and elsewhere.
Mark Sveen and Kaye Melin, a Minnesota couple, married in 1997 and divorced ten years later. One year into the marriage, Mr. Sveen bought a life insurance policy, named his wife as the primary beneficiary and his two children from a previous marriage as contingent beneficiaries. The divorce decree ending the marriage did not mention the life insurance policy, and Mr. Sveen did not change his beneficiary designations.
Upon his passing in 2011, his ex-wife and his children got into a dispute over the insurance proceeds. In 2002, Minnesota adopted a “revocation-on-divorce" law which holds that a divorce automatically revokes any revocable beneficiary designation of property made by an individual to his or her former spouse in a “governing instrument." The law defines “governing instrument" as including insurance or annuity policies and wills. Citing this law, Mr. Sveen's children argued that Ms. Melin did not have a valid claim on the life insurance proceeds, since her designation as a beneficiary automatically disappeared when the divorce was decreed. Consequently, they were the rightful beneficiaries under the policy.
Ms. Melin countered that argument by noting that her ex-husband bought the policy and named her as beneficiary in 1998, four years before the state adopted the revocation-on-divorce law. Applying the law to a policy sold before its enactment, she argued, would violate Article 1 of the U.S. Constitution, which states in Section 10, “No State shall … pass any … Law impairing the Obligation of Contracts …" Therefore, she should receive the policy's proceeds.
A federal trial court sided with the children, but the appellate court agreed with Ms. Melin and held that retroactively applying the law violated the Constitution. The children appealed to the Supreme Court, which heard arguments last March. On June 11, the court awarded the proceeds to the children by a vote of 8 to 1.
Writing for the majority, Associate Justice Elena Kagan said that the Contracts Clause in Article 1 applies to insurance policies. However, “not all laws affecting pre-existing contracts violate the Clause." To determine whether a particular law violates the Clause, she wrote, the Court must consider “the extent to which the law undermines the contractual bargain, interferes with a party's reasonable expectations, and prevents the party from safeguarding or reinstating his rights." In the case of the Minnesota law and Mark Sveen's life insurance policy, she said that the law did not do any of these things.
Justice Kagan wrote,
“…(T)he insured's failure to change the beneficiary after a divorce is more likely the result of neglect than choice. And that means the Minnesota statute often honors, not undermines, the intent of the only contracting party to care about the beneficiary term. The law no doubt changes how the insurance contract operates. But does it impair the contract? Quite the opposite for lots of policyholders."
Further,
“(E)ven when presumed and actual intent diverge, the Minnesota law is unlikely to upset a policyholder's expectations at the time of contracting. That is because an insured cannot reasonably rely on a beneficiary designation remaining in place after a divorce."
Lastly, she noted, “The law puts in place a presumption about what an insured wants after divorcing. But if the presumption is wrong, the insured may overthrow it. And he may do so by the simple act of sending a change-of-beneficiary form to his insurer. … The statute thus reduces to a paperwork requirement (and a fairly painless one, at that): File a form and the statutory default rule gives way to the original beneficiary designation." She cited cases dating back to the 19th century in which the Court held that laws imposing minimal paperwork burdens do not violate the Contracts Clause.
Associate Justice Neil Gorsuch, the newest member of the court, dissented. He pointed out that recent Court precedents held that a state law “substantially impairing" contracts violates the Contracts Clause unless they are “reasonable" in light of a “significant and legitimate public purpose." He wrote:
“No one pays life insurance premiums for the joy of it. Or even for the pleasure of knowing that the insurance company will eventually have to cough up money to someone. As the Court concedes, the choice of beneficiary is the 'whole point.' ... So when a state alters life insurance contracts by undoing their beneficiary designations it surely 'substantially impairs' them."
He also argued that Minnesota could have achieved the goal of ensuring that insurance proceeds are not misdirected to a former spouse without impairing the insurance contracts. Further, he disagreed with the retroactive application of the law:
“A court can fine you for violating an existing law against jaywalking. That doesn't mean a legislature could hold you retroactively liable for violating a new law against jaywalking that didn't exist when you crossed the street. No one would take that idea seriously when it comes to crime, and the Contracts Clause ensures we don't when it comes to contracts, either."
Justice Gorsuch was a minority of one, so the Court reversed the appellate court's decision and awarded the life insurance proceeds to the children.
If you're reading this and you're a life insurance agent in New York, why should you care? Well, New York also has a revocation-on-divorce law, Section 5-1.4 of the Estates, Powers & Trusts Law. Gov. David Paterson signed it into law on July 7, 2008, and its text is very similar to that of the Minnesota law. If you have clients for whom you have obtained life insurance, and you learn that they have divorced (and I realize the insurance agent is often the last to know), it might behoove you to inform the insured of this law. The Supreme Court has now ensured that the law will apply to life insurance policies you sold before July 7, 2008.
The insured may well say, “Good riddance," but it's possible that the couple parted on amicable terms and the insured still wants the ex-spouse to receive the life insurance proceeds. If that's the case, the insured will need to take action. He or she can't do that if they're unaware.
A word of caution: If you decide to provide this service, consistency will be important. If you have attended Big I New York's annual errors and omissions loss control seminars, you have heard the attorneys who present them stress this. Do it for all your clients or don't do it at all. Part one of Murphy's Law implies that the one insured who does not get notified will be the one who has a contested claim. Part two states that Murphy was optimistic. Unless getting deposed is on your bucket list, you should implement air-tight procedures for doing this.
The Supreme Court's vote on this indicates that it was not a controversial decision. We can expect these types of laws to stick, so life insurance providers must be prepared for the consequences.
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