What happens to the nominated beneficiaries once a life policy is ceded with a bank?

A few years ago, Mr. Moduke* applied for a personal loan of P400k with one of the local banks. One of the major deductions on the loan offer letter was insurance. The bank was going to withhold up to P25K as insurance for the loan among the usual deductions. Because of the deductions, Mr. Moduke was going to get an amount less than the P400K that he had applied for. This was despite the interest of the loan being charged on the principal loan amount of P400K.

When Mr. Moduke discussed the offer letter with a friend, they agreed that the P25K that the bank was going to deduct for insurance was too much money. The friend advised that Mr. Moduke can get a life policy of P500K with one of the insurance companies and cede it at the bank instead.

Upon ceding the life policy to the bank, indeed Mr. Moduke managed to stop the bank from withholding the P25K for insurance. Unfortunately, three years into repaying the loan, Mr. Moduke passed on while still owing the bank over P250K.

The life insurance company paid all of the policy's sum assured of P500K to the bank. The family had thought that the life insurance company would pay the bank only the outstanding debt of P250K and pay the balance of P350K from the proceeds of the policy to Mr. Moduke's nominated beneficiaries.

The life insurance company however argued that it was not part of the cession and would not have known about the amount of the underlying debt. It turned out that when Mr. Moduke ceded the policy, he had agreed to the bank acquiring all rights, tittle and interest in the policy. This implied that all benefits from the life policy would become payable to the bank & not to Mr. Moduke's previously nominated beneficiaries.

So, after subtracting their outstanding debt of P250K from the policy payout of P500K, the bank later paid the balance of P350K to Mr. Moduke's estate instead. While that appeared to be above board, it unfortunately meant that Mr. Moduke's nominated beneficiaries had to wait for months until the estate is wound up before they could get their share from the life policy proceeds. It also meant that, the life policy proceeds would then be subject to the estate executor fees, something that would not have happened had the proceeds been paid directly to the beneficiaries and not to the estate.

There was another dilemma. The beneficiaries of the estate written in Mr. Moduke's Will were different from those previously nominated on his life policy before he ceded it to the bank.

With the benefit of hindsight Mr. Moduke's friend realized that they should have established the following before & after the life policy was ceded to the bank:

• Would the beneficiary nomination be revived if the policyholder dies while the life policy cession is in force?
• When the loan is finished and the life policy cession is cancelled, does the beneficiary nomination revive automatically?
• Would it be possible to have a written agreement with the bank that the balance from the policy proceeds after settling the outstanding debt be paid to the nominated beneficiaries and not to the estate?
• When the loan is finished, does the life policy cession also become automatically cancelled or the policyholder must still notify their insurance company and reinstate the interests, rights & tittle of the policy to the nominated beneficiaries?

Thank you for reading. If you have an existing life policy cession or considering ceding your life cover with a bank, it is advisable to carefully read the life policy document, the cession document, the loan agreement & any other related documents to get a picture of how these scenarios would play out in your case. Practices and document wording can differ between banks & insurance companies. You can engage your bank directly & your insurance broker (financial advisor) for further clarifications.

*Disclaimer: The name Mr. Moduke portrayed in this article is a character meant to aid explanation. No identification with actual persons (living or deceased) should be inferred.