Mike’s looking to buy a home. Problem is the banks want him to take out life insurance and cede it to them. He wants to know whether he should.
Here’s what you should know…
A life insurance policy is basically a contract between the life insurance company and the owner of the policy who is usually also the life insured. If something happens to the life insured, then the policy pays to the policy owner.
Of course, none of this helps if the owner of the policy also happens to be the life insured. Who gets the money when the life insured passes away? That’s why we have beneficiaries. These are the people who have been nominated within the contract to receive the life insurance when the policy owner passes away. If the life insured chooses no-one then the insurance pays into his or her estate.
So, you got that? There’s the insurance company, the life insurance policy owner who can also be the life insured and is usually the payer. Then there are the beneficiaries.
But things get complicated once we start talking of cessions.
If you think about it, Mike has two options:
- The bank can take out life insurance on his life. The bank would be the owner, the payer, and the beneficiary. But what would happen once Mike had paid off the debt? There’s no law which forces the bank to cancel the life insurance once the debt is paid off. So theoretically, the bank can collect once Mike eventually passes on at 85. The only reason why they wouldn’t do that is because they don’t want to waste their own money paying to insure your life when they can force you to do that.
- Mike can take out life insurance on his own life. Mike is the owner, the life insured, the payer, and the beneficiary. Mike can easily make the bank the beneficiary, but he can also remove them as beneficiary whenever he wants. The bank loves the fact that Mike is paying for his own life insurance but they’re not too happy about him being able to change the beneficiary whenever he wants. Is there anything they can do?
A cession works as follows:
Mike asks the life insurance company to send him a cession document. He then takes this to the bank for completion. Mike temporarily hands over the ownership of his life insurance to the bank for the term of his loan. He is known as the cedent and the bank as the cessionary. Once the bank has signed and stamped the forms, Mike sends them to the life insurance company who register the cession on their records.
If anything happens to Mike before the loan has been repaid, the life insurance is obligated to repay the loan amount to the bank.
But does this mean that the bank is entitled to the full amount of life insurance if the loan amount has halved? No. The bank will be paid the amount owing to them and the balance will go either to Mike’s estate or to his beneficiaries.
But what if the bank refuses to give the policy back?
There are two types of cessions:
- A collateral or security cession, and
- An outright cession
A collateral session is typically used when banks want security for a loan.
An outright cession happens when the transfer of ownership is permanent in nature. For instance, a business may cede a company owned life insurance policy to an employee when he resigns or retires.
So, there you have it. The parties to a life insurance contract are:
- the life insurance company
- The policy owner
- The life insured
- The payer
- The beneficiary
But it’s also possible to replace the policy owner with another by ceding your policy to them. If this is temporary in nature, then a security cession is done. If it’s permanent in nature, then an outright cession is done. With an outright cession, not only does the policy owner change, but the payer and the beneficiaries usually change as well.
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