Thinking ahead about several types of insurance that may be required to protect the terms of your settlement will enable you to include discussion of them during negotiations. You don’t not want any surprises at the end, whether you are the prospective insured or the beneficiary. Such a surprise could derail the terms you and your spouse have thus far agreed upon.
The most commonly understood need for life insurance involves having a policy on the life of the payer of any stream of post-divorce payments, with the payee as the beneficiary. Consider this: if you, as the payee, have agreed upon a Marital Dissolution Agreement (MDA) which includes child support, alimony, and/or property settlement note payments, which your ex-spouse will make to you for some number of years, you will be depending upon those funds in order to meet your own needs. If your ex-spouse should die, those payments would stop and his or her estate would have no obligation to honor your divorce agreement. Dead people do not write checks. To remedy this situation, the payout of a life insurance policy to you as the beneficiary would replace the funds that would have come to you each month, had your ex-spouse lived.
I always recommend that the payee/beneficiary spouse be the owner of the policy on the life of the payer/insured. Yes, the insured and the owner of the policy can be two different persons. Being the owner will enable you communicate with the insurance provider and assure yourself that the policy continues to be in force and provide the agreed upon protection. In fact, as the owner, the insurance company will be required to notify you of any events that occur in relation to the policy. Such events may include a notification of past due premium payment, with the policy having slipped into a grace period and soon will lapse (be cancelled) if no payment is made, or a change in beneficiary to someone other than yourself. In any event, you will want to be current on all matters related to this policy and only the owner of the policy has access to information from the insurance provider.
It is often necessary to require that new life insurance policies be obtained to meet this need because the prospective insured has no existing personal policy. Life insurance provided by an employer will not fulfill this need because it is contingent upon the employer and neither you nor your ex-spouse can control it or even assure that it will continue to remain in place. If a new policy is required, a simple term policy will be the most economical and can be provided for the number of years required.
In the event that your ex-spouse has existing life insurance in place, this policy may be designated as providing the needed protection for the post-divorce stream of payments. It is only necessary to assure that the coverage of any policy is sufficient to replace the highest existing balance of unmade payments.
A less understood need for insurance to protect the flow of post-divorce payments is disability insurance for the payer. It is actually about six times more likely that a person may become disabled, and not be able to work to capacity, than they are to die. If a payer is not able to sustain a living, they are likely not able to sustain post-divorce child support, alimony and/or property settlement payments. Although they may have some disability coverage through their employer, that seldom provides sufficient coverage to maintain all current obligations. Most people are unaware that only about one-third of all employees have any kind of disability insurance to protect loss of income. Further, of those who do have coverage, they will only have about 50-60% of their income replaced under such coverage. It is simply not sufficient and payment obligations, incident to divorce, should also be protected by additional disability insurance on the payer. Private disability coverage needs to be part of the settlement negotiations and written into the MDA. Most major life/health insurance companies have private disability policies available at reasonable rates.
Another type of insurance protection applies to situations where a property settlement note allows for the termination of payments to the payee upon the death of the payee. Such would be unfortunate for the payee’s heirs. Therefore, a life insurance policy on the payee to protect the interest of his/her heirs may be appropriate.
To understand this better, let’s re-examine the circumstances that may require a property settlement note. If there is a marital interest in an illiquid asset, like a closely held business, and the spouse operating the business has no other liquid assets with which to buyout the non-operating spouse, then the operating spouse agrees to buyout the non-operating spouse through a series of future payments, according to a property settlement note. These future payments may be scheduled to terminate upon the death of the payee spouse. This would deprive the payee spouse’s heirs of their inheritance. Remember, if the marital estate had the required liquidity at the time of the divorce, the non-operating/payee spouse would have received compensating value for the marital business that was retained by the operating/payer spouse. In turn the payee spouse’s heirs would inherit that value upon the payee spouse’s death.
To protect the interests of the heirs, a life insurance policy may be taken out on the life of the payee spouse, with the heirs as beneficiaries. This need only be a term policy to coincide with the term of the property settlement payment schedule. Upon completion of the property settlement, there is no longer a need to protect any unpaid balance. Because the need for this insurance is due solely to the inability of the operating spouse to provide an alternate asset at the time of divorce, the cost of this insurance may become a negotiated item in the divorce.
In summary, whenever there is “unfinished” business at the time of the divorce and the settlement involves future payments of any type, such payments are always in jeopardy and need to be protected. Fortunately, we have insurance coverage available that will replace any future anticipated cash flows.