Life insurance does not automatically terminate upon bankruptcy. However, a policy’s cash value or a payout may become relevant to the bankruptcy estate.
How life insurance is dealt with in bankruptcy depends on who owns the policy, who is insured, who receives the money, when monies are received and the applicable provincial exemption law.
To explain how bankruptcy can affect life insurance, our content team consulted the Office of the Superintendent of Bankruptcy’s asset-realization directive, its Statement of Affairs form, Ontario’s Insurance Act and the Financial Consumer Agency of Canada’s life insurance guide.
What Happens To Life Insurance During Bankruptcy In Canada?
Death benefits can be used to pay estate debts if the policy pays out to the estate. A benefit payable to a valid named beneficiary may instead pass outside the insured person’s estate under provincial insurance law. If the recipient of the death benefit is currently bankrupt, their Licensed Insolvency Trustee will have to assess if the death benefit forms part of the recipient’s bankruptcy estate.
Term life insurance policies usually have no cash value, while permanent life insurance policies may. In bankruptcy, any existing cash value needs to be disclosed to the Licensed Insolvency Trustee, who will review this amount. Depending on the terms of the insurance policy, who owns it, who is the beneficiary and the exemption law of the applicable province, the cash surrender value may be available to creditors or protected. Term insurance normally remains in force if premiums are paid and the contract is not otherwise changed.
| Situation | Issue the trustee must review |
|---|---|
| You own term insurance on your life | No cash value, whether premiums continue and who the beneficiary is |
| You own permanent insurance | Cash surrender value, loans, owner, beneficiary and provincial exemption |
| Your life is insured but someone else owns the policy | The trustee should be looking at the owner’s rights and bankruptcy, not merely at the insured person’s status. |
| You are named on someone else’s policy | Timing of the death benefit and your own bankruptcy estate |
| Your estate is the policy beneficiary | The proceeds may enter the estate and face estate creditors |
Who Owns The Policy And Who Receives The Money?
Do not confuse these three terms. The owner or policyholder is the person with the right to surrender or borrow against a policy or make changes to a revocable beneficiary. The insured is the person whose death triggers the benefit. The beneficiary is the recipient named in the contract who may receive the benefit, subject to the contract’s terms and the law.
| Role | Document to confirm | Why bankruptcy cares |
|---|---|---|
| Owner | Policy contract and current statement | The owner holds the cash value and controls contractual rights. |
| Insured person | Policy schedule | The insured event is linked to this person’s life. |
| Beneficiary | Latest accepted designation | It shows who may receive the death benefit. |
Term Vs Permanent Life Insurance In Bankruptcy
| Policy type | What can have value today | Practical next step |
|---|---|---|
| Term life | The policy usually has no cash surrender value. | Disclose the policy, keep premiums current and confirm the beneficiary |
| Whole life | Guaranteed or non-guaranteed cash value may exist. | Obtain a statement from the insurer indicating cash surrender value of the policy and its loans. |
| Universal life | The policy may hold value through an investment account or cash value. | Provide the current value, surrender terms, investments and any policy loans. |
| Group life | There is often no individual cash value. | Verify who owns the plan and review portability provisions and beneficiary rules in the certificate. |
Do not assume that your life insurance is worthless because you have already paid more in premiums than its current cash value. Also, don’t assume it’s protected just because a family member is the beneficiary.
The federal Statement of Affairs asks for the cash-surrender value of life insurance policies. Whether an exemption applies is for the trustee to review. Include your life insurance contract and a current insurer statement in the documents you provide to the trustee.
Read More: See How Cash Value Works in Permanent Life Insurance
Ontario’s Beneficiary Protections
In Ontario, a life insurance policy may be protected from creditors of the person whose life is insured under section 196 of the Insurance Act during the insured’s lifetime if the policy’s beneficiary is the insured’s spouse, child, grandchild or parent. Do not assume everyone commonly described as a spouse or partner qualifies under this section. Also, there may be limitations on the owner of the policy’s rights to borrow from, assign, change beneficiaries on, or surrender the policy if an irrevocable beneficiary is named.
If the proceeds of the insured’s policy pass to a validly designated beneficiary on the insured’s death, those proceeds generally pass outside of the insured’s estate, and are not available to the estate’s creditors. However, they may be available to the beneficiary’s creditors, including the beneficiary’s bankruptcy trustee.
These rules differ in other Canadian provinces. Ask an insolvency lawyer or Licensed Insolvency Trustee to review the policy’s ownership, beneficiary designation and applicable provincial law.
Read More: Review Revocable and Irrevocable Beneficiary Designations
Will My Beneficiaries Still Get the Payout?
The death benefit generally goes directly to them and is not used to repay creditors.
What Happens If I’m the Beneficiary of Someone Else’s Policy?
If you’re the beneficiary of the life insurance policy while in bankruptcy, the payout may become part of your bankruptcy estate and can be used to pay creditors.
Can I Still Borrow Against My Life Insurance?
You can technically borrow against your life insurance, but it may require approval from a trustee. However, remember that borrowing against your life insurance policy reduces its death benefit if you pass away before repaying it.
What Happens After Discharge?
You can still keep your life insurance policy after you’re discharged from bankruptcy. However, it may give you difficulties if you drop your current policy and plan to apply for another life insurance policy. In that case, answer any questions about your past bankruptcy accurately to ensure you’re not misrepresenting yourself.