Saturday, December 15, 2012

What Is the Collateral Assignment of a Life Insurance Policy?

Simply put, it means making a lender the beneficiary of your life insurance policy

Collateral assignment refers to the contractual designation of a company or other entity as beneficiary of a life insurance policy. This arrangement is fairly common among business owners in search of additional funds or credit.

Many lenders will consider the assignment of life insurance alongside other factors when evaluating creditworthiness for business financing applications. Some lenders even require an assignment of life insurance as a condition of loan approval.

When leveraged properly, a collateral assignment can help business owners obtain funding that would otherwise be unattainable.

The Contract

Life insurance collateral assignments have become commonplace and the documents necessary to enact these agreements can be obtained directly from the life insurance company. These assignment templates contain widely accepted language and terms, and after filling in the blanks regarding the specific details of the arrangement, the forms must be signed by both the policy owner and lender.

However, no obligation exists requiring the use of boilerplate documents; collateral assignments may be negotiated and created by the parties involved. The insurance company remains disinterested in the assignment arrangements, except for its obligation to uphold the terms of a properly executed contract.

Death Benefit

Typical insurance assignments focus on a policy's death benefit as the source of collateral for a loan. The agreement places the lender in the primary beneficiary position, ensuring the recovery of an outstanding loan balance if the owner dies before final repayment is made.

If the policy's death benefit exceeds the dollar amount of the collateral assignment, the remaining proceeds are distributed to the owner's listed beneficiaries as per the original policy documents.

Cash Value

Although less common, some collateral assignments involve the cash value of existing permanent life insurance policies. Under this type of arrangement, the lender is granted permission to access cash value and make withdrawals if the borrower defaults on loan payments.

Additionally, these agreements restrict the policy owner's access to the cash value to protect the integrity of the lender's new collateral. Cash value-focused collateral assignments provide the added benefit of allowing borrowers to keep current beneficiary designations without a reduction in benefits.

Termination of the Policy

Collateral assignment contracts require the policy owner to keep coverage in force for the length of the loan term. If the policy is cancelled or terminated for non-payment, the lender may consider the loan contract violated in the absence of collateral.

To protect the lender from such situations, most assignment agreements institute the delivery of duplicate policy correspondence to the lender. Non-payment notices or other policy change documents would allow the lender to proactively intervene and prevent termination. In such cases the lender might be permitted to add payments made to the insurance company to the outstanding loan principle.

Rescinding the Agreement

Once the terms of the loan have been fulfilled and repayment completed, the assignment must be removed from the policy. Rescinding the agreement requires the borrower and lender to acknowledge the fulfillment of the loan terms and removal of the lender's position as beneficiary. After the life insurance company receives the collateral assignment rescission documents, all access to cash value and policy documents is returned exclusively to the owner.

About the Author

Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.

Article originally published on (12/15/2012) 

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