Breaking up is hard to do

Separation and divorce can have a negative financial impact on many clients. In these situations, advisers often play a critical role by assisting with the practical aspects of splitting assets and cash, and can further demonstrate the value of personal advice in the area of life insurance. 

Some may consider raising the topic of life insurance during the beginning of a marriage breakdown as bad timing; however, it’s an important conversation to have earlier rather than later. 

According to the Australian Bureau of Statistics (ABS), the median duration from marriage to separation is 8.5 years; and from marriage to divorce, 12.2 years. Often, a considerable period passes between separation and divorce, so your client’s financial situation and needs are likely to change far ahead of a divorce being formalised. 

For example, they may need to enter or return to the workforce, or give up work to look after young children. Furthermore, a divorce can result in both parents taking on more debt, due to the sale/purchase of property/ies. This creates greater financial exposure if either parent becomes disabled or dies.

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This article offers some tips for advisers who are taking clients through how to best protect themselves and their families during an emotional and stressful time. 

1. DON’T DELAY WITH ESTATE PLANNING 

Advisers providing full-service advice (similar to solicitors and other professional advisers) have an obligation to consider estate planning issues if they become aware of a client separating from their partner. Failing to meet this obligation can have serious consequences. Advisers may be exposed to negligence claims from clients and, should the client die while a family law matter is ongoing, potentially the intended beneficiaries too.

It’s important to make clients aware of the need to review their will upon separation and review joint ownership of assets, as well as death benefit nominations made under superannuation and non-super life insurance policies.

When reviewing a client’s financial situation, advisers should also be mindful of Standards 2 and 6 of Financial Adviser Standards and Ethics Authority (FASEA) code of ethics: to act with integrity and in the best interests of each client, and “actively consider the client’s broader long-term interests and likely circumstances”.

Case study

Peta and Pedro separated in 2019. As they had not yet applied for divorce, they were still legally married when Peta passed away last year. 

Peta had a term life policy outside super, where she named Pedro as her sole beneficiary.  Peta had also provided a non-lapsing death benefit nomination to her super fund trustee in favour of Pedro. She had not updated her will since 2010, in which she named Pedro as the sole beneficiary of her estate. Her full-service financial adviser, Elena, after learning of Peta and Pedro’s separation, had not advised Peta about the importance of reviewing her will. Further, she neglected to advise Peta about reviewing her death benefit nominations and the possibility of severing the joint ownership of the couple’s family home, upon separation. 

Peta passed away in 2020 while the family law proceedings were ongoing in relation to their separation. 

It was clear that Peta’s intention was to forge her own future without being involved in Pedro’s financial affairs; however, as she had not changed her will, Pedro received the death benefit from Peta’s non-super term life policy as well as from the super fund. Pedro also assumed full ownership of the couple’s jointly-owned family home, by right of survivorship.

Peta’s intended but disappointed beneficiaries were her adult children from a previous relationship. Taking into account the life policy, super benefit and the value of the family home, the initial economic loss suffered by the adult children was substantial. 

Potentially, the client’s children may make a negligence claim against Elena. This may then have an impact on Elena’s professional indemnity insurance and even on her personal assets. Note that the children may be entitled to make an application under the family provision legislation in their state, however their financial outcome would have been much better if Peta had changed her death benefit nominations, joint ownership of the family home and her will.

2. UPDATE INCOME PROTECTION POLICY

While dealing with a marriage breakdown is always going to be difficult, eliminating financial exposure or instability will help your client focus on what matters most, especially if they have young children.

Currently, through income protection (IP) insurance, your client and/or their former spouse can cover up to 85% of their monthly income, which can help to maintain the children’s lifestyle and wellbeing, in the event of a disability.

Child support is an important factor when calculating how much IP cover a client should have. The amount of child support payable can be determined through an informal or formal agreement between both parents. However, if this is not feasible, the amount will be calculated by a Services Australia assessor, based on the amount of adjusted taxable income derived by each parent, the individual percentage of care that they provide to their children, the number of children, and the children’s ages. Therefore, any changes to the income of either parent may affect the mandated child support payments. 

In regard to how much IP cover should be recommended in these situations, for the child support-paying parent, cover could be provided up to when mandated payments would normally cease – generally at age 18. The required level of cover may decrease at this point. However, the maximum amount of IP cover (up to 85%) may be chosen, as any excess can be used at their discretion. It would also be common for the main caregiver’s income (if applicable) to be insured up to the maximum level possible or to have a monthly benefit under a home duties income protection policy. 

3. LIVING INSURANCE CAN HELP COVER MEDICAL COSTS 

Living insurance (also known as trauma insurance) can provide a lump sum payment for people suffering from one of a range of specified medical events. Such a payment can

assist with medical and accommodation expenses, and also be used to reduce debt to allow more flexibility with work; eg, where a parent wants to work part-time or change careers after the illness or injury.

In addition, trauma payments could be used to replace income. If the child support-paying parent chooses to take leave from work after suffering from a specified medical event, their adjusted taxable income will reduce and their required payments to their former spouse may also reduce.

However, parents who are focussed on the best interests of their children can use trauma proceeds to continue the financial support that would otherwise be provided by child support payments.

For the main carer, trauma payments could be used to replace their income (if applicable) and/or to pay for professional help with domestic duties, allowing time away from these responsibilities in order to regain their health.

4. REVIEW HOW TPD DEFINITIONS APPLY 

In more serious circumstances, total and permanent disability (TPD) insurance can pay a lump sum benefit if your client becomes totally and permanently disabled as defined under the policy. 

There are two main types of occupation-based TPD insurance – ‘own occupation’ and ‘any occupation’. Own occupation TPD insurance benefits are payable if your client is permanently unable to work in their current or most recent occupation. Any occupation TPD insurance benefits are payable if they are permanently unable to work in an occupation that they would be suited to by their education, training and experience. Some policies will also pay a benefit if your client is able to work, but in a severely reduced capacity. Again, while mandatory child support payments may reduce, allowing for lost income in the TPD sum insured will allow the contributing parent to continue to financially support their children.

Home duties TPD policies are also available for homemakers who are severely disabled and unable to perform normal household duties.

5. BENEFITS OF TERM LIFE INSURANCE 

Term life insurance pays a lump sum benefit if the insured dies or suffers a terminal illness. For example, if your client is deemed to have less than 24 months to live, an advanced payment can be made for terminal illness – though it’s important to note that some policies have shorter time frames.

The non-residing parent can provide for their children’s future, by allowing for their portion of lost income and education expenses in the term life sum insured. A term life payment could also ensure that property is passed onto their children debt-free, if the mortgage is fully covered.

Claim proceeds from a policy owned by the main carer can be used to eliminate the mortgage on their home, and allow the children to remain there, where suitable. Cover can also be for the remaining portion of lost income and education expenses, as well as any final expenses.

CONCLUSION

The breakdown of a marriage can have wide-ranging financial impacts. Your client may experience a significant lifestyle change, and if so, their insurance needs are likely to change. A review of their current insurance portfolio is paramount, with an assessment of whether existing definitions and level of cover are still suitable. 

In addition, as part of estate planning, it is imperative to review the beneficiaries named in a client’s will, super fund and insurance policies, as well as any joint ownership of assets, as soon as practicable when they separate from their partner. 

While holding an advice conversation during an emotionally difficult time for a client can be challenging, your careful consideration of their changing circumstances can be a powerful demonstration of the value of personal advice. Full-service financial advisers should also keep in mind that they are obligated to hold such a conversation, and can be left legally exposed if they fail to do so.  

Alex Koodrin is senior product manager – advised, life insurance at BT.