Did you know that if an individual becomes bankrupt, certain life insurance policies (both inside and outside of superannuation) may be protected against bankruptcy?
Section 116(1) of the Bankruptcy Act 1966 (the Act) provides a broad description of ‘property’ that is divisible amongst creditors. This includes all property that:
- belonged to, or was vested in, the client at the commencement of the bankruptcy, or
- is acquired by the client, or devolves on them, after the commencement of the bankruptcy and before the client’s discharge.
The definition of ‘property’ would normally include life insurance policies and their proceeds, however, section 116(2) of the Act specifically excludes certain assets such as from being divisible among creditors, such as:
- policies of ‘life assurance’ or endowment assurance in respect of the life of the bankrupt or the spouse or de facto partner of the bankrupt
- the proceeds of such policies received on or after the date of bankruptcy
- an interest in a regulated superannuation fund, approved deposit fund or exempt public sector superannuation scheme.
However, there is a discrepancy between the Bankruptcy Act 1966 and the Life Insurance Act 1995 as to what constitutes a policy of ‘life insurance’ as opposed to policy of ‘life assurance’.
The Bankruptcy Act does not include reference to the term ‘life insurance’. Instead, it refers to 'life assurance’, which is undefined. At common law (as expressed by the High Court in National Mutual Life Association of Australasia Ltd v Federal Commissioner of Taxation (1959)), the definition of life assurance refers to policies on the life of an insured person (ie. a pure life insurance policy) as opposed to policies covering total and permanent disability (TPD), trauma, and income protection.
Whereas the Life Insurance Act defines a policy of ‘life insurance’ to also include any TPD, trauma and income protection.
This means the exemption under the Bankruptcy Act will only protect a bankrupt person's life insurance policy (and generally any TPD or trauma policies that are riders to that life policy) from being divisible amongst the creditors of the bankrupt. Thus, in the event of bankruptcy, the policy proceeds would go to the bankrupt policy owner, a surviving joint owner or a nominated beneficiary, or to the bankrupt policy owner’s estate.
As stand-alone TPD, trauma, and income protection policies are not considered ‘life insurance’ policies at common law, these policies will not be excluded from being property divisible amongst creditors of a bankrupt.
