§ 80.9 — Claims Secured by Insurance Policies, Proceeds or Premiums

Revised: June 1, 2004

[1]

The standard form mortgages used by most financial institutions require the borrower to contract for hazard insurance. Often these documents also provide for the (optional) purchase of credit life, credit disability and other insurance. Although the specific language may differ, it is not unusual for the security instruments to state that insurance policies, proceeds and the premiums payable or rebatable with respect to insurance policies are “additional security” for the loan.

[2]

Many courts have considered whether a security interest in an insurance policy, proceeds or premiums forfeits the protection from modification in § 1322(b)(2). A strong majority of courts, including the U.S. Courts of Appeals for the Fifth and Sixth Circuits, have concluded that an interest in an insurance policy or proceeds does not forfeit the protection from modification in § 1322(b)(2).1 A minority of courts hold that a security interest in hazard insurance, credit life, proceeds of an insurance policy or insurance premiums is not an interest in real property and thus forfeits the protection from modification in § 1322(b)(2).2

[3]

The majority courts reason, in the context of hazard insurance, that the insurance is not additional collateral but is a substitute for the real property itself in the event of fire or other mishap. Many of these courts express the concern that a contrary holding creates an “exception to the exception” that swallows the protection from modification itself. Almost every real estate mortgage contains a requirement of some kind of insurance. A holding that standard form language granting a security interest in insurance policies, premiums or proceeds forfeits the protection from modification in § 1322(b)(2) would have a widespread effect in Chapter 13 cases.

[4]

On the other hand, an insurance policy, the proceeds payable under the policy and the premiums that are paid or rebatable are not real property. Truth is probably that Congress didn’t consider that most home mortgage transactions would contain interests in insurance that would threaten the protection from modification in § 1322(b)(2).

[5]

Even in jurisdictions holding that a security interest in insurance does not forfeit the protection from modification in § 1322(b)(2), a careful reading of the language of the mortgage may affect whether it is protected. For example, in Allied Credit Corp. v. Davis (In re Davis),3 the Sixth Circuit held that a requirement of hazard insurance with the lender as beneficiary “will not ordinarily take a creditor outside the protection of § 1322(b)(2)”; but the court reserved for another day “the issue of whether additional interests in insurance premiums or other types of insurance might serve as ‘additional security’ for purposes of § 1322(b)(2).”4 The Sixth Circuit acknowledged but did not overrule an earlier district court opinion from the Western District of Tennessee (also within the Sixth Circuit) that held a debt consolidation loan secured by a second mortgage on the debtor’s residence and by credit life and credit disability insurance, including unearned or returned premiums, was not protected from modification by § 1322(b)(2).5 Applying Davis, one bankruptcy court concluded that a mortgage holder’s unmatured rights to payment under credit life and credit disability insurance policies were not security interests for purposes of § 1322(b)(2), but the loan documents did create a security interest in unearned premiums that forfeited the protection from modification.6 Similarly, the district court in United Companies Financial Corp. v. Davis7 read the Fifth Circuit’s decision in RTC v. Washington (In re Washington)8 to recognize the forfeiture of the protection from modification in § 1322(b)(2) if certain conditions were present in the security instruments.9

[6]

The kind of insurance involved and the interest taken by the lender should make a difference whether the protection from modification in § 1322(b)(2) is available. The argument that hazard insurance is not additional collateral because it substitutes for the real property fails with respect to life insurance sold to the debtor as part of a credit transaction. The premiums payable or rebatable on a credit life policy or even the proceeds payable upon the death of the debtor are not incidents or attributes of the real property. Life insurance policies typically are not (or cannot) be required as conditions for making the mortgage loan. When the borrower elects to buy credit life insurance, it is truly a different kind of security than the real property. Mortgage lenders often directly or indirectly profit from the sales of credit life insurance and credit disability insurance to borrowers. Policy arguments for protecting the availability of home mortgage credit do not extend to the lender that takes a security interest in a credit life policy or premiums.

[7]

Debtor’s counsel has to get the mortgage, deed of trust or other security documents and look carefully for interests in insurance policies, proceeds and premiums. The protection from modification in § 1322(b)(2) is most fragile when the lender or a related entity separately contracted to sell the debtor life or disability insurance and then acquired a distinct security interest in the policy, its proceeds and its premiums.


 

1  Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208, 211–12 (6th Cir. 1993) (“Like credit life and disability insurance, hazard insurance is merely a contingent interest—an interest that is irrelevant until the occurrence of some triggering event and not an additional security interest for purposes of § 1322(b)(2). . . . Although the district court cited several cases in which the presence of insurance was held to take away the protection of § 1322(b)(2), most of these cases may be distinguished because they involved a security interest in premiums or in credit life and disability insurance, not hazard insurance. . . . [W]e hold that a requirement of hazard insurance with the creditor designated as beneficiary will not ordinarily take a creditor outside the protection of § 1322(b)(2). This is true even where the creditor retains physical possession of the policy. We reserve for another day the issue of whether additional interests in insurance premiums or other types of insurance might serve as ‘additional security’ for purposes of § 1322(b)(2).”); RTC v. Washington (In re Washington), 967 F.2d 173, 174–75 (5th Cir. 1992) (Reported decisions are divided but “have begun to step . . . toward a consensus that credit life and disability insurance does not constitute additional security. . . . [T]hese courts have reasoned that credit life and disability insurance policies are merely contingent interests—interests that are illusory until the occurrence of some triggering event and not security interests for section 1322(b)(2) purposes. . . . The plain meaning of section 1322(b)(2)’s language establishes that its purpose is to protect creditors. . . . [I]nterpreting ‘additional security’ to include optional credit life and disability insurance would defeat this purpose for such insurance has become a standard accompaniment for mortgage loans.”); In re Rosen, 208 B.R. 345, 352 (D.N.J. 1997) (“[O]ther courts which have addressed related issues have determined the provision of items such as insurance in a mortgage does not create additional security within the meaning of the Bankruptcy Code. See [Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208, 211 (6th Cir. 1993)].”); United Cos. Fin. Corp. v. Davis, 148 B.R. 16 (W.D. La. 1992) (Applying RTC v. Washington (In re Washington), 967 F.2d 173 (5th Cir. 1992), a credit life and disability insurance policy might be additional security that would forfeit the protection from modification in § 1322(b)(2), but only if all four (really three) conditions stated in Washington are satisfied: (1) the insurance policy must be a prerequisite for obtaining the loan; (2) the insurance must be separately pledged as additional security; (3) the contract must contain an assignment of interest; or (4) the contract must contain other language perfecting a security interest in the policy. Here, the contract does contain an assignment of interest, but there is no evidence that the insurance policies were a prerequisite for obtaining the loan.); In re Pedigo, 283 B.R. 493 (Bankr. E.D. Tenn. 2002) (Applying Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208 (6th Cir. 1993), mortgage holder’s rights under credit life and credit disability insurance are not security interests for purposes of § 1322(b)(2).); Cupp v. Associates Consumer Discount Co. (In re Cupp), 229 B.R. 662, 664–65 (Bankr. E.D. Pa. 1999) (Credit life and credit disability insurance financed by lender did not forfeit protection from modification in § 1322(b)(2) because lender did not take a separate security interest in the policies, proceeds or premiums. “[T]he estate has no interest in proceeds as they have been absolutely assigned to the lender. As to the prepaid premiums, . . . the policy provides for a refund to Mr. Cupp of any unearned premium if certain events occur.” The policy was owned by the lender and the beneficiary designation in favor of the lender was irrevocable.); In re Surber, 211 B.R. 17, 18–19 (Bankr. N.D. Ohio 1997) (Provision allowing lender to apply any premium refund upon cancellation of credit life insurance to payments under the mortgage is not a “lien” and does not forfeit the protection from modification in § 1322(b)(2). Citing RTC v. Washington (In re Washington), 967 F.2d 173 (5th Cir. 1992), “[c]redit life and disability insurance policies should only be considered additional security if certain conditions are met. . . . Examples of these conditions are: (1) the insurance was . . . required . . . (2) the insurance was separately pledged as additional security, (3) the security agreement contained an assignment of the interests in the insurance or (4) the security agreement contained other language perfecting an interest in the policy. . . . While the Sixth Circuit has never faced the issue directly before the Court, it has specifically approved and adopted the Washington decision and its rationale in the context of fire hazard insurance. Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208 (6th Cir. 1993). . . . City Loan had the right to apply insurance premium refunds to the loan balance . . . . The boilerplate language included in the security agreement’s cancellation of insurance provisions is insufficient to create a lien.”); In re Spano, 161 B.R. 880, 890 (Bankr. D. Conn. 1993) (“The respondent’s right to receive proceeds from hazard insurance does not constitute collateral other than the real property that is the debtor’s principal residence. . . . [T]he hazard insurance proceeds have no independent existence apart from the improvements insured. The proceeds will come into existence only if and to the extent the improvements are damaged. Hazard insurance proceeds are similar to proceeds from the condemnation of the mortgaged property, on which proceeds the mortgagee generally has a lien to secure its debt.”); In re Williams, 161 B.R. 27, 29 (Bankr. E.D. Ky. 1993) (Applying Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208 (6th Cir. 1993), the requirement that the debtor provide hazard insurance in favor of second mortgage holder does not constitute “other security.” “[T]he mere existence of credit life insurance does not constitute additional collateral and thus the Bank here is not outside of the protections afforded by § 1322(b)(2).”); In re Amerson, 143 B.R. 413, 418 (Bankr. S.D. Miss. 1992) (Respectfully disagreeing with In re Stiles, 74 B.R. 708 (Bankr. N.D. Ala. 1987), “This court is of the opinion that the drafters of § 1322(b)(2) did not contemplate that a credit life insurance policy, naming the creditor as the beneficiary, would be considered an additional security interest.”); In re Ireland, 137 B.R. 65 (Bankr. M.D. Fla. 1992) (Credit life and credit disability insurance listing the mortgage holder as loss payee and hazard insurance did not forfeit the protection from modification in § 1322(b)(2).); Wright v. C&S Family Credit, Inc. (In re Wright), 128 B.R. 838, 844 (Bankr. N.D. Ga. 1991) (Security interest in “returned, unearned and payable insurance premiums are not included in the description of the collateral in the habendum clause of the security deed. Thus, the rights to returned, unearned and payable insurance premiums do not constitute additional security for the debt.”); In re Braylock, 120 B.R. 61 (Bankr. N.D. Miss. 1990) (Requirement of fire and casualty insurance does not constitute an additional security interest. To hold that fire and casualty insurance coverage constitutes an additional security interest would eviscerate the protective exception for residential lenders in § 1322(b)(2). Optional credit life insurance policy in which the unearned premium is refundable to the debtor and the proceeds are payable to the creditor only upon the debtor’s death is not an additional “security interest.”); In re Diquinzio, 110 B.R. 628 (Bankr. D.R.I. 1990) (“[C]ontingent interest in a credit life insurance policy” does not represent additional security and does not forfeit protection under § 1322(b)(2).).

 

2  See Transouth Fin. Corp. v. Hill, 106 B.R. 145 (W.D. Tenn. 1989) (Debt consolidation loans secured by a second mortgage on the debtor’s residence and by credit life and credit disability insurance, including unearned or returned premiums, are not protected from modification by § 1322(b)(2).); In re Pedigo, 283 B.R. 493 (Bankr. E.D. Tenn. 2002) (Distinguishing Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208 (6th Cir. 1993), loan documents create a security interest in unearned premiums with respect to credit life and credit disability insurance; that security interest has value and forfeits the protection from modification.); In re Jones, 201 B.R. 371 (Bankr. D.N.J. 1996) (Security interest that included insurance proceeds not protected from modification.); In re Pinto, 191 B.R. 610 (Bankr. D.N.J. 1996) (Lien that extended to funds held in escrow for payments of taxes and hazard insurance premiums not protected from modification.); In re Selman, 120 B.R. 576 (Bankr. D.N.M. 1990) (Section 1322(b)(2) does not prohibit the debtors from modifying mortgage that includes interest in credit life and hazard insurance policies.); In re Klein, 106 B.R. 396 (Bankr. E.D. Pa. 1989) (Security interest in hazard insurance proceeds and personalty supplying heating renders § 1322(b)(2) inapplicable.); In re Wilson, 91 B.R. 74 (Bankr. W.D. Mo. 1988) (Mortgage holder is not secured only by a security interest in the debtors’ principal residence when the creditor also took a security interest in credit life insurance, disability insurance, and property damage insurance.).

 

3  989 F.2d 208 (6th Cir. 1993).

 

4  989 F.2d at 212. See also In re Surber, 211 B.R. 17 (Bankr. N.D. Ohio 1997) (Bankruptcy court applies Sixth Circuit’s Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208 (6th Cir. 1993) opinion in the context of a security interest in credit life insurance premiums in a home mortgage.).

 

5  See Transouth Fin. Corp. v. Hill, 106 B.R. 145 (W.D. Tenn. 1989).

 

6  In re Pedigo, 283 B.R. 493, 498–502 (Bankr. E.D. Tenn. 2002) (“Citifinancial had a right to collect the death benefit without regard to whether the debtors granted it a security interest in the insurance or assigned their rights in the insurance to secure the debt. . . . [T]he credit life policy is similar to a payment bond or guaranty for the benefit of one creditor. A guaranty or payment bond is not property subject to the beneficiary’s security interest. . . . The same reasoning applies with regard to the credit disability insurance. The disability benefit is payable to Citifinancial to reduce the debt. The insurance company’s promise to pay is not a security interest in property. . . . Citifinancial’s right to the death benefit or the disability benefit was not acquired by transfer from the debtors of their rights under the policy. On the other hand, the insurance policy makes the debtors the owners of the right to the unearned premium, and Citifinancial could have obtained that right as collateral for the debt only by transfer from the debtors. The security agreement . . . authorizes the insurance company to pay the unearned premium to Citifinancial. Citifinancial can pay the unearned premium to the debtors or apply it to their debt. . . . The option of applying the unearned premium to the debt gives Citifinancial a charge against or an interest in the debtors’ property—the right to the unearned premium—to secure their debt to Citifinancial. . . . [P]erfection of a creditor’s security interest against third parties is not required for the creditor to be ‘secured’ as that term is used in the home mortgage exception. . . . The right to unearned premiums is property that has value to Citifinancial as a source for collection of the debt. . . . The court has no evidence to support the conclusion that the amount of the unearned premium is de minimis or insignificant . . . . Citifinancial’s right to collect the debt from the unearned premium is a security interest in collateral other than the debtors’ principal residence. It follows that the home mortgage exception does not prevent cram-down of the second mortgage claim.”).

 

7  148 B.R. 16 (W.D. La. 1992).

 

8  967 F.2d 173 (5th Cir. 1992).

 

9  United Cos. Fin. Corp. v. Davis, 148 B.R. 16 (W.D. La. 1992) (Applying RTC v. Washington (In re Washington), 967 F.2d 173 (5th Cir. 1992), a credit life and disability insurance policy might be additional security that would forfeit the protection from modification in § 1322(b)(2), but only if all four (really three) conditions stated in Washington are satisfied: (1) the insurance policy must be a prerequisite for obtaining the loan; (2) the insurance must be separately pledged as additional security; (3) the contract must contain an assignment of interest; or (4) the contract must contain other language perfecting a security interest in the policy. Here, the contract does contain an assignment of interest, but there is no evidence that the insurance policies were a prerequisite for obtaining the loan.). See also In re Surber, 211 B.R. 17 (Bankr. N.D. Ohio 1997) (Applying RTC v. Washington (In re Washington), 967 F.2d 173 (5th Cir. 1992), to a mortgage that permitted the lender to apply premium refunds upon cancellation of credit life insurance to payments under the mortgage.).