Everything You Need to Know about Absolute vs. Collateral Assignments
Collateral Assignment
What is a collateral assignment?
A collateral assignment of life insurance gives lenders the right to collect the death benefit of your policy up to the amount of the outstanding loan balance.
How is a collateral assignment used?
A typical scenario involves taking out a business loan.
The lender may require a life insurance policy as collateral.
The type of life insurance policy used, whether it’s term, whole life, or universal life doesn’t matter.
Should you die while the loan is outstanding, the insurance policy will pay off the balance.
When you borrow from the SBA, life insurance for SBA loans is required.
The collateral assignment applies to the entire policy including any life insurance rider benefits that may be part of the policy.
How to Complete a Collateral Assignment
The process is similar whether you are adding the assignment to an existing policy or are buying new coverage.
There are two parties to a collateral assignment.
- Assignor – Is the owner of the life insurance policy
- Assignee – Is the lender
Life insurance companies have standardized forms used for this purpose.
- The owner completes the form and sends it to the lender for review and signature.
- Once complete, the form gets sent to the insurance company.
- The insurance company records the assignment and sends a confirmation to the owner and lender that the assignment is complete.
This may all seem confusing if you haven’t used an assignment before, but the reality is that most life insurers make it pretty easy to complete.
Releasing a Collateral Assignment
When you pay off your lender, you have the right to have the collateral assignment removed.
The life insurance companies have collateral release forms as well.
- The owner completes the form and sends it to the lender.
- The lender signs off on the release.
- Once complete, the insurance company records the release and sends the discharge letter to all parties.
Once complete, you should re-check with the home office to ensure that the assignment was released from your policy. Your agent can help with this.
Death and Collateral Assignments
How do collateral assignments work when you die?
Check out this example:
- Policy Face Amount = $1,000,000
- Beneficiary = Your Spouse
- Original Bank Loan = $200,000
- Outstanding Loan Balance at Death = $100,000
What happens next?
- Your beneficiary will file the death claim with the life insurance company.
- The life insurance company will review the claim and see that a collateral assignment is attached to your policy.
- The lender is contacted for an updated payoff figure.
- Payoff amounts are sent directly to the lender.
- Your beneficiary receives the balance of the policy death benefit.
For the above example, your lender would be paid $100,000, and the remaining $900,000 would be paid to your beneficiary as intended.
This is a good time to remind you that you NEVER want to name your lender as the beneficiary as they would receive the entire proceeds rather than just what was owed.
Collateral Assignments for the Uninsurable
While lenders may want a life insurance policy as collateral, sometimes it’s difficult to obtain if the insured has substantial health issues.
If you have an existing life insurance policy in effect, it’s possible to use that for the assignment.
Another option that exists in some states is contingent coverage.
Contingent coverage is a one-year policy that can be renewed.
The policy will exclude death from the known health issue, but provide coverage for new health issues that develop or from accidental deaths.
We’ve had many lenders accept this type of coverage when it’s the only option available.
Absolute Assignment
What is an absolute assignment?
Absolute assignments are used when you are permanently giving up all ownership rights to your life insurance policy.
Some examples:
Life Insurance Settlements
With this type of transaction, you are selling your life insurance policy to a third party.
1035 Exchange
A 1035 exchange is a tax-free transfer of cash value from universal life or whole life policy to another similar policy.
Gifting Life Insurance to Charities
Absolute assignments are used to permanently transfer your policy to your favorite charity.
Irrevocable Life Insurance Trusts (ILIT)
Absolute assignments are used to permanently transfer your policy to an ILIT.
There are lot of other potential issues that may arise with transfers to an ILIT that are beyond the scope of this article.
Business Cases
If you purchased key person life insurance on an employee, absolute assignments are used to transfer ownership to the employee.
FAQ
You may have questions about your life insurance assignment and how it works.
The following are meant to be general guidelines as each situation is uniquely different.
Can the collateral assignment change the beneficiary?
No, the collateral assignment does not change the beneficiary.
The life insurance assignment gives the lender the right to receive proceeds equal to their outstanding loan balance.
Can a business be beneficiary in a collateral assignment of life insurance?
A business can be the beneficiary of a life insurance policy that is collaterally assigned.
Conclusion
Life insurance assignments are common for absolute and collateral assignments.
What is most important is that you understand what is involved with this process.
That’s where we’ll help you make the best decision for your life insurance.
There is never any pressure or obligation with our life insurance service.
Please take a few minutes to submit your quote request today. Thank you.
Michael Horbal
Author
Michael Horbal is the founder and owner of RiskQuoter.com and a licensed life insurance agent who has helped thousands with affordable protection for families and businesses.
