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Life Insurance and Divorce

It's a sticky situation that requires expert guidance.

Judith A. Hasenauer, 07/02/2009

Divorce is an ever-present fact of modern life. Financial problems are often a key ingredient in married couples' disagreements that lead to divorce. Once divorce becomes a reality, finances assume a central position in the proceedings that follow. Splitting the marital property, properly caring for children, and spousal support questions often result in rancor between the parties and cause a cessation of necessary dialogue. If the marital couple have life insurance in force on either party or on both of them, financial planners have to work with the divorce lawyers and often the courts to sort out how divorce will affect the insurance and what changes may be required as a result of the split.

We can all agree that life insurance can be a complex product that is difficult enough to understand during normal circumstances. When divorce looms, these complexities cause confusion and can often end up with unintended consequences. Yet, life insurance can be a valuable tool to protect dependent spouses and children from the premature death of a principal breadwinner; provided the structure of the insurance is proper. This will always require the assistance of an insurance professional to coordinate the coverage, ownership, and beneficiary designations. Many otherwise competent lawyers have little experience with the structuring of life insurance in general, let alone in a divorce situation. It is not sufficient to rely on the divorce lawyer to properly structure necessary life insurance.

In divorce situations, life insurance is often used to secure obligations for one of the parties, either for spousal or child support. Court-ordered child support is worthless if the obligor is dead and there is no insurance in place to guarantee it. This can result in destitution and or the inability to pay for a child's education. Yet, at the same time, the need for life insurance protection changes over time as children mature and ex-spouses remarry. Life insurance in a divorce situation needs to be flexible enough to handle whatever changes will occur after the divorce--often years after the divorce.

Frequently, life insurance is used to guarantee that child support will be available in the event that the obligated party dies before the children reach adulthood. In many instances, existing life insurance policies may be modified to accomplish this goal. In other instances, new policies may have to be acquired to permit the certainty that support will be there over the years following divorce.

When existing life insurance policies are used to secure obligations like child support or spousal support (in some jurisdictions, spousal support is still referred to as "alimony," and it is still characterized as such in the Internal Revenue Code), ownership and beneficiary designations may need to be changed to reflect the use of the life insurance policies to secure the obligations. The difficult part of the process, both for use of existing policies and for purchase of new ones, is the inability to guarantee that the obligated party will continue to pay premiums. If cash value life insurance is used, it may be possible to have the policy structured to provide that the cash values will be used to continue premium payments. If there is insufficient cash value, or if term insurance is used (which is frequently the case when the divorcing couple is already having financial problems) then it is essential that the divorce decree, or its equivalent, contain a provision that obligates the payment of premiums. This does not guarantee that a policy will not lapse, but it at least causes the obligated party to risk the hazard of contempt of court for failure to pay premiums.

It is critical to recognize that, absent restrictions, the owner of a life insurance policy has complete control over the contract, its cash values and death benefit. Such an owner can change beneficiaries, assign the policy or surrender all or part of it, unless the policy has been restricted to prevent such changes. All too often we see situations where a life insurance policy was part of a divorce settlement but the necessary acts were not done to secure the transaction by making changes on the books of the insurer. Mere agreement between the parties and even court decrees are not enough. Instead, the intent of the parties with respect to the life insurance policy must be reflected on the books of the insurer either in the form of changes of ownership, irrevocable beneficiary designations or other legal acts to ensure the policy itself reflects these intents. The necessity of going back to court to enforce a provision respecting life insurance is not an appealing prospect.

Whatever the parties agree with respect to life insurance in the divorce situation, these agreements must be a part of the divorce decree and when such agreements involve life insurance transactions, the necessary documents should be filed with the insurer to ensure that the agreement is implemented. These questions often get complicated in situations where there is a necessity to split ownership between spouses. For instance, it may be that the cash values should be retained in the ownership of one spouse while the death benefit is payable to the other if death occurs while child or spousal support is still obligated. On the other hand, it may well be necessary to change the entire structure of the policy in the event of remarriage of either party or on the reaching of majority of children. Since these events may take place years after the divorce, sufficient flexibility must be built into the transaction and the parties and their advisors must ensure that the changes occur automatically upon the triggering of an event. The structuring of these types of transactions is not easy and often insurers "push back" when asked to assist. Even if there is no such "push back" by the insurer, it is sometimes difficult to make the policy owner service people at the insurer understand what is wanted and how to implement it.

Depending on the structure of life insurance transactions within a divorce situation, it is usually necessary to have an automatic notification to a party to the divorce in the event of failure to pay premiums, attempted changes in ownership or of beneficiaries or attempts to surrender or borrow against the policy. It is too late to wait until the death of an ex-spouse to find out that the policy lapsed for failure to pay premiums or that the beneficiary was changed to children of a subsequent marriage. That information is necessary when the event occurs.

Financial planners need to study the financial ramifications of divorce in order to be able to properly advise their clients when divorce occurs. Structuring of policies in the divorce situation is a complex, difficult and often frustrating task, yet one that is essential to the financial well-being of divorcing couples.


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