What is a collateral assignment of life insurance?
A collateral assignment of life insurance is a conditional assignment appointing a lender as the primary beneficiary of a death benefit to use as collateral for a loan. If the borrower is unable to pay, the lender can cash in the life insurance policy and recover what is owed. Businesses readily accept life insurance as collateral due to the guarantee of funds if the borrower were to die or default. In the event of the borrower's death before the loan's repayment, the lender receives the amount owed through the death benefit and the remaining balance is then directed to other listed beneficiaries.
The borrower must be the owner of the policy, but not necessarily the insured, and the policy must remain current for the life of the loan with the owner continuing to pay all necessary premiums. Any type of life insurance policy is acceptable for collateral assignment, provided the insurance company allows assignment for the particular policy. A permanent life insurance policy with a cash value allows the lender access to the cash value to use as loan payment if the borrower were to default.
Alternately, the policy owner's access to the cash value is restricted in an effort to protect the collateral. If the loan is repaid before the borrower's death, the assignment is removed and the lender is no longer the beneficiary of the death benefit. Insurance companies must be notified of collateral assignment of a policy, but other than their obligation to meet the terms of the contract, they remain disinterested in the agreement.
This is a very common question among business owners applying for a bank loan. Let's look at an example.
Bob wants to borrow $2 million from his local bank, to expand his business. His banker agrees to lend him the money, but wants to have life insurance in place on Bob's life. Why? Because if Bob tragically dies before the loan is paid off, his banker doesn't want to have to chase his wife or his estate for the money.
So, the race is on for Bob to get a policy. He wants that coverage quickly so he can close the loan and get his money. He gets prequalified for coverage, finds a company that will give him good underwriting, and submits an application. The application is approved, the policy is delivered, he pays for it, and the coverage is put into force.
Now he is ready to execute a collateral assignment. He gets a form from his bank, or from the insurance company – whichever the bank prefers – and completes it. His wife is the beneficiary, and the bank is the assignee. He gets the money from the bank and sinks it into his business.
Now let's suppose he unfortunately meets his demise a year later. His wife files a claim. The claims department of the insurance company pulls the file and notices that the benefit has been collaterally assigned to the bank. They contact the bank and ask for documentation of any outstanding balance on the loan. The bank provides this, gets paid, and then Bob's wife gets the rest of the death benefit.
The use of a collateral assignment makes sure the lender gets paid only what they are due. If the bank had been made the beneficiary, they would've been given the full death benefit, even if some of the loan had already been paid off. They would've been overpaid, and Bob's wife would've been given nothing.
If you are applying for life insurance to secure your own business loan, remember that there is no reason to make the lender the beneficiary. Use a collateral assignment and make sure your broker walks you through its execution.
Please feel free to contact me with additional questions.
A collateral assignment is using a life insurance policy to pay off a debt/ loan. The life insurance policy names the lender as a primary beneficiary for the amount of the debt, so if you die before paying the debt, the lender gets paid the balance of the money owed. It is common for a lender, bank or other entity to ask a business owner to take out and maintain a life insurance policy and name the lender as a primary beneficiary for the debt (payoff schedule is usually attached to the assignment), as a condition of the loan until the loan is repaid. Once repaid, the lender should write a letter and release the condition on the policy. An assignment is a formal written document and is filed with the insurance company and parties involved.
A so called “collateral assignment” of a life insurance policy is often requested by the lender. It is used as a means to cover a loan in the event of the assignees failure to repay the debt. Once the proper insurance company forms have been completed and recorded by the insurance company, repayment of any outstanding loan can be paid from the policy cash surrender value or death benefit should the insured pass away and the loan becomes past due.