Things to Consider Before Pledging Your Life Insurance as Collateral on a Loan

Policyowners use a collateral assignment (as the creditor’s interest may appear) form of transfer almost exclusively as a secondary source of payment when they pledge a policy on a temporary basis as collateral for a loan.1 The term “collateral” implies that the policyowner-debtor is primarily liable for the loan and only if he or she defaults will the lender call upon policy values to back up that obligation. The cash values in the policy serve as protection to the lender as long as the insured lives and the death benefit protects the lender if the insured dies. Once the debtor/policyowner repays the loans, all rights in the policy automatically revert to the policyowner. 

Policy rights transferred when policyowners use the collateral assignment form of transfer generally include the right to:

1. receive the death benefit (but the lender must transfer the excess over the debt unpaid at the insured’s death to the beneficiary specified by the policyowner);

2. cash in the policy in the event the policyowner defaults on a loan or fails to pay premiums (but the lender must give reasonable notice and transfer the excess over the debt unpaid at that time to the policyowner); 

3. exercise nonforfeiture options; and

4. receive policy dividends.

The major right virtually always retained by the ‐policyowner is the right to change the beneficiary.

After the debtor/policyowner repays the debt, the transferee must reassign all policy rights back to the policyowner. Again, the lender/assignee must inform the insurer in writing at its home office before it will allow the policyowner to resume exercising all policy rights.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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