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Insurance Law

Insurance as an Asset in the Estate – New Appleman on Insurance Law Library Edition, Chapter 108

By Susan N. K. Gummow



Having reviewed the basic elements and concepts of bankruptcy law in Chapter 107 above, Chapter 108 focuses on how insurance functions as an asset of the debtor’s bankruptcy estate.  Section 108.01 begins by examining the relationship between the debtor’s bankruptcy estate, its insurance policies, and the rights and obligations arising under the insurance policies.  Although the Bankruptcy Code’s definition of property of the estate is broad enough to include the debtor’s insurance policy, this does not necessarily mean that the proceeds of the policy are also property of the estate.  That determination depends on what type of policy is involved. 

Under a first-party policy, insurance proceeds are payable to the insured debtor, and so are usually considered to be property of the estate.  Thus, they would be subject to the jurisdiction of the bankruptcy court.  Sometimes, however, first-party policies name a secured creditor of the debtor as a loss payee or mortgagee.  In that instance, despite being payable under a first-party policy, the proceeds may not be property of the estate because they would be payable to a non-debtor third party.  The phrasing of the loss payee provision – naming the secured creditor as either a sole or co-payee – is often determinative.  Generally, if named as a sole loss payee, the secured creditor would take its share of the insurance proceeds up to the amount of their allowed secured claim, with any remainder going to the debtor’s bankruptcy estate.  However, if the secured creditor is listed as a co-payee, then the proceeds are considered property of the estate subject to the creditor’s allowed secured claim.

In contrast, the proceeds of third-party insurance policies are generally not considered property of the debtor’s estate.  This is because proceeds payable under third-party policies are not payable to the debtor; the debtor has no property interest in them.  In most cases where insurance proceeds are payable to an injured claimant, the insurance proceeds do not become an asset of the bankruptcy estate, and thus fall outside the bankruptcy court’s jurisdiction.  Occasionally, courts will interpret third-party policy insurance proceeds to be property of the estate, such as where the available proceeds are insufficient to pay all claimants, as further discussed in Section 108.01[2][c].

Chapter 108 also addresses the treatment of collateral held by an insurer when the insured files bankruptcy.  Insurance companies often require insureds to provide collateral to secure obligations owed under a policy, including deductibles or retrospective premiums.  If the debtor has provided the insurer cash collateral, the debtor-insured retains an equitable interest in the cash.  Under the Bankruptcy Code, the insurer is not free to use cash collateral to pay any unmet obligations without seeking bankruptcy court approval; the cash collateral constitutes “property of the estate”.  Letters of credit, however, are drawn upon the assets of the bank that issued the letter of credit on the debtor’s behalf.  Thus, a letter of credit is not property of the estate and is therefore a preferable form of collateral for insurers to hold.

Section 108.02 examines issues related to the debtor’s maintenance of insurance during bankruptcy.  Maintaining insurance during bankruptcy is not optional; a Chapter 11 debtor’s failure to adequately insure property of the estate constitutes “cause” for either converting the case to a Chapter 7 liquidation or dismissing it altogether.

Section 108.02 also discusses the concept of insurance as an “executory contract.”  Whether an insurance policy is executory or non-executory affects how the debtor-insured must treat its obligations under the policy.  In bankruptcy, an executory contract is a contract where material obligations remain so far unperformed on both sides that either party’s failure to perform would constitute a breach that would excuse the other party from continued performance.  If a contract is executory, bankruptcy law allows the debtor to either “assume” or “reject” it.  Put simply, those contracts that are beneficial to the debtor will be assumed, while those that are burdensome will be rejected.  Rejection is treated as a breach of the contract as of the petition date, and leaves the non-debtor party with merely pre-petition claim for breach of contract.  In contrast, when a debtor assumes a contract, it must comply with all obligations.  It is an all or nothing proposition — the debtor cannot assume the beneficial parts of the contract and reject those it considers burdensome.

Insurance policies are only executory when the policy period is still in force and there are outstanding premium amounts owed by the debtor.  If the debtor elects to assume the policy, it will have to become current on all obligations owed under the policy.  That means that the debtor-insured must pay all obligations in the ordinary course, whether for premiums, deductibles or self-insured retentions.

While an insurer whose policy is executory can expect favorable treatment, in the typical bankruptcy case most policies have expired prior to the debtor’s bankruptcy filing and so are not executory.  The fact that the insurer remains obligated to pay covered claims does not make the policy an executory contract.

Section 108.02[3] discusses renewal of insurance policies in bankruptcy.  Because of its bankruptcy, a debtor is not obligated to pay its pre-petition insurance obligations.  Those obligations constitute unsecured claims that are subject to discharge.  However, renewal during bankruptcy is often predicated on the insured complying with all current and former insurance programs.  Insureds, in recognition of the unlikelihood of finding a different carrier willing to provide more favorable coverage or terms, will often agree to the insurers demands, agreeing to comply with otherwise dischargeable  policy obligations.  

Section 108.02[4] examines cancellation of a policy during bankruptcy.  If the policy was issued pre-petition it is subject to the automatic stay (see Chapter 109 for a full discussion of the automatic stay).  Thus, the insurer must first obtain court approval before cancelling the policy.  If the policy was issued to the debtor post-petition, the policy is not subject to the automatic stay.  Thus, the insurer would be able to cancel the policy without first seeking permission from the court.

Also examined in Section 108.02 is the “bankruptcy” clause that is generally included in insurance policies.  Many states have statutes that require insurers to insert a provision into every policy providing that the insured’s bankruptcy filing will not relieve the insurer of its obligations under the policy.  Thus, the insured’s bankruptcy filing and resulting inability to perform certain obligations under non-executory contracts will not serve to prevent the insurer from having to respond to applicable claims. 

Section 108.03 examines issues surrounding the preservation and pursuance of claims while the insured is in bankruptcy.  The term “claim” as used in the context of bankruptcy is extremely broad and statutorily defined.  A creditor holding a bankruptcy claim files a proof of claim against the debtor’s bankruptcy estate.  A proof of claim allows the creditor to collect from the debtor’s estate.  But a proof of claim does not relate to the creditor’s “claim” as it is understood under an insurance policy. It is the insuring agreement of a policy that defines whether a claim is covered; bankruptcy does nothing to change this. Many of the other standard obligations that an insured must comply with outside of bankruptcy are equally enforceable in bankruptcy. 

Also examined is the concept of insurers with claims against the debtor-insured.  An insurer can hold a claim against its debtor-insured in a variety of instances.  To receive payment from the debtor, the insurer will need to file a proof of claim.  By filing the proof of claim, though, the insurer is submitting to the jurisdiction of the bankruptcy court to resolve the claim.  To preserve the right to have the matter liquidated in a non-bankruptcy forum, the insurer should incorporate a reservation of rights into its proof of claim.

Section 108.04 examines common types of policies and bankruptcy’s affect on the parties to them.  Under a deductible policy, the insurer is responsible for paying claims from “dollar one,” and then seeks reimbursement from the insured.  In bankruptcy, the insurer’s reimbursement claim is treated as a general unsecured claim. 

Self-insured retention (“SIR”) obligations are the responsibility of the debtor-insured, not the insurer.  It is the third party who seeks payment from the debtor-insured for amounts due within the retained limit.  Thus, it is the third-party claimant who holds a general unsecured claim for unsatisfied amounts within the SIR.  Courts do not require the insurer to “drop down” and pay amounts within the SIR.  Insurers generally continue to have an obligation for amounts payable above the SIR, consistent with the terms, conditions, and limitations of the applicable policy.

Chapter 108 also addresses specific types of insurance policies, such as fronting policies and loss-sensitive policies.  Fronting policies are designed in such a way that the insured retains the entire risk.  Typically, a fronting policy’s limits of liability equal the deductible.  Thus, the insured is entirely responsible for paying claims.  If the insurer pays any amounts, it is entitled to reimbursement.  In bankruptcy, this reimbursement claim is treated as a general unsecured claim.  However, most fronting policies are backed by collateral to secure the debtor-insured’s payment obligations.

A loss-sensitive insurance policy is an insurance policy which has a premium that varies based on the actual loss experience during the policy term.  Since the final premium is not determined until after the loss exposure is determined, the premium is often referred to as “retrospective.”  For those policies that expired pre-petition, the insurer will have a secured claim to the extent of the value of any collateral it holds to secured the retrospective premium obligations, and an unsecured claim for the remaining amount due for the retrospective premium.  Depending on the circumstances, the insurer may also have an administrative claim, as discussed in Section 108.04[3] of this chapter.

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Susan N.K. Gummow is a partner in the Chicago office of Foran Glennon Palandech Ponzi & Rudloff, P.C., where she handles business-related matters including bankruptcy, business litigation, and insurance law.  She has extensive experience representing insurance companies confronted with a full array of bankruptcy issues and is the author of several publications, including the BANKRUPTCY AND INSURANCE Law MANUAL, currently in its third edition.

The author would like to thank John P. Eggum and Eric J. Shukis for their valuable contributions to the drafting of this chapter.

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Table of Contents

§ 108.01 The Debtor’s Insurance Policies Are Property of the Estate

[1] The Debtor’s Contract Rights Under Its Insurance Policy Renders the Policy Property of the Bankruptcy Estate

[2] Even When the Policy Is an Asset of the Estate, the Proceeds of the Policy May Not Be

[a] The Type of Insurance Policy Affects Whether Proceeds Are Considered Property of the Debtor’s Estate

[b] Loss Payable Clauses in First-Party Policies

[i] The Loss Payable Clause May Determine Whether or Not the Insurance Proceeds Ever Become Property of the Insured’s Bankruptcy Estate

[ii] Creditor Named as Sole Loss Payee Versus Being Listed as Co-Payee

[iii] In Order to Assure That It Is Paying the Correct Party, an Insurer Can Seek a Stipulation From the Bankruptcy Court

[c] Proceeds of Third-Party Insurance Policies Are Typically Payable to Non-Debtor Third Parties and Therefore Generally Not Considered Property of the Estate

[3] Determining Whether Collateral Held by an Insurer Is Property of the Estate

[a] Cash Collateral Held by an Insurer Is Considered Property of the Estate, and So Is Subject to the Automatic Stay and Cannot Be Freely Used by an Insurer

[b] Letters of Credit Are Not Property of the Estate and Are Therefore a Preferred Form of Collateral for Insurers

§ 108.02 Issues Related to the Debtor’s Maintenance of Insurance in Bankruptcy

[1] Failure to Maintain Ongoing Insurance Can Result in Conversion or Dismissal of the Debtor’s Bankruptcy Case

[2] The Insurance Policy as an “Executory Contract"

[a] Defining “Executory” Contracts

[b] If a Contract is Executory, Then the Debtor May Either “Assume” or “Reject” It

[i] Assumption

[ii] Rejection

[iii] Time Frame for Assumption or Rejection

[iv] Standard of Review Applied to a Debtor’s Decision to Assume an Executory Contract

[c] An Insurance Policy Is an Executory Contract Only When It Has Not Been Cancelled or Expired by Its Own Terms and Premiums Remain Unpaid as of the Bankruptcy Petition Date

[d] Insurance Policies That Have Expired Prior to the Filing of Bankruptcy and for Which the Premium Has Been Fully Paid Are Not Executory Contracts

[3] Renewal of Insurance Policies During Bankruptcy Is Often Predicated on Compliance With Prior Policy Obligations

[4] Cancellation of an Insurance Policy During Bankruptcy

[a] Cancellation of an Insurance Policy Issued Pre-petition Requires Court Approval

[b] Cancellation of an Insurance Policy Issued to the Debtor Post-petition May Be Cancelled Without First Seeking the Court’s Permission

[5] Most States Require the Insertion of a “Bankruptcy Clause” in the Insurance Contract

§ 108.03 Preserving and Pursuing Insurance Claims During Bankruptcy

[1] A “Claim” in a Bankruptcy Proceeding Is Significantly Different From a Claim Under an Insurance Policy

[a] The Term “Claim” Has a Broad Yet Specific Meaning Under the Bankruptcy Code

[b] A “Claim” Under an Insurance Policy Is Determined by the Policy and in Many Ways Is Unrelated to the Bankruptcy Claim

[2] Bankruptcy Generally Has No Affect on Basic Insurance Requirements

[a] The Insurer Is Entitled to Notice of Claims as Required Under Its Policy Notwithstanding the Bankruptcy of the Insured

[b] A Debtor-Insured’s Duty to Cooperate Is Typically Unaffected by Its Bankruptcy Proceeding

[i] Overview

[ii] The Burden of Proof to Demonstrate a Failure to Cooperate Is Initially on the Insurer, but May Shift to the Insured

[iii] The Obligation to Cooperate Is Unaffected by the Insured’s Bankruptcy

[iv] An Insurer May Enforce Examination Under Oath and Sworn Proof of Loss Provisions During the Bankruptcy

[c] Voluntary Payments

[i] An Insured Cannot Settle a Claim Without the Consent of the Insurer

[ii] An Insurer Must Be Legally Obligated to Pay a Claim

[3] Fulfilling Proof of Claim Requirements for Amounts an Insurer May Be Owed

§ 108.04 Common Types of Insurance Policies and Bankruptcy’s Effect on Them

[1] Deductible Policies Versus Self-Insured Retentions ("SIRs")

[a] Distinguishing Between Deductibles and SIRs

[b] Bankruptcy’s Effect on Deductibles Versus SIRs

[i] Treatment of Deductibles

[ii] Treatment of Self-Insured Retentions

[A] The Debtor-Insured Will Include Amounts Due Within the SIR as General Unsecured Claims

[B] An Insurer Is Not Legally Obligated to Drop-Down and Pay Amounts Owed Within the SIR

[C] The Debtor’s Failure to Exhaust a SIR Does Not Relieve an Insurer of Its Coverage Obligations for Amounts Above the SIR

[D] Even Though the Insurer Does Not Have to Drop-Down, as a Practical Matter the Insurer May Elect to Pay Defense Costs Within the SIR to Protect Its Interests and Prevent Possible Exposure Above the SIR

[2] Fronting Policies

[3] Loss-Sensitive Policies

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