Life insurance and the collateral assignment

The short version

• If the loan is not fully secured and the business depends on one owner, SBA rules require life insurance on that owner.
• If you die, the policy pays off part or all of the loan, protecting your family and the business.
• The policy is assigned to the lender through a collateral assignment. The lender is paid first; anything left goes to your beneficiaries.
• Term life insurance is the usual choice. Arrange it early, because underwriting takes time.
• The lender may also require disability coverage and will require insurance on the business itself.

Why lenders ask for it

A small business often depends on its owner. If the owner dies, the business may struggle to repay the loan. Life insurance protects the lender, and it also protects your family from a debt you personally guaranteed.

For SBA loans, lenders follow their own policy, with one firm rule. If the business assets and other collateral do not fully secure the loan, and the business depends on one owner, life insurance is required on that owner in the amount of the shortfall.

The collateral assignment

A collateral assignment gives the lender the right to be paid from the life insurance policy, up to the amount still owed, if you die. You keep owning the policy. Your beneficiaries receive anything above what the lender is owed. When the loan is repaid, the assignment ends.

You sign the assignment, the insurance company acknowledges it and the lender keeps a copy.

What kind of policy

• Term life is the usual choice: lower cost, for a set number of years.
• The amount is usually the part of the loan not covered by other collateral. Your lender will specify.
• Whole life is not required. Term coverage is enough.
• The term usually matches the loan.

You may be able to use an existing policy, if it is large enough and the insurer accepts the assignment.

Start early

Life insurance underwriting can take weeks, especially if a medical exam is required. Start when you sign the letter of intent. A missing policy can delay closing.

Other insurance the lender will require

• Property and liability coverage on the business.
• Hazard insurance on any real estate or equipment securing the loan, naming the lender.
• Sometimes disability insurance on the owner.

Your insurance agent should coordinate all of it with the lender's requirements.