Ceding life policies: Beware the pitfalls

Intermediaries providing advice or performing services relating to the cession or sale of policies must understand the distinction between ceding the policy as security for a debt or selling the policy to a new owner entirely.

Besides the credit life policies available, life policies are often used as security for major debts such as the debts of new businesses, and to secure major lending transactions. The intention is not to transfer the policy entirely to a new owner, but to put up the policy proceeds - including any proceeds due on cancellation or surrender - as security for the balance of the debt. Once the secured debt is discharged, any proceeds of the policy not required for that purpose must be returned to the policyholder.

To achieve the cession of a policy for security purposes, the policyholder should not “cede, assign, transfer and make over all and any rights in and to the policy” as we so often read. The insured is not transferring all rights in the policy, only the right to the proceeds. All that the policyholder should do is “cede and transfer to the creditor the rights of the policyholder to receive any proceeds or benefits under the policy”, as security for the amount owing.

The documents should also deal with the policyholder’s residual rights to cancel the cession and get back the rest of the benefits left after the secured debt is discharged. After all, the debt may be paid by the debtor and the policy benefits may not be used at all. If the security is provided in favour of an individual, or a company within thresholds under the National Credit Act, that Act will have to be complied with.

Selling the policy

The other form of cession is an out-and-out assignment of a policy to a new owner. This can happen, for instance, to give only two examples, within the market for second-hand policies or when the life assured under a keyperson policy in favour of an employer or partnership retires and takes over the policy for his or her own benefit.

In this case, the policyholder should “cede, assign and transfer and make over all the policyholder’s rights in the policy”. The out-and-out assignment of a policy is a novation of the policy where a new contract comes into being. The old policyholder receives the proceeds from the sale of the policy and falls out of the picture entirely, with no residual rights under the assigned policy at all.

English law and practice accept that a person who takes out a policy on his/her own life, can sell that policy on the secondary market to raise money. The marketing of second-hand policies has been examined in certain South African High Court actions without adverse comment.

Buyer beware

Once the policy is assigned to the new owner, it is a contract between the new owner and the life assurer. Provided it is a commercial transaction, the new owner will have acquired an insurable interest in the life of the previous policyholder, the life assured, by paying good value for the policy.

The policy may contain conditions or exclusions relating to the previous policyholder as the life assured. By arrangement between the parties, it is usually possible to add or substitute a new life assured and to change the conditions of the policy to suit the new owner. A sensible life assurer who wants to ensure that its policies are tradable as investments, will facilitate such changes.