Thursday, March 5, 2009

Annuity Bought for $10,000 by Debtor a Few Months Before Filing Chapter 7 Case is Not Exempt Either as Life Insurance or a Private Retirement Plan

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

Simpson v. Burkart (In re Simpson)

Ninth Circuit Court of Appeals, Case No. 07-15626
February 23, 2009

The Ninth Circuit panel agreed with both the bankruptcy court and the Bankruptcy Appellate Panel that a single-premium annuity purchased by debtor a few months before filing Chapter 7 was not exempt as either life insurance or private retirement account under California exemption statutes.

Although this opinion turns on statutory interpretation of California statutes, it is of broader interest because it addresses two important general issues:
a) what factors determine whether an annuity with life insurance components qualifies for a life insurance exemption, and
b) the role of debtor's subjective intent in determining whether an annuity qualifies for a retirement exemption.

(The BAP opinion being appealed from, Simpson v. Burkart (In re Simpson), 366 B.R. 64 (9th Cir. B.A.P. 2007) was authored by Judge Randall Dunn writing for the three-judge BAP.)

Essential Facts
The Annuity: Simpson paid $10,000 to buy an annuity "a few months" before filing a Chapter 7 bankruptcy.
  • Simpson was the annuity contract owner and annuitant (the person entitled to receive benefits or payments from the annuity); his two sons were the beneficiaries.
  • Non-qualified for IRS purposes, meaning that contributions to it are not tax-deductible.
  • No loan value, so could not be borrowed against.
  • If the annuity was surrendered before 2043 when Simpson was to begin receiving payments from it, he would have to pay a 10% early surrender penalty.
  • If Simpson were to die before 2043--when he would be 95 years old, his beneficiaries could either surrender the annuity and receive the principal and interest, or could wait until that date and receive the payments as usual.
  • Cute twist: Simpson bought the annuity through his bankruptcy attorney, who sold financial products as an apparent side business.
Judge Dunn's BAP Opinion Corrected on Methodology
The Ninth Circuit called "incorrect" the BAP opinion's statement that "[w]hether an annuity contract qualifies as exempt life insurance under California law is a factual determination that we review under the clearly erroneous standard.” Instead, the Ninth Circuit asserted:
we undertake two inquiries. The first is a question of statutory interpretation, that is, whether the claimed statutory exemption includes the asset at issue. . . .. If the statutory exemption categorically includes the questioned asset, then the inquiry is at an end. If the asset is not categorically embraced within the statutory exemption, then the question is whether, as a factual matter, the particular financial instrument qualifies for the exemption. . . . . Statutory interpretation and whether a particular policy qualifies as a life insurance policy are questions of law subject to de novo review. We do, however, review factual findings for clear error.
Life Insurance Exemption

The pertinent exemption statute states: "Unmatured life insurance policies (including endowment and annuity policies), but not the loan value of such policies, are exempt without making a claim."

As to the first inquiry, the Court determined that, notwithstanding the parenthetical reference to "annuity policies," "single-premium annuities are not included categorically within California’s statutory life insurance exemption." It based this on a prior BAP opinion's "careful statutory analysis" which concluded that the purpose of this parenthetical language was "to clarify that life insurance that includes the essential features of an annuity or endowment policy does not lose its exempt character." But that language apparently did not add annuities to this category of exemptions, which "applies only to life insurance."

On the second inquiry, in response to debtor's argument that the annuity "is actually a life insurance policy," the Ninth Circuit held that a "single-premium annuity that provides a guaranteed stream of income and has no contingencies that can divest the debtor or his beneficiaries of their right to payment is an investment, not a life insurance policy."

To make this determination, the Court looked to the following list of non-exclusive factors from the BAP opinion Turner v. Marshack (In re Turner), 186 B.R. 108, 117 (9th Cir. B.A.P. 1995):
(1) whether the annuity is truly contingent;
2) whether the debtor can accelerate the maturity date;
3) whether the debtor can borrow against the policy;
4) who owns the policy;
5) whether payment of the premium is consistent with an investment or payment;
6) whether the seller was licensed to sell life insurance in the debtor’s state;
7) what, if any, is the opinion of testifying experts;
8) what provisions of the application are also part of the policy; and
9) whether a life insurance policy in the debtor’s state must contain a death benefit.
The Ninth Circuit held that the BAP did not err in concluding that, based on the bankruptcy court's findings, the debtor's annuity was not a life insurance policy. The BAP had focused on six of the above factors, determining that the annuity is not life insurance because:

  • "the payments under the . . . Annuity are not contingent upon debtor's life" (above factor 1);
  • the "Annuity does not allow for the debtor to accelerate the maturity date" (factor 2);
  • the "Annuity . . . does not allow the debtor to borrow against it" (factor 3);
  • “[i]nstead of creating an immediate estate for the benefit of others, the annuitant [reduced his] immediate estate in favor of future contingent income." (factor 4);
  • the "limited death benefits do not change the fundamental purpose of the . . . Annuity — to provide the debtor with fixed, periodic payments for life or a stated period of time, without requiring his death to trigger [the annuity obligor]’s obligation to pay" (factor 5); and
  • the annuity obligor was"authorized to sell life insurance . . .[but this is] not dispositive as to whether the annuity contract qualifies as life insurance . . .." (factor 6)
The only "death benefit" of the annuity was that upon debtor's death his beneficiaries would not have to pay the 10% early-surrender penalty and received an accelerated vesting of accrued interest; "those features do not change the 'fundamental purpose' of the . . . Annuity."

"Private Retirement Plan"
The pertinent exemption statute states:
All amounts held, controlled, or in process of distribution by a private retirement plan, for the payment of benefits as an annuity, pension, retirement
allowance, disability payment, or death benefit from a private retirement plan are exempt.
To be a "private retirement plan," the asset must fit into one of the following definitions:
(1) Private retirement plans, including, but not limited to, union retirement plans.
(2) Profit-sharing plans designed and used for retirement purposes.
(3) Self-employed retirement plans and individual retirement annuities or accounts provided for in the Internal Revenue Code of 1986.

Starting again with the first inquiry, the Court asked if under this statute a single-premium annuity would "categorically" fit under the the term, "private retirement plan." It reviewed California case law, which did not directly address whether a single-premium annuity would qualify as a private retirement plan, observing that not a single one of the appellate decisions interpreting the term did so "to include independent retirement investments." From this the Court inferred that such annuities would not "qualify categorically under California law as a private retirement plan."

And on the second inquiry, whether this particular annuity qualifies for the exemption, the debtor argued that it was a private security plan under subsection (1) above "because he subjectively intended to use it as one." But the Court cited an earlier Ninth Circuit opinion, Lieberman v. Hawkins (In re Lieberman), 245 F.3d 1090, (9th Cir. 2001) to determine that "debtor's subjective intent for or use of the asset is irrelevant to this analysis." That same earlier opinion held that "private retirement plans" under subsection (1) applied "only to retirement plans set up by private employers, 'not by individuals acting on their own, outside the employment sphere.' " As such, debtor's annuity here did not qualify as a "private retirement plan"

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
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