March 6, 2010
By Laura du Preez
Be sure you understand all the implications before you cede a life policy as security for a loan, and be particularly aware of how the cession affects the nomination of beneficiaries to the policy.
In most such cases, ceding a policy will have the effect of denying the person you have nominated as the beneficiary direct access to the proceeds of your policy should you die before the cession is cancelled.
This is often the case even if you have repaid all or part of the debt before you die because, after your debt has been settled, the balance of the proceeds of the policy may be paid into your estate instead of directly to the beneficiary.
However, the exact effects of ceding a policy as security for a debt will depend on the wording of the various documents involved, Chris Nel, a director for trust and estate planning with Finscape Executors and Trustees, says in an article in a recent issue of the Financial Planning Institute's magazine The Financial Planner. Nel is an advocate and holds a Certified Financial Planner accreditation.
Typically, you would cede a life policy to a bank as security for a home loan, overdraft or personal loan. Many hundreds of thousands of policies have been ceded for this purpose in South Africa.
Nel says many problems can arise with the payment of the proceeds of a policy that has been ceded. These include:
You have repaid your debt, but your insurer is unaware of this and pays the proceeds of your policy to the bank or creditor to whom you previously owed money instead of to the person you have named as the beneficiary;
You have repaid part of the loan, and the proceeds of the policy now exceed the balance of the loan. The policy is still ceded to your creditor and so your insurer will pay the entire proceeds to the creditor. The creditor may then pay the amount by which the proceeds exceed the debt to the executor of your estate instead of to a nominated beneficiary, or vice versa. It may even fail to pay the money over as a result of its own insolvency, greed or ignorance, Nel says.
If the proceeds of a policy are paid into your estate rather than to someone you have named as a beneficiary, the proceeds will attract executors' fees.
Executors can charge up to 3.5 percent of the assets in your estate plus VAT, which amounts to 3.99 percent.
Policy proceeds paid directly to a named beneficiary will be free of executors' fees.
When it comes to estate duty, it does not matter whether the policy is paid directly to your beneficiary or into your estate and then left to the beneficiary. The Estate Duty Act says a policy on your life is a deemed asset in your estate and only in certain circumstances are the proceeds exempt. A policy paid to your spouse would, for example, be exempt from estate duty, but one that pays out to your children would not be.
If the proceeds of a policy are paid into your estate instead of directly to a beneficiary, it also means that the beneficiary will not receive the money immediately and may have to wait months for the estate to be wound up and the inheritance paid out from the estate.
Nomination suspended
Nel says generally the effect of ceding a policy as security for a debt is that it suspends an existing beneficiary nomination.
In this case, to reinstate the beneficiary nomination, the cession needs to be cancelled when the debt has been repaid.
However, Nel says, sometimes the legal documents stipulate that a security cession will revoke an existing beneficiary nomination. In such a case, even if you repay the debt and cancel the cession, the nomination will not be reinstated. You can, however, make a new nomination.
Nel says the relevant clause may be on any one of four different documents and you need to study the terms of all these legal documents before you cede a policy (see "Documents to check when ceding a policy for debt").
Anna Rosenberg of the Association for Savings & Investment SA says there are subtle differences between life assurers' contracts, and the consequences of ceding a policy may be different depending on the contract and the circumstances.
Rosenberg says in most circumstances, any cessionary (creditor) to whom a policy has been ceded acquires all rights, title and interest in the policy, and all benefits become payable to that cessionary and not to a previously nominated beneficiary.
Most life assurers deal in their policy wording with the case of what will happen when the policy proceeds exceed the debt for which the policy was ceded, Rosenberg says. Because the life assurer is not a party to the cession and may not have information on the amount of underlying debt and so on, she says, the policy wording may state that the full amount is paid to the creditor - it is then up to the policy owner to arrange with the creditor for the excess amount to be paid to the estate or beneficiary.
In terms of the underlying credit agreement, the creditor would not be allowed to keep the excess amount and would, in any case, have to pay it over to the person who ceded the policy or to the estate of that person on his or her death, Rosenberg says.
Different wordings
A few years ago Old Mutual put out a circular outlining how it deals with cessions and beneficiary nominations. It said that over its 157-year history the wording of its policies have changed several times and different wordings apply to different policies.
Older policies, for example, declare the beneficiary nomination null and void when the policy is ceded as security. This means that the beneficiary nomination is cancelled on cession and does not revive when the debt is repaid and the cession is released.
Some newer Greenlight policies state that the rights of an entity to which the policy is ceded take precedence over any rights given to a nominated beneficiary as long as the cession is noted in Old Mutual's records. The beneficiary nomination revives as soon as the cession is cancelled.
Policies in-between the older and newer ones have clauses that state that the beneficiary nomination will be overruled by a later valid cession of the policy. In these cases it is likely that the beneficiary nomination would be revived when the cession is cancelled, Old Mutual's circular says.
Old Mutual says beneficiaries can be nominated on its policies when the policy is taken out or later, when a beneficiary nomination form is completed and the policy is endorsed.
The rules on beneficiary nomination forms completed later may differ from the rules in the original policy document, it says. In such cases, the endorsement overrides the original rules.
In cases where the beneficiary nomination will be revived when the cession is cancelled and you have repaid the debt for which you ceded a policy as security but failed to cancel the cession, it may be possible for the nominated beneficiary to still be paid the policy proceeds if he or she quickly informs the life assurer that the debt has been repaid.
Old Mutual's circular states that "except for the policies which have clauses stating that the beneficiary nomination will be null and void, we will treat beneficiary nominations as being operative if we receive notification of the cancellation of the cession before proceeds are paid out".
The life assurer says that if a policy is ceded to a creditor, such as a bank, and the debt owed is less than the proceeds of the policy, the bank will pay any balance to your deceased estate because, while the cession is in force, the beneficiary nomination is not operative.
To have any other situation apply, you would need to make a private agreement with your bank, the life assurer says.
Key questions
If you have ceded a policy as security for a debt or need to cede a policy on which you have named a beneficiary, Old Mutual says these are some key questions you need to answer:
What happens to the beneficiary nomination while the policy is ceded to the bank?
Will a beneficiary nomination for proceeds revive automatically (during the lifetime of the policy owner) when the security cession has been cancelled?
Will the surplus of a ceded policy be paid to the beneficiary who was nominated on the policy prior to the security cession, or will it be paid to the deceased estate?
Will the beneficiary nomination revive if the policyholder dies while the security cession is in force even though the debt to the creditor has been discharged prior to death?
Documents to check when ceding a policy for debt
Nel says the documents you need to consider when you cede a policy for debt are:
1. The policy document. Your life assurance policy may contain provisions relating to the nomination of beneficiaries and/or the cession, whether outright or as security for a loan. Nel says the terms of the policy may:
Prohibit the cession of the policy;
Prohibit the nomination of beneficiaries;
Prescribe the form in which a cession must be made;
Prescribe the form in which a beneficiary nomination must be made; or
Stipulate how a security cession would affect an existing beneficiary nomination and possibly even subsequent beneficiary nominations.
2. The debt agreement. Nel says the agreement you have with your bank or other creditor may contain provisions requiring the cession of policies and may stipulate how the creditor will deal with any policy proceeds that exceed the outstanding debt.
3. The cession document. This is the document in which you cede your rights to the policy as security for the debt, and it may stipulate the effect the cession will have on an existing beneficiary nomination.
4. The beneficiary nomination document. This is the document in which you name a beneficiary to a policy. Nel says it may stipulate the effect any subsequent security cession will have on an existing beneficiary nomination.
  
 
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