The effect of an assignment on the rights of the beneficiary depends not only on the type of beneficiary designation but also on the type of assignment involved: an absolute assignment or a collateral assignment.

The absolute assignment divests the policyowner of all incidents of ownership and transfers all rights and interests in the policy absolutely and permanently to the assignee. It is designed for situations (such as a gift or a sale) in which the assignor’s clear intent is to make the assignee the new owner of the policy. The collateral assignment, on the other hand, transfers to the assignee those rights—-and only those rights—-needed to protect a loan from the assignee to the assignor. It resembles a mortgage of land or a pledge of marketable securities. The arrangement is intended to be temporary; upon repayment of the loan, the assignment terminates, and all assigned rights revert to the previous owner. The assignee’s interest in the policy is limited to the amount of the indebtedness and unpaid interest, plus any premiums paid by the assignee to keep the policy in force.

For reasons explained later in this chapter, absolute assignments have frequently been used when only a security arrangement was intended. In such cases the assignment is treated as a collateral one and is released upon satisfaction of the assignor’s obligation to the assignee. In fact, the courts will enforce such a result if the assignor can prove that a collateral assignment between the assignor and assignee was intended.

If assignment of a policy is absolute in form, and the parties intended the assignment to be absolute in substance as well, the beneficiary’s interest is completely extinguished, provided the designation was revocable, or if irrevocable, that the beneficiary joined in the assignment. If an assignment is collateral in substance, irrespective of its form, the beneficiary’s interest will be extinguished to the extent of the assignee’s interest, which is limited in the manner described above. If the policyowner attempts to assign the policy without the consent of the beneficiary when such consent is necessary, a valid transfer of the policyowner’s interest takes place, but the beneficiary’s interest is not affected. If the assignment affects a revocable beneficiary in a jurisdiction that sees a defeasible vested interest, the designation remains in effect until a change has been accomplished in the prescribed manner. If the assignment involves an irrevocable beneficiary, the designation is unaffected and the assignee can exercise no contract rights and privileges without the irrevocable beneficiary’s consent.

With regard to whether the interest of a third-party beneficiary is subordinate to that of the assignee without a formal change of beneficiary, courts in general have based their rulings purely on the intent of the parties. Most of the litigation involved collateral assignments; in such cases, there is usually a clear intent to subordinate the beneficiary’s interest to that of the creditor-assignee.

In absolute assignments the courts recognize this intent to subordinate the beneficiary’s interest to that of the assignee in two ways. First, if the assignee can perfect his or her claim by observing the formalities of a change of beneficiary, the courts are willing to spare the assignee the trouble of doing so. Thus in cases involving absolute assignments that are not incidental to a credit transaction, some courts have concluded that a formal assignment with notice to the insurance company substantially conforms to the requirements for a change of beneficiary and operates as such. (This rationale is patently inappropriate for collateral assignments, however, since the beneficiary of record receives the proceeds in excess of the claims of the assignment.) Second, an absolute assignment of policy ownership does not operate to change the preexisting beneficiary designation. Consent of the beneficiary to the assignment is therefore regarded in all jurisdictions as conclusive evidence of intent to give a preferred status to the rights and claims of the assignee (the new owner), who must act in accordance with the policy provisions to name a new beneficiary.

In all states it is held that whenever the beneficiary of a policy is the insured or the insured’s estate, the claims of the assignee will prevail over those of the executor or administrator of the insured’s estate. This is true whether the assignment is absolute or collateral in form. Accordingly, it is the current practice to use collateral assignment forms that require the beneficiary’s signature. In the execution of assignments incidental to policy loans, insurers require this procedure unless the wording of the policy makes it unnecessary (as is the case with current policies). A sample provision reads as follows:

The effectiveness of this type of provision has been upheld even under the laws of New Jersey, which historically has been one of the states requiring the consent of a revocable beneficiary to an assignment of the policy. Nevertheless, it would seem that an assignee who wants to avoid any possible legal complications upon the death of the insured would be well advised to designate himself or herself as beneficiary. There could then be no doubt as to the assignee’s right to receive the proceeds.