Each year, thousands of life policies are ceded to financial istitutions, usually as security for a debt such as a bond, loan or overdraft.Cessions play a important role for many people in gaining access to finance, giving the lender a comfort in the knowledge that their loan will be repaid in the event of their death. Unfortunately, few people take the time to understand the implications of a cession and the impact on nominated beneficiaries, usually loved ones. Even fewer people actually cancel cessions once their debts have been paid off, leaving potentially serious implications for beneficiaries should the policyholder die or become disabled. The best person to help you with this is your financial adviser.
Craig Harding, managing director of Altrisk says that policyholders need to know the ins and outs of cessions and consider all the scenarios and implications for their beneficiaries before signing on the dotted line. "The reality is that if you cede a life policy, or even a portion thereof to another party, the law provides that the cessionary will be paid before any other party. It is also not necessary for the beneficiaries to give any consent to the ceding of a policy and they may not even be aware that a cession exists.
"The harsh reality is that ceding an insurance policy, for example to provide security for a loan such as a mortgage, could leave your loved ones without any source of income if you die. The cessionary will take what's due to them first and any surplus could end up in your estatewhich could take months to settle before they see any financial relief," explains Harding.
Given the above implications, it's vital that policyholders understand what a cession is, the different types of cessions, how to implement and cancel a cession and what the considerations are before ceding a policy. Once again, the best thing to do is to consult your financial adviser so they can factor existing cessions into your financial plan. The status of cessions should then be part of the regular financial review.
What is a cession?
A cession is the transfer of the rights to a policy from one party to another. The party acquiring the rights is called the cessionary. The party giving the up the rights is called the cedent. A policy can be ceded in two ways:
-Outright cession- all rights in terms of the policy are transferred to the cessionary and all proceeds of the policy are paid directly to the cessionary in the event of a claim and not the previous owner, his/ her beneficiaries or estate.
- Collateral security cession- in this instance the policy will be ceded as security for a loan, typically for a home loan. The cessionary's rights are limited to receiving the lower of the claim proceeds and the amount of the policy owner's liability to the cessionary. All other rights of ownership of the policy remain with the ploicy owner.
If the policy is ceded, the rights of the cessionary takes precedent and will be paid before any payments to nominated beneficiaries.
Implementing a cession
Before ceding a life policy there are a number of steps that need to be followed:
- check your policy document- it should contain:
*rules relating to the nomination of beneficiaries or to ceding the policy eg can the policy be ceded.
*the requirements (including forms)to cede a policy or nominate a beneficiary
* how a cession will affect existing beneficiaries
* how to cancel a cession.
- Check the debt agreement you have with the bank or creditor may contain provisions regarding cessions and may stipulate how the creditor will deal with any surplus funds in excess of your liability.
- Go through the cession document is where you will cede your rights to the policy as security for a debt and may also stipulate the effect the cession will have on an existing beneficiary nomination.
- The beneficiary nomination document names the beneficiary to a policy and it may also contain provisions regarding the effect than any subsequent security cession will have an existing beneficiary nomination.
-Make sure you understand who has the right to cancel the cession. "The exact effects od ceding a policy as security for a debt will be governed by the wording of the various documents involved, so it's vital to thoroughly study these documents and asess their impact in various scenarios
- your broker or financial adviser will be an important source of information in this regard,"says Harding.
You should be aware of the following:
>Where the creditor pays any balance into an estate, it may attract additional unforseen costs.
>Even if you have paid off your debt but failed to cancel the cession, the insurer will pay the policy proceeds to the cessionary instead of to your nominated beneficiaries. Aside from the possible unforseen costs, there is also the time required to resolve the estate to consider and its impact on the beneficiary's liquidity.
Cancelling a cession
In order to reinstate the beneficiary and policyholder's rights the cession must be cancelled. "In the case of an outright cession, or a collateral cession where the right to revocation has also been ceded, the institution to which the cession was made must cancel it in writing. This releases you of your responsibility and confirms that you no longer have a debt in this regard. which in turn must be communicated to the insurer. In some situations a cession will revoke an existing beneficiary nomination even if the cession has been cancelled- in this instance it is essential that you make a new nomination and record this with your insurance company," explains Harding.