March 6, 2010
By Laura du Preez
If you cede a life assurance policy with an investment value as security for a debt, be aware that the bank may not only call in that security if you die, but also if you cannot repay the debt.
And as one unfortunate widow discovered, that may happen at the very time your family most needs the cover the policy would have provided.
Joanna van Aswegen of Bronkhorstspruit in Mpumalanga complained to the Ombud for Financial Services Providers about the loss her husband's estate suffered because First National Bank (FNB) surrendered the policies he ceded to the bank as security for his overdraft.
But Charles Pillai, the ombud, dismissed her complaint, finding that the bank had been within its rights to cash in the ceded policies to reduce the debt it was owed.
Gerhardus van Aswegen ran up an overdraft of R500 000 with FNB in 2005. He exceeded his overdraft limit by about R114 000, and the bank wanted him to reduce his debt to within the overdraft limit. Van Aswegen was unable to do so.
Van Aswegen had ceded five life policies to FNB as security for the debt. The life cover on these policies amounted to R517 813, and the surrender value of the policies amounted to R97 629.
The bank informed Van Aswegen that it would surrender the policies and use the R97 629 to reduce his overdraft.
It suggested that Van Aswegen use one of its financial advisers to assist with the surrender of the policies.
Sixth policy
The adviser suggested that Van Aswegen switch a sixth policy, which he had taken out with Sanlam and that was not ceded to FNB, for a cheaper one with Liberty. The motivation here was to reduce the premium payments and the savings from those used to pay off the overdraft.
The five policies were surrendered in February 2005, and the proceeds were paid to the bank. But in March 2005, before the new policy with Liberty was put in place, Van Aswegen died.
The Sanlam policy paid out R1.2 million.
Van Aswegen's widow complained to Pillai that the bank should have waited until the new policy was in place before surrendering the ones that were ceded to the bank.
She wanted to claim R420 919 from FNB - the difference between the insured value of the five policies and the surrender value the bank used to reduce the overdraft.
A manager at FNB told Pillai that various options aimed at reducing the debt were discussed with Van Aswegen. These included selling some of his vehicles, taking a loan on his policies and taking out a further mortgage bond on his farm. In the end, it was agreed that none of these options was suitable and that the ceded policies would be surrendered.
The ombud said although there is some dispute as to who decided to surrender the policies, the bank was entitled to surrender them if it chose to do so to settle the overdraft, because Van Aswegen was unable to do so.
He therefore found no grounds for the complaint.
However, Pillai did comment that the proposed policy switch appeared to be commission-driven selling, because it would have saved Van Aswegen only R106 a month and would have resulted in a lower insured value and the loss of other benefits.
However, since the switch never occurred, Van Aswegen's estate suffered no loss, he said.
Secure your debt for peace of mind
Regardless of whether your bank or any other creditor requires you to have a life policy ceded to it as security for a debt, you should consider whether you need such cover as security for your family, Chris Nel, a director for trust and estate planning with Finscape Executors and Trustees, says.
You should be sure you have enough cover should you die before repaying a debt such as a home loan, so it can be repaid and your dependants can continue to live in your home.
In addition to your existing debts, make sure the payout will cover costs your estate will incur after your death - for example, taxes and executor's fees. If you don't, the executor of your estate may have to sell your assets to provide this cash unless the beneficiaries make up the shortfall, Nel says.
A financial plan that takes into account what could happen if you die before repaying a debt is the first step, Nel says.
To avoid problems arising with proceeds of a policy that exceeds your debt, he says, it is best to have at least two different policies - one with no beneficiary nominations to cover your debt and which can be ceded to a creditor, and one in which you name beneficiaries, that is intended to provide for them, and which you do not cede.
Nel says although it may be a good idea to have a policy whose value declines as your debt declines, you should be aware that these policies are often expensive when you compare them with others.
A creditor can insist you take out life cover for a loan, but cannot dictate the institution from which you obtain that cover. You should shop around for the most cost-effective cover.
Declining life cover may also prove difficult to find. Metropolitan still offers this kind of cover, but both Momentum and Old Mutual, say they no longer do. Old Mutual says this is because of the prevalence of access bonds, which allow you continually to borrow on what you have paid back on your loan.
Old Mutual also says that if you take out declining cover you lose the flexibility of having cover in place. The cover cannot be used for other liabilities such as buying a bigger house later on or providing for estate duty that could arise.
Nel says that if you take on debt but cannot afford to take out a separate policy covering your debt, and plan to cede an existing policy to your creditor, before you do so you should ask yourself why you took out the policy in the first place and why you nominated any beneficiaries on that policy.
Ceding a policy outright or as security for a loan
You can cede a policy outright or as security for a debt. When a policy is ceded as security for a debt it becomes the property of the person or entity to whom you have ceded it only if you default on the loan, die before you repay it or if you are retrenched or disabled and are covered for your debt under these circumstances.
If you cede a policy outright, you transfer the ownership of the policy to another person permanently. Any beneficiary nomination would fall away and the new owner can nominate a beneficiary, Anna Rosenberg of the Association for Savings & Investment South Africa, says.
Beware not to confuse the two processes. An application for curatorship of Bonitas Medical Fund reveals that officials of this large medical scheme confused the two and, instead of ceding endowment policies valued at R39 million to a hospital as security for a debt, ceded the policies outright. When the policies matured the proceeds were paid to the hospital to the detriment of the scheme and its members.
What the banks say
Your bank may ask you to cede a life policy as security for a home loan, but it will not necessarily do so.
Toni Fritz, the head of home loan wealth products at Standard Bank, says that, in terms of the National Credit Act, banks are entitled to require you to have life assurance to cover what you owe in the event of your death, retrenchment, contracting a dread disease, or permanent or temporary disability.
Fritz says the bank's decision on whether you should have life cover on home or other loans may depend on your age, whether you are a first-time home-buyer, and the nature of the product.
He says some products require that you take out credit life cover because this allows the bank to lend to markets to which it would not normally lend and to do so at affordable interest rates.
Typically, Fritz says, juristic entities, such as companies or close corporations, would be required to cede a life or keyman policy as security to Standard Bank to cover the entity's debt.
Riana Tizzone, the marketing manager at First National Bank, says FNB has its own cession document that in effect gives the bank power of attorney to deal with the policy only in relation to the debt or purpose for which it was given.
To cancel the cession when the debt is repaid, Fritz says you need to ask the bank directly to cancel it. The bank will then inform the life assurance company that the cession has been cancelled.
  
 
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