Collateral Assignment of Life Insurance

What Is Collateral Assignment?

Valuable assets (like a home or vehicle) typically serve as collateral for a mortgage or an auto loan. If you default on payments, the lender can repossess it to recover their money.

Lenders require reassurance for loans that aren’t directly tied to a physical asset. You can use a life insurance policy as loan collateral in these cases.

As owner of the life insurance policy, you collaterally assign it to the lender, which means:

If you die before the loan is repaid, the death benefit covers your remaining loan balance
Any remaining proceeds go to your named beneficiaries

Collateral vs Absolute Assignment of Life Insurance

There are two types of assignment for life insurance: collateral and absolute.

Collateral assignment of life insurance: You control the policy. It’s commonly used to secure a small business loan.

Absolute assignment: You transfer all policy rights to the assignee. It’s often used when a policy owner sells it to a third party for an immediate cash benefit.

Similarities between collateral and absolute assignment:

Both involve the transfer of rights under a policy.
Both require the consent of the insurance company.
Both can be used as a means of managing financial risks or responsibilities.

Differences between collateral and absolute assignment:

Collateral assignment:

Used to secure a loan or other financial obligation.
The policy owner maintains ownership and control over the asset, except for the rights assigned as collateral.
The lender (assignee) only has rights to the asset in the event of death or, in some cases, default.
The assignment is temporary and removed when the loan is repaid.

Absolute assignment:

The policy is fully transferred to a new owner.
The original owner gives up all rights and control over the policy, including the right to name beneficiaries and access cash value.
The new owner can manage the policy however they see fit, including selling it, borrowing against it, or changing its terms.
The assignment is permanent; the original owner can’t reclaim rights to the policy without the new owner’s consent.

Life Insurance Assignee vs Beneficiary

A life insurance assignee is a person or entity to whom a policy’s rights have been transferred.

A beneficiary is a person, trust, or entity designated by a policy owner to receive the death benefit when the insured person dies.

Whether used for collateral assignment or not, your policy needs designated beneficiaries.

Here’s why:

The lender only has a legal claim to the death benefit if you die before the loan is paid.
If you pass away, the lender gets their payment, and the rest goes to your beneficiaries.
If you repay the loan in full and die, the lender receives nothing, and your beneficiaries receive the full benefit.

Life Insurance Policy Options for Collateral Assignment

Using life insurance for collateral assignment when applying for loans is a common practice that almost every life insurance company and lender is equipped to handle.

Examples of when life insurance can be collaterally assigned include:

Personal loans
Business loans
SBA loans

There are two types of life insurance—term life insurance and permanent life insurance—and both kinds can be used for collateral assignment.

Term Life Insurance

Lenders typically accept term life insurance as collateral, provided that the policy aligns with the size and duration of the loan.

Coverage and term length must equal the loan’s terms– or exceed them.

For example, if you’re securing a 20-year loan, you would need a term life insurance policy that spans 20 years.

If you pass away before repayment, the insurance company pays the outstanding loan balance to the lender from your policy’s death benefit first. Any remaining amount after the loan is fully paid would then be distributed to the beneficiaries you have named on your policy.

If you repay the loan before passing, the collateral assignment ends, and the total death benefit amount is reserved for your beneficiaries.

Permanent Life Insurance

Lenders often find permanent life insurance policies appealing as collateral due to their unique cash value component.

Life insurance with cash value provides an added level of reassurance to the lender, ensuring the cash value will offset the loan if the borrower defaults. 

However, even though the policy’s worth grows over time, the death benefit must cover the entire loan.

If you pass away before the loan is repaid, the company would first pay the loan balance from your policy’s death benefit to the lender.

Any remaining proceeds from the death benefit would then be distributed to the beneficiaries named on your policy.

Learn more about the differences between term and permanent life insurance.