Money Corner: Financial Protection and Divorce
Published: 01/04/2022 05:52
The area of financial protection is one that most of us first come across when we are buying a house. The mortgage adviser will deftly remind us of all the things that might go wrong for our family if we were to become seriously ill or die. During my training in my early years in financial services, I worked for a national estate agency as a mortgage consultant and recall being shown a devastating video of the consequences for one family of not having sufficient protection in place. So, why is it important for those who are going through divorce?
Many of our clients rely on their maintenance payments. Whether child maintenance or spousal maintenance, without them they may struggle to pay bills and buy food, never mind any treats, holidays or entertainment. Often these payments are made to the spouse who gave up work to look after the children and haven’t had the same opportunity to build a career or achieve a high paying job.
With this reliance on an income stream from their ex, what happens if the ex becomes too ill to work or even dies? They are unlikely to benefit in the will and an Inheritance Act claim is costly, stressful and uncertain. So, what can they do to insure themselves against this situation? There are a few different financial protection products available that might suit this situation.
I should begin by explaining that insurance, or financial protection, cannot be taken out on just anyone’s life. There must be ‘insurable interest’, which is defined by the Association of British Insurers (ABI) as:
‘The interest that a person has in something such as a particular property or another individual, which means that the person would suffer a loss should that property or individual be harmed. In insurance law, you can only buy insurance for something or someone in which you have an insurable interest.’
In the case of a divorced couple, the maintenance recipient has an insurable interest in the maintenance payer, who will be the ‘life assured’ on the protection policy, as they would lose this income stream in the event of their becoming seriously ill or dying.
Now, let me summarise what each one does and the benefits they may have:
Term Assurance (Life Insurance)
Term Assurance is the most straightforward financial protection policy, providing a defined lump sum payment in the event of the death of the life assured occurring within the specified term, e.g. if John’s death occurs within 10 years, the policy owner, ex-spouse, receives £500,000. If the policy is a ‘level term’ policy the amount will always be the same. However, there are options for the sum assured (amount paid out) to increase, which is more expensive, or decrease, which is cheaper.
Whole of Life
As the name suggests, this policy does not have a limited term. It is therefore either very expensive to begin with or increases in cost as time moves on. If you are in a position where you have pension benefits, either yours or via a sharing order, the maintenance will be likely to cease at some point, removing the ‘insurable interest’ and the policy issue if something happens to your former spouse. Therefore, this may not be appropriate, unless there is a lifetime maintenance order.
Critical Illness Cover
This is usually paid as a lump sum if the life assured is diagnosed with one of a list of specified illnesses within a defined term. There is no deferred period, i.e. they don’t have to be ill for a certain amount of time, but there will be no pay out if the illness is not on the list. As an example, many providers cover some cancers but they may only cover the advanced stages, even if the life assured cannot work in the initial stages. There are providers who offer a basic list and a comprehensive list.
Family Income Benefit
This can be a form of Life Insurance or Critical Illness Cover. Rather than receiving a lump sum, you will receive a monthly or annual benefit to the end of the policy term. There are options for the benefits to be taken to retirement and the annual amount could increase with inflation. It tends to be lower cost than the lump sum options because the total amount of cover that would be received decreases year on year.
Income Protection will pay a monthly benefit after a set amount of time (deferred period), such as 4, 12, 26 or 52 weeks. Short term policies are available or those that pay to retirement. The benefits can also be taken to increase with inflation so that you continue to receive an equivalent amount.
The cost of financial protection often increases with age and so existing cover held by a couple may cost less than a new policy would. However, it is important to review any existing policies to ensure that the cover remains appropriate and fit for purpose. Also, many protection policies are held in trust, which again may name beneficiaries who the individuals may no longer wish to benefit.
One important issue is that cover should not be cancelled during the divorce process as it may provide valuable protection until the decree absolute (or Final Order) are issued.
What protection is appropriate?
As my family lawyer friends often say, it depends! There are many aspects that we should take into consideration when considering financial protection for clients.
Firstly, the willingness of the ex-spouse to provide essential information in a timely manner for the application. If we are insuring the life of another, i.e. one spouse is taking out an insurance policy on their ex-spouse, there will still be a need for both parties to be involved. The ‘life assured’ will need to complete a medical questionnaire. There may also be requirements for further medical information from the GP or even an in-person medical assessment.
Secondly, the cost of the new policy. The ex-spouse’s age, smoker status and medical information will all impact the cost of the policy. If the ex-spouse is a smoker, older and in poor health, it may be that the maintenance recipient cannot afford the premiums for the new policy.
Thirdly, the type of cover needed may not be available. In many cases, the most appropriate cover might be income protection for the ex-spouse’s income. However, this is only available as cover for the individual’s own earnings or by an employer. This might mean the maintenance payer taking a policy to ensure that they can always make their maintenance payments, and also protect their own income for themselves. This is not entirely satisfactory as they could cease cover at any time, without the knowledge of the maintenance recipient.
In conclusion, this is an area in which specialist advice is essential to ensure that your client receives the best possible advice. Financial advisers, financial planners and wealth managers should all usually be able to help, although it is worth considering a divorce specialist who will have come across the various scenarios during their everyday work.