The phrase Life Insurance Collateral Assignment is an often used term in the industry, but most people don’t have a clue what it’s for. Worse yet, your bank may have requested one when you’re applying for an SBA loan. Do the top 10 life insurance companies offer it? Does it cost more to do it?
This article will cover the basics as well as important details that you’ll need to know before you secure a business loan by buying life insurance. We’re here to help make sense of it.
Collateral Assignment Life Insurance
If you’re reading this article, chances are you’ve been informed that you may need to buy a life insurance policy to assist you in securing a loan. We’ll provide you what you need know to make an informed life insurance purchase.
WARNING [Read this first!] This article is NOT a post on “How to Get a Loan.” We get many shoppers contacting Life Insurance Blog wanting a loan. You will need to research lenders in order to get a loan.
Securing a Business Loan by Purchasing Life Insurance
Perhaps you’re at the final stages of getting a small business loan and your lender surprises you by saying, “You need life insurance before we give you a loan.” All you want is a simple loan, but they’re now saying you need some business life insurance.
When you are a small business owner you may need to secure a loan through the Small Business Administration (also known as SBA) or your bank. Many times your lender may require you to buy a life insurance policy in order to cover and protect the loan amount. This is when the SBA or bank may insist that you get a collaterally assigned life insurance policy to the SBA or bank.
Receiving approval for a loan is contingent on several aspects.
- First, it explains how you plan to repay the loan in the event of your death. This is where assigning a life insurance policy is useful.
- It’s a practical feature that promises payback of the borrowed funds to the lender. Therefore, a lender is more inclined to approve your request for a loan.
- You’re welcome to assign your life insurance policy – Just as long as there aren’t any restrictions in your contract that doesn’t allow it.
- You can also have the same policy assigned to more than one bank to have multiple loans secured.
Assume you have a $2 million dollar life insurance policy. You can have portions of the loan assigned to 2 different banks.
An assignment can be used to have the rights to some or all the policy’s proceeds transferred to an assignee. Fundamentally, the assignment is contingent on the agreement and negotiations between the lender and the borrower.
Collateral Assignment of Life Insurance Definition
A collateral assignment is a typical transaction that will involve financial institutions as well as private lenders.
When you buy a life insurance policy you always have to name a beneficiary to the policy and the beneficiary would receive the benefit in the event that you were to die.
The beneficiary to a typical life insurance policy is a family member or spouse. A life insurance policy’s collateral assignment operates in a similar way.
You will still choose a beneficiary but your lender will be named the collateral assignee. Your lender will act as the primary beneficiary on your life insurance policy and the balance of your loan is paid if you were to die. The remaining balance of your life insurance policy would be given to your actual primary or contingent beneficiary.
Collateral Assignment Policy Types
What type of policy should you purchase for your collateral assignment?
First, there isn’t a specific “Collateral Assignment” type of policy. You may purchase a Term Life or Permanent Life insurance policy for your collateral assignment. Be sure to check with your lender to see what types of policies they require.
Any kind of policy will work for a collateral assignment, assuming the insurance company permits an assignment for that specific type of life insurance policy.
What Kinds of Life Insurance Policies are Used for Collateral Assignment?
Let’s see which type of life insurance can solve your goals.
Term Life Insurance
Term life insurance is the least expensive life insurance policy. In the event of death, your loan can be secured through a term policy, and it is necessary for several kinds of bank loans.
These policies will provide you the largest death benefit at the lowest cost. There is no cash value that is applicable to term policies.
The most popular term lengths are:
You are buying a policy that will only provide a death benefit. The most affordable coverage option is a term life insurance policy.
Several lenders only need the loan for a set duration of time that matches the loan’s terms. In other words, sometimes a 1 year annual renewable term, 5-year term, and even 10 year term life insurance policies work.
After the loan is repaid, the policy can be canceled or kept going for the sake of keeping your family protected.
Permanent Life Insurance
Permanent life insurance will last your entire life. Permanent life insurance can provide a death benefit and can build cash value.
Types of Permanent Life Insurance
There are many types of permanent life insurance. The most common are:
The cash value of a permanent life insurance policy is the collateral and can include either whole or universal life policies. Specified cash value on a permanent life insurance policy lets the lender access those funds as a loan repayment if the borrower defaults. The policy owner has limited access to the cash value to protect the collateral.
If the loan is repaid prior to the death of the borrower, the assignment is taken away, and the lender doesn’t have any access to the life insurance death benefit.
In comparison to an absolute assignment — which essentially assigns the policy as is, without any way of reversing it – the collateral assignment acts as more of a restricted kind of transfer.
If you were to pass away prior to the repayment of a loan, the lender acquires the balance that is owed via the death benefit. The outstanding balance is then sent to the remaining beneficiaries specified. The policy must remain current, so you must stay on top of keeping the premiums paid throughout the loan’s lifetime.
Further, you won’t be able to access the cash value (assuming you have a universal or whole life policy) in order to safeguard the collateral.
If the loan is repaid prior to your death, the lender won’t be the beneficiary anymore and will not receive the death benefit. Cash value assignments are alluring to lenders since the finances can be re-obtained without the borrower passing away.
The cash value life insurance company needs to be informed of a policy’s collateral assignment, but aside from keeping the contract terms updated, they hardly have any authority or involvement in the agreement.
Do I Name a Beneficiary with a Collateral Assignment?
Absolutely.
You do not want to have your lender be your beneficiary with a collateral assignment. You will want to name one or several beneficiaries to your life insurance policy.
However, there are a couple of assignments you need to be aware of. Conditional and Absolute are the two main categories of a policy assignment.
With an absolute assignment, you transfer all of the rights of the life insurance policy to the designated assignee. This includes the responsibility that any premiums that remain get paid by the assignee.
In essence, you’re transferring the ownership of the policy to the new party.
With a conditional assignment, this arrangement is temporary. The ownership interest and rights of the life insurance policy are limited and transferred based on the terms of the agreement. An example of the conditional assignment is with a repayment of a loan. The assignment is terminated once the conditions of the agreement have been met.
The Bank Shouldn’t Be Assigned as the Beneficiary
If you receive a request from the bank to assign them as the beneficiary, refrain from doing so.
If you pass away and only have a portion of the loan paid back, the bank will acquire the outstanding balance since they are the beneficiary, and no will can take precedence over that contract.
Don’t allow this to occur. Banks only need a collateral assignment.
As such, if the balance owing on your loan goes down, so, too, does the amount that the bank gets.
If a $750,000 dollar loan is taken out on a collateral assignment and half the loan is repaid, the collateral assignment will only give the bank what’s left over from the loan. The remainder will go to the primary beneficiary.
If no other beneficiaries are listed, it will be sent to your estate. Don’t give the bank all that money. The collateral assignment minimizes the benefit to be in sync with your loan.
Precautions with Collateral Assignment
There are several details that you will want to be aware of when securing a life insurance policy for a business loan.
- Do you have a balance on your loan? If so your primary beneficiary (family or spouse) will not get the entire death benefit from your life insurance policy. Remember that your lender receives the benefit to cover the balance of the loan. Whatever is left will go to your beneficiary.
- Your life insurance policy may dictate if you get a loan or not. You may not be able to secure a small business loan until your life insurance policy is approved. This can be a stressful time as your lender may require you to get a policy quickly which may limit the types of policies available to you.
- Time is of the essence. If you are in need of a policy immediately, there are no medical exam life insurance options. These policies can be issued much faster than a policy requiring a medical exam.
Basic Example
Assuming you’ve bought a $1 million term life insurance policy.
At some point, you’ll need to research banks that accept life insurance as collateral for a $500,000 loan – the loan secured by life insurance policy.
Life Insurance Blog Tip: You will need to find banks or lender that accept collateral assignment. Life insurance brokers do not provide this service. Once you find your lender, we will assist you in buying the best life insurance policy available to beet your goals.
For partial collateral, you will use a collateral assignment on the policy. Your spouse is listed as the life insurance policy’s primary beneficiary.
Once you are deceased, both your wife and the bank file claims for the death benefit with the insurance company. The bank does have money owed to them, and that takes precedence over what your spouse would get. The bank (aka the collateral assignee) has priority.
As such, they’ll be paid back before the remainder of the death benefit is sent to the beneficiaries (your spouse, in this instance).
A Real Collateral Assignment Example
We recently were contacted by someone who was purchasing a business in just over a month.
The bank required a $5 million life insurance policy to cover her bank loan. We researched the company who provided the best rate and processed her application. Time was a factor and we were able to get the medical exam setup quickly and the underwriting process was underway.
However, the client was nervous about cutting it too close and wanted to get coverage in place as soon as possible even though it wasn’t the best rate. We simply pivoted to the fastest collateral assignment company and had the policy approved with one of the life insurance companies known to approve faster than average.
Lenders that Accept Collateral Assignment?
For an assignment, several lenders may allow a current life insurance policy. Other lenders might ask for a new life insurance policy to suit their demands. Regardless, securing a loan by using life insurance as collateral is standard protocol for just about all insurance companies.
To start with, secure your loan. Visit your bank and learn what their requirements are, as well as the types of loans they issue. Loans tend to be backed by the Small Business Administration and sold by big banks like Chase, Wells Fargo, or Bank of America. Of course, small banks are also available.
Ready To Get Coverage Quickly?
Please contact us if you have any questions about collateral assignment life insurance or about how to buy the best and most affordable policy.
If you are in need of a collateral assignment of life insurance, we can help.
We’ll be happy to answer all of your questions to make sure you get your policy as quickly as possible at the best rate available. Life Insurance Blog has access to the fastest life insurance companies and will find the one that meets your goals.
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