Maximize Benefits with Collateral Assignment Strategies

Collateral assignment strategies can be used to maximize benefits in various financial and business scenarios. Collateral assignment involves using an asset – in this case, your life insurance policy – or as security for a loan or other financial obligation. Find out how collateral assignment of life insurance works and if it’s a good idea.

What is the collateral assignment of life insurance?

Collateral assignment of life insurance is when you put up your life insurance as collateral for a loan or other financial obligation.  Using collateral makes the loan “secured,” and reduces risk for the lender. This can improve your chances of approval, and in some cases, lower your interest rate.

Here’s how it works: the policyholder (the person who owns the life insurance policy) pledges the policy's cash value or death benefit as security for a loan. The lender becomes the assignee and is entitled to receive the policy's proceeds up to the outstanding loan amount if the borrower defaults.

How do you set up collateral assignment of life insurance?

With a collateral assignment of life insurance, you agree to use your life insurance policy as collateral for a loan. This involves some paperwork, namely a collateral assignment form.

Collateral Assignment Form

A collateral assignment form is completed, signed, and filed with the insurance company. This document legally assigns a portion of the policy's cash value or death benefit to the lender as security for the loan.

Here are the key components typically found in a collateral assignment form for life insurance:

• Identification of parties: The form identifies the policyholder (assignor) who owns the life insurance policy and the lender (assignee) who is receiving the collateral assignment rights.
• Policy details: Next, you’ll have to share specific details about the life insurance policy, such as the policy number, type of policy, and the insurance company's name.
• Collateral assignment clause: This section outlines the terms and conditions of the collateral assignment. It specifies which rights of the policy are being assigned to the lender, such as the right to access the policy's cash value and receive a portion of the death benefit.
• Loan details: If the collateral assignment is related to a loan, the form may include details about the loan amount, interest rates, repayment schedule, and any other relevant terms of the loan agreement.
• Revocation clause: A collateral assignment form typically includes a provision allowing the policyholder to revoke the assignment once the loan or obligation is fully satisfied. This ensures that the policyholder regains control over the assigned rights. This also requires the assignee to release the assignment.
• Signatures and notarization: The form requires signatures from both the policyholder and the lender (or their authorized representatives). In some cases, notarization may be required to validate the signatures.

Once the collateral assignment form is completed, signed, and filed with the insurance company, the assignment becomes effective. The insurance company acknowledges the assignment and updates its records accordingly.

Which life insurance is available for collateral assignment?

Collateral assignment is typically associated with permanent life insurance policies, which include cash value components. Here are the common types of life insurance that are often available for collateral assignment:

Whole Life Insurance: Whole life insurance provides coverage for the entire lifetime of the insured. It has a cash value component that grows over time, and policyholders can borrow against this cash value or assign it as collateral.

Universal Life Insurance: Universal life insurance is a flexible policy that allows policyholders to adjust their premium payments and death benefits. Like whole life insurance, universal life policies accumulate cash value, and this cash value can be used for collateral assignment.

Variable Life Insurance: Variable life insurance allows policyholders to invest the cash value in various investment options. The cash value and death benefit are subject to market fluctuations. Variable life insurance policies can be used for collateral assignment, but the cash value is influenced by the performance of the underlying investments.

Indexed Universal Life Insurance: Indexed universal life insurance combines elements of universal life insurance with the potential for cash value growth based on the performance of a stock market index. Policyholders can potentially use the cash value for collateral assignment.

It's important to note that term life insurance, which provides coverage for a specific term without a cash value component, is generally not suitable for collateral assignment. Term policies do not accumulate cash value over time, making them less suitable for serving as collateral.

Which types of loans allow you to use a collateral assignment of life insurance?

Collateral assignment of life insurance is commonly associated with certain types of loans. These may include:

Life insurance policy loans: Many life insurance policies, such as whole life insurance and universal life insurance, allow policyholders to borrow against the cash value of the policy. The policy itself serves as collateral for the loan.

Business loans: Small business owners may use the cash value of their life insurance policies as collateral for business loans. This can provide a source of financing for business expansion or other needs.

Personal loans: Individuals can use the cash value or death benefit of their life insurance policies as collateral for secured personal loans. This can be a way to access funds for various personal expenses.

Premium financing: Collateral assignment of life insurance is sometimes used in premium financing arrangements. In this scenario, the cash value or death benefit of a life insurance policy serves as collateral for a loan to pay insurance premiums.

Estate planning loans: Individuals engaged in estate planning may use the collateral assignment of life insurance to secure loans. These loans can be used for various purposes, including paying estate taxes or equalizing inheritances among beneficiaries.

Debt consolidation loans: Some individuals may use the cash value of their life insurance policies as collateral to secure loans for debt consolidation purposes.

Is using a collateral assignment of life insurance a good idea?

The decision to use a collateral assignment of life insurance depends on individual circumstances, financial needs, and objectives. Here are some considerations to help you determine if it is a good idea for your specific situation:

Pros:

• Access to funds: Collateral assignment allows you to use the cash value of a life insurance policy as collateral for a loan, providing a potential source of liquidity when needed.
• Lower interest rates: Loans secured by life insurance policies often come with lower interest rates compared to unsecured loans or credit cards.
• Retain policy ownership: You maintain ownership of the life insurance policy, which means you can still benefit from the policy's death benefit and potential cash value growth.

Cons:

• Impact on beneficiaries: The collateral assignment can reduce the amount of the death benefit payable to the policy's beneficiaries. The lender is entitled to receive the outstanding loan amount before the remaining proceeds go to the designated beneficiaries.
• Cost of borrowing: While interest rates may be lower compared to other forms of credit, there is still a cost associated with borrowing against a life insurance policy. It's important to consider the total cost of borrowing over time.
• Risk of policy lapse: Failing to repay the loan can lead to a policy lapse if the outstanding loan amount, including interest, becomes too high. This could result in the loss of life insurance coverage.

Collateral assignment agreements can be complex, and it's essential to fully understand the terms, including any fees, interest rates, and potential consequences of default. Depending on your financial situation, there might be alternative sources of funds or financing options that better suit your needs without impacting your life insurance policy.

Before entering into a collateral assignment arrangement, consult with financial and legal professionals to ensure that the arrangement aligns with your financial goals and needs.