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 dies or defaults. 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.

Key Takeaways

  • The borrower must be the policy owner, who may or may not be the insured.
  • The collateral assignment may be against part or all of the policy's value, and if any amount remains, beneficiaries receive the difference.
  • Full repayment of the loan terminates the assignment.

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 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 defaults. Many lenders do not accept term life policies as collateral because they do not accumulate cash value and the term of the policy may be too short to accommodate the loan.

Some lenders will not guarantee a loan unless a life insurance policy with a collateral assignment is issued.

Alternately, the policy owner's access to the cash value is restricted 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 the collateral assignment of a policy; other than their obligation to meet the terms of the contract, they remain disinterested in the agreement.

Advisor Insight

Steve Kobrin, LUTCF
The firm of Steven H. Kobrin, LUTCF, Fair Lawn, NJ

This is a common question among business owners applying for a bank loan who want to use their life insurance as collateral to increase their chances of getting the loan. Collateral assignments make sure the lender gets paid only what they are due. If the bank is named as the beneficiary on the insurance policy, they would be paid the full death benefit even if some of the loan had already been paid off, leaving nothing for the deceased’s other beneficiaries. 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.