DEFINITION of 'Collateral Value Insurance'

Collateral Value Insurance is a type of business insurance used by lenders to guarantee the value of appraised property. This type of insurance also guarantees a minimum liquidation value in the event the property must be sold. In most cases, the property being used as collateral is appraised before a certificate of guarantee is issued.

BREAKING DOWN 'Collateral Value Insurance'

A collateral value is the estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal from a qualified expert. Collateral value is often a key determinant in the terms associated with a secured loan. Secured loans are typically made for a specified loan to value amount with the collateral used to secure the loan in case of default.

Many insurers offer this type of protection, which is used primarily by asset-based lenders. In some cases, this type of insurance can be used for liquid assets such as closely held stock. Usually, however, it is geared for tangible property, such as buildings or equipment.

Appraisal Methods

Cost approach. The value of an asset is simply the cost to replace or reproduce it. In the case of a property, appraisers look at the age of the building, comparable building values and construction prices on a per square foot basis. For private company stock using this approach, an appraiser would subtract liabilities from the fair market values of the company’s assets such as property, patents and equipment.

Income approach. An appraiser looks at what investors would pay for the expected cash they’ll receive annually from the asset. They also take into account when the asset is eventually sold or scrapped down the line.  Appraisers commonly discount future cash flow based on the asset’s risk, using a discounted cash flow analysis. DCF analysis uses future free cash flow (FCF) projections and discounts them to estimate the present value, which is then used to evaluate the investment potential. 

Market approach. An asset such as a property is compared with other assets with similar use or value in the marketplace. With private company stock, an appraiser might look at recent transactions involving other companies in the same industry and compute pricing multiples based on these.

Valuation is part art, part science. According to the Internal Revenue Service, value is “the price at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

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