Kimberlee S. Knopf, Esquire

SOP 50 10 5(D) gives Lenders discretion as to whether life insurance should be required as collateral for a loan. The Lender is instructed to analyze the adequacy of the collateral and secondary repayment sources in addition to determining whether the death of the owner or other key person will adversely affect the business operations and cause a loan default. If the Lender elects not to require life insurance as a result of its analysis of the collateral and business operations, the rationale for such decision must be documented in Lender's underwriting. Unfortunately, however, in the event Lender does not require life insurance for the loan and otherwise complies with SOP 50 10 5(D), but the business fails as a result of the death of an owner or key person, the risk of loss on the loan due to such individual's death lies solely with the Lender and there will likely be a repair or denial of the SBA guaranty.

The mechanism by which a Lender obtains an interest in the life insurance policy is through a collateral assignment of life insurance which assigns to Lender those ownership rights necessary to preserve its collateral while correspondingly prohibiting the owner from taking certain actions that could jeopardize Lender's interests, such as cashing in or cancelling the policy. The policy owner often retains certain rights of ownership which would not interfere with Lender's interest, such as the ability to designate or change a beneficiary.

The collateral assignment is signed by the owner of the policy, as assignor (and such owner is not necessarily the named insured), and often by the Lender, as assignee. In all cases, the collateral assignment must be acknowledged by the home office of the life insurance company. An acknowledgement is most frequently accomplished by either a stamped notation and/or signature of an authorized officer of the life insurance company in the space provided on the collateral assignment form or in a letter issued by the insurance company confirming Lender's interest as a collateral assignee under the applicable life insurance policy.

When the collateral assignment is properly acknowledged, and the life insurance policy is in effect at the time of an insured's death, a Lender is entitled to be reimbursed out of policy proceeds for the amount owed on the outstanding obligations (or some other amount as previously agreed among the parties). After the Lender is paid in full in accordance with the collateral assignment, the beneficiaries under any such life insurance policy receive any remaining proceeds.

Even when a Lender requires and obtains an assignment of a life insurance policy of collateral, a Lender must still carefully review the life insurance policy in order to be assured that Lender will be entitled to promptly receive the death benefit from any such policy upon the death of the owner. Recently, a Lender client required a collateral assignment of life insurance on the husband but received a collateral assignment of a life insurance policy insuring the lives of both the husband and the wife. A review of the insurance policyrevealed it to be survivorship life insurance (also called second to die life insurance or last to die life insurance). Under such a policy, the death benefit is not paid until the second life covered under the joint policy is deceased.

While second to die life insurance policies may be useful for estate planning, a Lender is taking a risk by accepting an assignment of any such policy to fulfill the life insurance requirement on an SBA loan. In this example, if the wife predeceases the husband then the Lender will not be in a worse position than if it had obtained an assignment of life insurance on the husband only. However, in the event the husband dies before the wife, the Lender will not be entitled to collect the proceeds from the life insurance policy until after the wife's death. If there is a business failure as a result of the husband's death, then the SBA guaranty would likely be jeopardized because Lender could not collect the proceeds of the life insurance until after the wife's death, which could be many years later.

As discussed above, in order to adequately protect the SBA guaranty, a Lender should not only obtain a collateral assignment of life insurance in accordance with SBA requirements, but also review the terms of the life insurance policy in order to assure prompt payment under the collateral assignment upon the death of the insured.

For more information on SBA's life insurance requirements or any other lending issues, contact Kim at KKnopf@StarfieldSmith.com or (215) 542-7070.

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