Beware the risks in ceding life policies

Joe Average had a life insurance policy which he ceded to one of South Africa’s "big four” banks to cover an existing debt. He passed away before the debt was settled and the bank duly exercised its rights, settling the debt out of the proceeds of the policy. The bank then paid out the remainder of the proceeds into Joe’s estate.

This sounds like an equitable resolution except that Joe had named beneficiaries on the life policy. And although Joe’s estate account was solvent and would have a positive balance after all liabilities had been settled, the beneficiaries of the estate were not the same as those named on the policy. Have the bank and insurer handled the situation correctly?

Ryan Chegwidden, Actuarial Executive at Altrisk, says that the correct procedure varies in line with the type of cession given. "If it is a collateral or security cession, then the bank is only entitled to the amount of the debt and the beneficiaries are entitled to the balance,” he says.

In the case of an outright cession the bank will receive all the proceeds, settle the debt, and then pay the balance into the estate. "The beneficiary’s rights fall away when the outright cession is given,” says Chegwidden.

Life insurer Sanlam offers another perspective. Clive Hill, Legal Adviser at Sanlam Trust, says that the wording of the cession agreement and policy must be considered. "A bank should ideally take only a security cession, in other words a cession of the policy as security for the money the bank has lent to the client. The banks typically insist that the client signs their cession documentation and different banks use different wording.

Although there is no general rule, the cession often specifies that all policy beneficiary nominations are cancelled as soon as the policy is ceded to the bank. If Joe signed such a cession, there would have been no automatic reinstatement of the beneficiaries and the balance of the policy must therefore be paid to the estate. To be fair to all parties, the wording should rather oblige the bank to pay the beneficiaries once it has received full payment of its debt.”

The banks typically insist that the client signs their cession documentation. Different banks use different wordings… Although there is no general rule, the cession often specifies that all policy beneficiary nominations are cancelled as soon as the policy is ceded to the bank! Had Joe signed such a cession there would have been no automatic reinstatement of the beneficiaries and the balance of the policy has to be paid to the estate.

Geraldine Macpherson, Legal Marketing Specialist at Liberty provides insight into how the insurer should behave in the case of a collateral or security cession. "The insurer will pay all of the benefits to the cessionary in the event of a claim, but the cessionary is only entitled to retain so much of the money as is outstanding in terms of the underlying loan agreement,” she says. "The balance is not for the bank”.

The obvious and simplest solution is for the bank to pay any excess to the estate of the deceased life assured. "This amount will then form part of that estate – subject to the terms and conditions of the will – and be available to settle any debts or claims against the estate, whether from creditors or dependents” said Macpherson.

Could Joe have done anything differently? The only "bullet proof” workaround is seldom used in practice. Macpherson says that the cession form/contract and the reference to cessions in policy documents issued by the life insurance company will usually be relatively straightforward: The cessionary will acquire all rights to the benefits under the contract.

These forms do not regulate what the cessionary must do with any excess. As a result, there is nothing that prevents the cessionary and the policyholder from agreeing in writing that the excess will be paid by the cessionary directly to specified third parties, such as the original policy beneficiaries.