Last Updated: July 2020
A collateral assignment of life insurance is a contract that allows the death benefit of a life insurance policy to be used as collateral for a loan.
Collateral assignments are usually used in business loans. However, it can also be used for equipment loans, structured settlement buyouts, and other loans.
How Does a Collateral Assignment of Life Insurance Work?
In the event of the death of the person who is named on the life insurance policy, the lender who has the insurance policy assigned as collateral gets paid first.
A collateral assignment will always take precedence over beneficiary claims for the proceeds of the death benefit. When a business owner applies for a business loan and wants to use their death benefit as collateral, the loan company must then ascertain whether should the owner die, will it affect the business, and cause the loan to default.
The death benefit on the life insurance policy is there as security that the lender will get the loan repaid should the recipient of the loan die.
It is important to remember that although only the policy owner can pledge the death benefits of a policy to the lender, they may not necessarily be the individual named on the policy. This individual could be their spouse or even the director of the company.
How to Set Up a Collateral Assignment of Life Insurance
When setting up a collateral assignment of life insurance, the lender should never be named as the beneficiary of the policy.
Setting Up the Beneficiary of the Life Insurance Policy
The beneficiaries should be the loved ones of the person named on the policy, as should the named person die, the loan will get paid off first, and then the collateral assignment is released and the death benefit will be paid to these beneficiaries.
When taking out life insurance at the same time as assigning the collateral, the collateral assignment form must be submitted with the life insurance application, so make sure you choose a life insurance agent who thoroughly understands the collateral assignment process.
Types of Life Insurance You Can Use for Collateral
In order to set up a collateral assignment of life insurance, there is no particular type of life insurance policy required by a lender.
The only stipulation is that the actual life insurance policy itself must be assignable. The loan policyholder must always make sure that the life insurance company is aware of and will allow the use of the policy as collateral for a loan.
An existing life insurance policy can be used to satisfy the lender’s requirements as long as the amount of the death benefit on the policy is enough to cover the loan amount required.
Here are some examples of policies accepted for collateral assignment:
- Term life insurance
- Whole life insurance
- Universal life insurance
- Second-to-die insurance
What Happens to the Collateral Assignment After the Loan is Paid?
If a loan is taken out using a collateral assignment of the life insurance policy, here is what happens when the loan is repaid in full. If the person insured on the policy is still living, then the lender relinquishes all rights to any death benefit on the policy and they will return all documents.
Keep Your Life Insurance Company Informed
Most life insurance companies will have strict rules that must be followed to ensure the collateral assignment of the life insurance policy will be allowed and they must always be informed that the assignment has been made.
The life insurance company will need to submit written notification to the lender that the collateral assignment of life insurance has been filed. This could be as a separate cover letter with a copy of the executed collateral assignment form or a just a stamped filed copy of the collateral assignment form itself.
The Lender will Need Information About Your Life Insurance Policy
The lender will also need to make further checks before allowing the loan to go ahead. They will need to check that there is no collateral assignment of the life insurance policy already in place and that all life insurance premiums are not only up to date, but have also been made for a period of at least six months.
Also, they will check that if the policy has a cash surrender value, there have been no borrowings secured against that and that the original life insurance policy is not required in order to make a claim.
Some types of loans have a cash surrender value. This is the amount that an insurance company will payout to the policyholder if the life insurance policy is terminated before it reaches maturity. If there is a filed collateral assignment of life insurance against the policy, any monies paid out will be used to pay off the balance of the loan before either the policyholder or their beneficiaries.
Filing the Collateral Assignment of Life Insurance
When a life insurance company sets a collateral assignment of life insurance, this usually takes about seven to ten days to be filed and acknowledged. However, some companies may expedite this if the collateral assignment is required more urgently.
If you need help with setting up a collateral assignment of life insurance, contact us.
Companies like SelectQuote and Zander Insurance are high volume call centers and often don’t see collateral assignments all the way through.
We’ve helped hundreds of people set up collateral assignments and have expert life insurance agents who can help. Our agents have a thorough understanding of the needs of the collateral assignment process and will be able to guide you through this and ensure that all the requirements of the loan company are met.