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What Is a Collateral Assignment of Life Insurance?

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A collateral assignment of life insurance is a conditional assignment appointing a lender as an assignee of a policy. Essentially, the lender has a claim to some or all of the death benefit until the loan is repaid. The death benefit is used as collateral for a loan.

The advantage to using a collateral assignee over naming the lender as a beneficiary is that you can specify that the lender is only entitled to a certain amount, namely the amount of the outstanding loan. That would allow your beneficiaries still be entitled to any remaining death benefit.

Lenders commonly require that life insurance serve as collateral for a business loan to guarantee repayment if the borrower dies or defaults. They may even require you to get a life insurance policy to be approved for a business loan.

Key Takeaways

• The borrower of a business loan using life insurance as collateral must be the policy owner, who may or may not be the insured.
• The collateral assignment helps you avoid naming a lender as a beneficiary.
• The collateral assignment may be against all or part of the policy's value.
• If any amount of the death benefit remains after the lender is paid, it is distributed to beneficiaries.
• Once the loan is fully repaid, the life insurance policy is no longer used as collateral.

How a Collateral Assignment of Life Insurance Works

Collateral assignments make sure the lender gets paid only what they are due. The borrower must be the owner of the policy, but they do not have to be the insured person. And the policy must remain current for the life of the loan, with the policy owner continuing to pay all premiums . You can use either term or whole life insurance policy as collateral, but the death benefit must meet the lender's terms.

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 don't accept term life insurance policies as collateral because they do not accumulate cash value.

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. However, other than their obligation to meet the terms of the contract, they are not involved in the agreement.

Example of Collateral Assignment of Life Insurance

For example, say you have a business plan for a floral shop and need a $50,000 loan to get started. When you apply for the loan, the bank says you must have collateral in the form of a life insurance policy to back it up. You have a whole life insurance policy with a cash value of $65,000 and a death benefit of $300,000, which the bank accepts as collateral.

So, you then designate the bank as the policy's assignee until you repay the $50,000 loan. That way, the bank can ensure it will be repaid the funds it lent you, even if you died. In this case, because the cash value and death benefit is more than what you owe the lender, your beneficiaries would still inherit money.

Alternatives to Collateral Assignment of Life Insurance

Using a collateral assignment to secure a business loan can help you access the funds you need to start or grow your business. However, you would be at risk of losing your life insurance policy if you defaulted on the loan, meaning your beneficiaries may not receive the money you'd planned for them to inherit.

Consult with a financial advisor to discuss whether a collateral assignment or one of these alternatives may be most appropriate for your financial situation.

Life insurance loan (policy loan) : If you already have a life insurance policy with a cash value, you can likely borrow against it. Policy loans are not taxed and have less stringent requirements such as no credit or income checks. However, this option would not work if you do not already have a permanent life insurance policy because the cash value component takes time to build.

Surrendering your policy : You can also surrender your policy to access any cash value you've built up. However, your beneficiaries would no longer receive a death benefit.

Other loan types : Finally, you can apply for other loans, such as a personal loan, that do not require life insurance as collateral. You could use loans that rely on other types of collateral, such as a home equity loan that uses your home equity.

What Are the Benefits of Collateral Assignment of Life Insurance?

A collateral assignment of a life insurance policy may be required if you need a business loan. Lenders typically require life insurance as collateral for business loans because they guarantee repayment if the borrower dies. A policy with cash value can guarantee repayment if the borrower defaults.

What Kind of Life Insurance Can Be Used for Collateral?

You can typically use any type of life insurance policy as collateral for a business loan, depending on the lender's requirements. A permanent life insurance policy with a cash value allows the lender a source of funds to use if the borrower defaults. Some lenders may not accept term life insurance policies, which have no cash value. The lender will typically require the death benefit be a certain amount, depending on your loan size.

Is Collateral Assignment of Life Insurance Irrevocable?

A collateral assignment of life insurance is irrevocable. So, the policyholder may not use the cash value of a life insurance policy dedicated toward collateral for a loan until that loan has been repaid.

What is the Difference Between an Assignment and a Collateral Assignment?

With an absolute assignment , the entire ownership of the policy would be transferred to the assignee, or the lender. Then, the lender would be entitled to the full death benefit. With a collateral assignment, the lender is only entitled to the balance of the outstanding loan.

The Bottom Line

If you are applying for life insurance to secure your own business loan, remember you do not need to make the lender the beneficiary. Instead you can use a collateral assignment. Consult a financial advisor or insurance broker who can walk you through the process and explain its pros and cons as they apply to your situation.

Progressive. " Collateral Assignment of Life Insurance ."

Fidelity Life. " What Is a Collateral Assignment of a Life Insurance Policy? "

Kansas Legislative Research Department. " Collateral Assignment of Life Insurance Proceeds ."

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What Is Collateral Assignment of Life Insurance?

Collateral assignment of life insurance designates a lender as the assignee of a policy, granting them the right to part or all of the death benefit until the loan is repaid.

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Director of Content Marketing, MoneyGeek

Nathan Paulus is the Head of Content Marketing at MoneyGeek, with nearly 10 years of experience researching and creating content related to personal finance and financial literacy. Paulus has a bachelor's degree in English from the University of St. Thomas, Houston. He enjoys helping people from all walks of life build stronger financial foundations.

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Updated: October 3, 2024

• How It Works
• Overview of Application Process

Pros and Cons

• Impact on Beneficiaries
• Alternatives

Related Content

Advertising & Editorial Disclosure

Collateral assignment of life insurance is an arrangement where a policyholder uses the face value of their life insurance policy, which can be a term or permanent life insurance policy, as collateral to secure a loan. If the policyholder dies before they pay off the loan, the lender is prioritized to receive a portion of the death benefit equivalent to the outstanding loan balance. The remaining benefit then goes to the policy's beneficiaries. This agreement ensures that life insurance collateral assignment acts as a safety net for both the lender and the beneficiaries.

• Collateral assignment involves using a life insurance policy as security for a loan, where the lender has a claim on the death benefit if the borrower defaults or passes away before repaying the loan.
• The lender receives priority over the death benefit, which means they are paid first from the policy's payout before any beneficiaries if the loan remains unpaid.
• Various life insurance policies, including term, whole and universal, can be used for collateral assignment, depending on the insurance company's policies and the policy's value.
• If a life insurance policy lapses or is canceled during a collateral assignment, it can breach the loan agreement, potentially resulting in immediate repayment demands.

How Collateral Assignment of Life Insurance Works

The collateral assignment allows you to use your life insurance policy as security for a loan. The process involves legally designating your policy as collateral, which means if you pass away before fully repaying the loan, the lender can claim the death benefit to cover the remaining balance. You start by choosing either a term policy or whole life insurance and then complete a collateral assignment agreement. This agreement is legally binding and sets the terms for the lender to access the death benefit .

For your beneficiaries, the assignment of your life insurance policy as collateral could reduce the death benefit they receive. If you die with an outstanding loan balance, the lender is paid first from the policy's proceeds. Any remaining amount goes to your beneficiaries only after the loan is settled.

For example, a policyholder with a $500,000 policy uses their life insurance as collateral for a $200,000 loan. If the policyholder dies before settling the loan, the lender will receive $200,000 from the policy's death benefit. Meanwhile, the remaining $300,000 gets disbursed to the policy's beneficiaries.

Roles of the Policyholder, Lender and Insurance Provider

Role of the Policyholder

• Ensure consistent premium payments to keep the policy active and in force.
• Inform the lender of any policy changes, such as lapses or surrenders.
• Understand that active management upholds the collateral agreement's integrity.

Role of the Lender

• Accept the life insurance policy as collateral.
• Right to recover owed amounts from the policy's death benefit if the policyholder dies before loan repayment.
• Priority claim on the death benefit, with remaining funds disbursed to beneficiaries.
• Responsible for releasing the assignment after full loan repayment.

Role of the Insurance Provider

• Approve or reject the collateral assignment of the policy.
• Evaluate and ensure compliance with policy terms.
• Officially record the assignment as part of the policy.

Applying for Collateral Assignment

Applying for collateral assignment is a process moderated by your life insurance company designed to secure loans using your life insurance policy as collateral. It involves a series of steps:

Obtain a Collateral Assignment Form

Request a collateral assignment form from your life insurance provider. This form is vital for designating the lender as a collateral beneficiary for the loan amount. Ensure you obtain the correct form, as forms vary based on policy type and insurer.

Fill Out the Form Correctly

Complete the form with accurate details, including policy number, loan amount and lender information. Pay close attention to all sections to avoid errors that could delay or invalidate the assignment. Incomplete or incorrect information can lead to processing delays or rejection.

Sign the Paperwork

Ensure both the policyholder and lender sign the form, confirming the agreement. This dual signature legally binds both parties to the terms of the collateral assignment. Any discrepancy in signatures may question the form's validity.

Submit the Completed Form

Submit the signed form back to the insurance company for processing. Consider using a traceable delivery method for submission to confirm receipt. Delays in submission can impact the timeline of the loan approval process.

Await Approval or Rejection From the Insurance Company

Wait for the insurer to review and approve or reject the collateral assignment. The insurer may request additional information or clarification, which can extend the approval timeline.

Receive a Letter of Acknowledgment

You and your lender will receive a letter of acknowledgment from the insurer if your collateral assignment application is approved.

Obtaining Required Documentation

The required documentation for collateral assignment of life insurance is straightforward. Typically, you'll need to provide two main types of documents for the assignment of a life insurance policy as collateral:

• Collateral Assignment Form: This form is critical because it officially transfers a portion of your life insurance policy benefits to the lender as collateral. It demonstrates to the lender that you have taken the steps to secure your loan against your life insurance policy.
• Original Life Insurance Policy and Proof of Loan: Lenders may require your original life insurance policy to ensure it is valid and enforceable. Proof of the loan agreement or obligation, such as a mortgage note or other loan document, is also commonly required. This establishes the legitimacy of your loan and substantiates the life insurance collateral assignment.

If you need more clarification about documentation requirements, contact your lender to confirm the necessary details to avoid process delays.

Pros and Cons of Collateral Assignment

Using life insurance as collateral can offer a range of benefits and potential drawbacks. Collateral assignment of a policy allows you to secure loans and is often safer than using physical assets as collateral. However, you should also note the inherent risks, primarily that the lender retains the first right to your policy’s death benefit upon your death.

• Lower interest rates on loans.
• Allows you to use the policy and not physical assets as collateral.
• The cash value of your insurance policy continues to grow.
• The lender has the first right to the death benefit.
• Failure to repay the loan can reduce or even eliminate the death benefit.
• Any lapse or cancellation of the policy may lead to violating the loan terms.

Impact of Collateral Assignment on Beneficiaries

While the collateral assignment of life insurance has its benefits, it’s important to remember that it can impact the amount your beneficiaries receive. If you pass away with an outstanding balance on your loan:

Your Lender Will Be Paid First

In the collateral assignment arrangement, the lender is designated as the collateral beneficiary holding the primary claim to the death benefit for the outstanding loan amount. This means if you pass away before fully repaying the loan, the lender is entitled to receive payment from the death benefit first. The amount collected by the lender is limited to the remaining loan balance.

Any Remaining Death Benefit Will Be Disbursed to Your Beneficiaries

After the lender's claim is satisfied, the remaining death benefit is disbursed to your policy’s designated beneficiaries. The amount they receive depends on the loan balance at the time of your death. If the loan balance is substantial, your beneficiaries will receive significantly less than the policy's total death benefit.

This structure underscores the importance of carefully considering life insurance collateral loans and their impact on future financial planning. Policyholders using life insurance as collateral need to understand the terms set forth by loan companies that accept it.

Alternatives to Collateral Assignment

Alternatives to collateral assignment include personal loans , home equity loans or surrendering the life insurance policy for its cash value. None of these options require using life insurance as collateral, and each offers different benefits and risks compared to using life insurance as collateral.

FAQ About Collateral Assignment

These questions cover various topics related to collateral assignments, including their requirements, implications for beneficiaries and what happens in different scenarios.

A collateral assignment is a contractual arrangement in which a borrower uses their life insurance policy as collateral for a loan. This agreement grants the lender rights to the policy’s death benefit. The lender is prioritized over other beneficiaries until the loan is repaid in full.

In the context of a life insurance collateral assignment, the collateral is the policy's death benefit. This setup allows lenders to be listed as collateral beneficiaries, guaranteeing that they can recover the outstanding loan balance from the death benefit in the event of the borrower’s death before the debt is fully paid.

In a life insurance contract, a collateral assignment allocates the policy's death benefit as security for a loan. This means that if the borrower dies before repaying the loan, the lender, as the collateral assignee of the life insurance, can claim the owed amount from the death benefit. The remaining balance, if any, goes to the designated beneficiaries, ensuring the loan is covered without affecting other assets.

Collateral assignment allows a lender to claim the life insurance death benefit for an outstanding loan amount while naming a life insurance beneficiary designated who receives the death benefit. The lender's claim is prioritized over the beneficiaries' in collateral assignment.

Most types of life insurance policies , including term, whole and universal life, can be used for collateral assignment, provided the insurance company allows it and the policy has sufficient value.

Yes, the policyholder can change beneficiaries after a collateral assignment, but the lender's right to the death benefit amount remains until the loan is repaid. This ensures the lender's position as a collateral beneficiary.

Canceling your life insurance policy before repaying the debt can lead to a breach of the collateral assignment loan agreement. This action may prompt the lender to increase your interest rate or demand immediate repayment of the outstanding loan balance.

These related sections offer additional insights into concepts and alternatives connected to collateral assignments and life insurance:

Using Collateral for a Personal Loan — This link explains how to use various types of collateral for securing a personal loan, providing a broader context to the specific use of life insurance as collateral.

Term vs. Permanent Life Insurance — This resource compares term and permanent life insurance, helping to understand which policies can be used for collateral assignments.

Permanent Life Insurance — This page details permanent life insurance, a type commonly used in collateral assignments due to its cash value component.

Life Insurance Calculator — This page helps you calculate the appropriate amount of life insurance coverage needed, which is crucial when considering using a policy for collateral.

About Nathan Paulus

Nathan Paulus is the Head of Content Marketing at MoneyGeek, with nearly 10 years of experience researching and creating content related to personal finance and financial literacy.

Paulus has a bachelor's degree in English from the University of St. Thomas, Houston. He enjoys helping people from all walks of life build stronger financial foundations.

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