Collateral Assignment Key Person Life Insurance: A Plain-Language Guide

Collateral Assignment Key Person Life Insurance: What the Bank Will Ask For

Collateral assignment key person life insurance is a written pledge. The policy owner gives a lender certain rights in the policy as security for a business loan. The policy stays in force, and the owner keeps most of its rights.

Banks often ask for this when a company’s loan depends on one person’s work. If that person dies, the lender wants a way to protect its money. This guide explains the process from the borrower’s side, in plain terms. NR CPAs & Business Advisors is a Miami CPA firm that helps business owners review life insurance as part of their tax and cash flow planning.

What a Collateral Assignment Means for a Key Person Policy

A collateral assignment is a pledge of specific policy rights to a lender, as security for a loan. Key person life insurance pays a business for financial losses caused by a key employee’s death or disability, according to the Insurance Information Institute.

The lender’s interest is tied to the loan. It is not ownership of the whole policy. The insurer’s contract stays between the owner and the insurer.

Why does the bank care? The key person often drives revenue, runs operations or holds relationships the lender relies on. If that person is gone, repayment can get harder. The policy gives the lender a source of funds tied to that risk.

One rule matters early. Under Fla. Stat. § 627.404, a business may insure a key person only with that person’s written consent, obtained before the insurance is bought. The business’s insurable interest must exist when the contract is made. Under Fla. Stat. § 627.404, any individual of legal capacity may buy insurance on his or her own life for the benefit of any person. A policy on another individual’s life, however, must pay its benefits to the insured, the insured’s personal representatives, or a person who had an insurable interest in the insured when the contract was made, and that insurable interest need not exist after the inception date of coverage under the contract.

The Two Types of Assignments: Absolute and Collateral

An absolute assignment moves all ownership rights to the lender. A collateral assignment moves only the rights needed to secure the debt. The difference decides who controls the policy while the loan is open.

With an absolute assignment, the lender takes over the policy’s ownership. The original owner gives up most control. That is a bigger step than many borrowers expect.

With a collateral assignment, the owner keeps the policy. The lender gets a limited claim tied to the debt. Here is the difference in plain terms:

The assignment type comes from the loan documents and the lender’s requirements. Confirm the wording before you sign. A single phrase in the form can change what the bank controls.

Who Signs, and Who Must Be Involved

The policy owner signs the assignment form, and the lender becomes the assignee. The owner may be the business, a trust or the insured. That choice decides who signs.

Four parties are usually involved:

• The insured: the key person whose life the policy covers.
• The owner: the person or entity that holds the policy and pays premiums.
• The lender (assignee): the bank that receives the assigned rights.
• The insurer: the company that issued the policy and records the assignment.

The insurer processes the form and confirms it in its records. Once that happens, the lender’s name is tied to the policy for loan purposes. Ask the insurer for written confirmation that the assignment is on file.

If a business entity owns the policy, the company must show who can sign for it. Its governing papers and its leaders’ written approval should set that out. Keep the key person’s written consent with the file, too.

What the Bank Will Ask For

Banks usually start with the policy details. Expect to provide the insurer’s name, the policy number and form number, the issue date, and the names of the owner and insured. The bank will also want the face amount (the death benefit), any riders, the premium amount and how often premiums are paid. Lenders also want to know whether premiums are current.

For a whole life policy with cash value, ask the insurer to show guaranteed and non-guaranteed values separately. Dividends are not guaranteed. Make sure the bank sees both figures, clearly labeled.

Loan documents usually include three items:

• The promissory note, which sets the loan amount, rate and terms.
• The signed collateral assignment form.
• Proof of the business’s insurable interest in the insured, including the key person’s written consent.

The bank may also ask for a current statement from the insurer. Request it in writing before you sign the loan papers.

Which Rights the Policy Owner Keeps and Which the Lender Controls

The owner usually keeps the right to pay premiums and receive policy statements. The lender typically gains a claim on the death benefit, up to the loan balance. It may also need to approve some actions. Surrenders, policy loans and beneficiary changes are often covered by the loan agreement.

Florida law also sets rules for policy loans. Under Fla. Stat. § 627.458, an insurer may defer a policy loan, other than a loan for the payment of a premium to the insurer, for six months after the application. That loan rule does not apply to term policies. If the owner later wants a loan, check which rule applies.

Get the list of restricted actions in writing. Ask the bank to confirm which actions need its approval. Agree in advance on what happens after repayment. The bank should release the assignment in writing so the owner’s full rights return.

Example: A Business Line of Credit Secured by a Key Person Policy

This example is hypothetical. A company borrows $400,000 on a line of credit. The bank asks for a key person policy with a $1,000,000 face amount, assigned as collateral. The insured is the company’s lead operator.

At the start, the bank reviews three things: the loan balance, the death benefit and any cash value. Here, the death benefit is larger than the loan balance. The bank checks that the coverage matches the debt.

If the insured died while $400,000 was still owed, the bank would be paid up to that balance from the proceeds. The rest would go to the beneficiary the owner named. This is a common structure, but the loan papers and the insurer’s rules control the actual terms.

Federal tax rules also apply. Under 26 U.S.C. § 101, life insurance death proceeds are generally excluded from gross income. A transfer for valuable consideration can limit that exclusion. Ask your CPA how that rule fits your structure.

This example is for illustration only. Your loan terms and the insurer’s rules decide the outcome.

Which Policies Lenders Usually Review

Lenders usually focus on the death benefit first. For term life insurance, they look at the death benefit and the length of the term compared with the loan. Term coverage has no cash value. The NAIC Life Insurance Buyer’s Guide explains the differences between term and permanent life insurance.

Whole life insurance includes cash value. The lender may review both the death benefit and the cash values. Show guaranteed and non-guaranteed values separately. The Florida Department of Financial Services life insurance guide covers cash value, policy loans and beneficiaries.

The lender sets its own requirements. The policy type is one factor among the loan terms, the company’s finances and the insured’s role. Our firm offers term life insurance, whole life insurance and key person insurance, placed through a licensed agent.

How the Death Benefit Relates to the Loan Balance

Compare the death benefit with the amount still owed, not just the policy’s size. The face amount is what the policy pays. The loan balance is what the bank is owed on the date of death.

A revolving line changes often. New draws raise the balance, and repayments lower it. Unpaid interest adds to what is owed. A coverage amount set at the start may not match the balance years later, so review it as the loan changes.

Ownership matters for estate tax, too. Under 26 U.S.C. § 2042, life insurance proceeds count in the insured’s gross estate when they are receivable by the executor, or when they go to other beneficiaries and the insured held incidents of ownership in the policy at death. Who owns the policy can change how those proceeds are treated.

The coverage amount should fit the loan and the business’s own plans. A coverage review covers the premiums, the loan interest and the ownership structure together.

Key Takeaways and a Coverage Review for Your Loan

A collateral assignment pledges certain policy rights to a lender as security. The business or owner keeps the policy and most of its rights. Collateral assignment key person life insurance ends when the loan is repaid and the assignment is released.

Before you sign, collect the bank’s document list and the policy’s details. Read the loan papers for actions that need the bank’s approval. Keep the insured’s written consent in your file.

Related pages to read next include our key person insurance page, our buy-sell agreement insurance page and our estate planning life insurance page.

If your bank has asked your business to assign a key person policy, you can contact NR CPAs & Business Advisors to set up a coverage review. Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the firm’s accounting practice.

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