March 2000

Revised UCC Article 9:
Insurance Policies As Collateral

by Cassandra K. Ward Brown

After more than two decades, Article 9 -- Secured Transactions -- of the Uniform Commercial Code (UCC) has been revised. Following years of discussion, reconsideration and rewriting, the Drafting Committee of the UCC Permanent Editorial Board (PEB) produced the final draft of the revised UCC Article 9 in 1998. The goal of the revision was to expand the applicability of Article 9 to reach certain kinds of modern and intangible personal property not reached by the current code. The intent was to make security interests easier to create and more difficult to defeat, reducing litigation and making secured transactions less expensive.

In May of 1998, the American Law Institute approved the changes to Article 9 at its annual meeting, and the National Conference of Commissioners on Uniform State Laws unanimously approved the revisions at its meeting in July of 1998. As of January 15, 2000, seven states had adopted the new Article 9,1 and approval of the revised uniform law was pending in 14 states,2 including Minnesota.3 The drafting committee hopes that states will promptly adopt the revised Article 9 as it has proposed July 1, 2001, as the effective date. The use of a common effective date is expected to ease the impact of complex transition rules upon the status of some security interests and financing statements.4

This article focuses on the proposal to make insurance policies collateral -- property subject to a security interest -- under the revised Article9.

Currently, UCC §9-104(g) explicitly excludes from the scope of Article 9 any transfer of an interest or a claim in or under any policy of insurance, except as provided with reference to proceeds and priority in proceeds of insurance. Comments to early drafts of the current Article 9 make it clear that insurance policies were meant to be included as collateral under the UCC. However, the exclusion is purported to have been politically inspired by defense counsel who did not want to risk potential legal hazards that could develop from allowing insurance policies to be included as the subject matter of security interests.5

Official Comment 7 to UCC §9-104(g) contains the explanation for the current exclusion of insurance as collateral under Article 9: "Rights under life insurance and other policies … are often put up as collateral. Such transactions are often quite special, do not fit easily under a general commercial statute and are adequately covered by existing law."

The Article 9 Drafting Committee sought to revise §9-104(g) based upon the recommendations of the Article 9 Study Committee, which asserted two main arguments in support of using at least some insurance policies as collateral. First, the study committee asserted that the explanation for the original exclusion of insurance as collateral under §9-104(g) was questionable at the time of inception, and that in the context of contemporary commercial practices, that explanation might not be as persuasive today. Second, the study committee suggested that since insurance is currently used as non-UCC collateral by assignment, to include some policies as Article 9 security would simply provide the benefit of a uniform law to govern such transactions and avoid the inconsistency of varying state statutes and common-law decisions.

Currently, under common law, a creditor can obtain a security interest in an insurance policy. Issues related to the validity of interests and priority of payments are addressed on a case-by-case basis by the courts and the law has evolved over time to address ever-changing situations and commercial practices. Although the current system is imperfect, defense counsel probably prefer it to a uniform law that cannot possibly take into account myriad variations of facts and circumstances, although a cut and dried code would seem attractive in its apparent simplicity.

Cassandra K. Ward Brown is an insurance defense attorney with Brett Olander & Associates (State Farm corporate litigation counsel). She is a 1995 graduate of the University of Minnesota Law School and was executive editor of and published in the Law & Inequality Journal.

"the concerns of consumer advocates and the insurance industry prevailed"

Ultimately, the drafting committee decided not to have Article 9 generally cover security interests in insurance claims. Under new §§9-102(a)(46) (Definition of health-care-insurance receivable) and 9-109(d)(8) (Limitation of applicability to only health-care-insurance receivables), the revised Article 9 deletes the general policy exclusion under the current §9-104(g) but allows security interests only in health-care-insurance receivables held by health-care providers.6 Thus, with the sole exception of health-care-insurance receivables, the revision retains the effect of the existing rule under §9-104(g), which allows security interests in insurance claims only as "proceeds." Based upon the very limited new provisions, it appears that the concerns of consumer advocates and the insurance industry prevailed. The use of insurance policies as collateral under the revised Article 9 remains limited, despite the development and regulation of modern commercial practices and the inconsistency of the common law.

The insurance industry may have faced potentially increased vulnerability and resultant litigation with a more expansive revision to Article 9. Ultimately, an insurance company probably does not care who it pays. However, difficulties could arise if the insurance company cannot determine whom it should pay (a beneficiary or secured party) or when the insurer fails to pay the "proper party," leading to litigation. Compliance costs, in terms of time and money to obtain and maintain updated information regarding who has a valid interest in a policy, would also be a concern with a more expansive revision. Notice requirements could be a significant issue with a more broad revision, also. Would an insurer have an obligation to notify beneficiaries, for example, of security interests taken in policies and/or to notify secured parties, for example, of missed premium payments or policy cancellations?

Potential conflict of interest issues under a more expansive revision of Article 9 could have arisen where, for example, an insurance company that sells a debtor a policy and also provides financial services extends credit to the debtor and subsequently takes a security interest in the debtor’s insurance policy. A potential for fraud or collusion may also have arisen, for example, related to fire policies which name a mortgage company as the beneficiary but in which another creditor has taken a security interest. In these scenarios, who would police insurance companies? Would insurance companies be required to police their policyholders?

Consumer advocates also identified several issues that might affect ordinary consumers if insurance policies were generally included as collateral under the revised Article 9.7 A primary issue involves the perceived danger of allowing security interests to be taken in life and other insurance policies held by individuals. If insurance policies as assets were added to the scope of Article 9, more creditors, particularly national creditors, could be expected to take security interests in the policies. Such widespread use of individual life or health insurance policies as collateral might implicate fundamental social policies and undermine the basic purposes of insurance, one of which is to be available to beneficiaries for unexpected or unplanned events. Another concern relates to the belief that there is not true and equal negotiation and understanding, by both creditors and individuals, of the clauses of preprinted form documents typically used in commercial transactions. The perception is that the average consumer guarantor could not reasonably be expected to fully understand the rights being lost in a waiver prepared by a creditor, especially if the waiver were executed before any default.

Whether the drafting committee was responding to concerns of the insurance industry and defense counsel, consumer advocates, or simply the realization that a more expansive revision to Article 9 could give rise to more complex questions and problems, it apparently determined that including insurance policies in general as Article 9 collateral was not presently workable. Certainly, the task of thinking through and developing all of the special rules that would be required to avoid upsetting established practices and to ensure that insurers would not face increased compliance costs or be put in danger of "paying twice" would be daunting. It will undoubtedly be several decades again before any further revisions to expand the use of insurance policies in general as Article 9 collateral are considered. Meanwhile, the Minnesota Legislature must consider whether to adopt all of the revisions to Article 9 in light of the overall impact the proposed changes could have on secured transactions in Minnesota.

1. Arizona, California, Maryland, Montana, Nebraska, Nevada, and Texas.

2. Alaska, Delaware, District of Columbia, Hawaii, Illinois, Indiana, Kansas, Louisiana, Maine, Minnesota, Missouri, Oklahoma, Vermont, and West Virginia.

3. See Minnesota H.F. 1394 (Pawlenty) and S.F. 1495 (Hottinger).

4. Generally, pursuant to Revised Article 9, §§9-702 through 9-708, a security interest perfected under the current Article 9 will remain perfected under the new Article 9, and a financing statement filed in the correct state under the current Article 9 will remain effective for a period under the new Article 9.

5. See G. Gilmore, Security Interests in Personal Property, §10.7 at 315 (1965).

6. See U.C.C. Article 9, §102(a)(46); see also U.C.C. Article 9, §109(d)(8).

7. See Gail Hillebrand, "The Revision of UCC Article 9: The 1992 Final Report," 27 UCC L.J., 179 (Fall 1994).