Congratulations on getting your Small Business Administration loan approved! However, If the success of your business depends on you being active in the business, the SBA or banks might require that you get a life insurance policy. Since the SBA doesn’t give out loans without protecting themselves, life insurance is a way to make sure your loan will get paid back one way or another.
You may be wondering… “Why do I need a life insurance policy to secure an SBA loan?”
Lending institutions such as the banks and the SBA, view new business ventures as a risky endeavor. They are sometimes reluctant to lend money without some sort of collateral. If the business owner does not have the collateral to back the loan, as a safety measure, the lender could require life insurance for small business owners as a back-up plan.
Statistics show that most new businesses fail within the first year and 50% close their doors within 5 years. Raising capital can be the difference between success or failure. Cash flow is crucial to the success of any business.
Requirements of Life Insurance for SBA Loans
There are 4 requirements for the life insurance policy to be accepted for satisfying the loan requirements and guidelines:
1. The policy must be in force or approved to the business owner before the loan can be issued.
2. The life insurance policy duration must equal or surpass the required loan repayment terms.
3. Coverage amount or death benefit must equal or surpass the outstanding principal amount of the loan being applied for.
4. A collateral assignment document must be completed prior to the loan’s approval.
Small Business Administration Guidelines Regarding Life Insurance
According to sba.gov: “Life insurance and/or disability insurance is not required for all loans, but the Lender should require life or disability insurance where there is a concern over whether the business could survive in the absence of an individual or small group of individuals that provide the management for the small business concern. When life or disability insurance is deemed prudent, the Lender may accept a Collateral assignment of an existing or new *decreasing term or universal life insurance policy. Lender SHOULD NOT be named as a beneficiary.”
In other words, lenders should require the borrower to purchase a life insurance policy if the borrower is the owner or key person of the company and vital to the success of the business. Although the SBA does mandate coverage, there are very few lenders that would issue a loan without life insurance being used as collateral assignment.
How Does Collateral Assignment of Life Insurance Work?
Once the policy is approved the owner or insured must request a collateral assignment form from the insurance company. A competent insurance agent can help with this process as well. Since the lender will require notification of collateral assignment, the life insurance company will send a copy of the accepted collateral assignment form. This paperwork exchange could take up to two weeks so if you need a policy as collateral for a loan, time is of the essence.
Who is the Named Beneficiary?
The lender is not named as the beneficiary of the policy. Your spouse or family members would be the beneficiaries. The owner of the life insurance would assign the proceeds to the lender as collateral assignment. If you were to pass away, the outstanding amount of the loan is due to the bank and the remaining life insurance benefit will be distributed to your loved ones. Since the loan has a decreasing balance, the bank is only entitled to receive the actual remaining balance of the loan. The loan would be paid in full and the business would be owned by your family.
What Type of Life Insurance Policies are Available?
Decreasing Term Insurance: Even though the SBA guidelines recommend decreasing term or universal life insurance, you do not want to buy this type of policy. The concept is; as you pay down your loan and your outstanding balance decreases, it would make sense to purchase a policy with a decreasing death benefit to go down with the reduced loan balance.
The major problem with decreasing term insurance is that is much more expensive than regular level term insurance. In addition, even though your death benefit goes down each year, the premium does not. So you will be paying more each year for less coverage.
Term Life Insurance: Term life insurance is probably the best choice for an SBA loan because it is inexpensive and can be tailored to fit the time frame of your loan. For instance, if you have a 10 year loan, you might want to choose a 10 year level term policy. Term lengths available range from 5, 10, 15, 20 and up to 30 years.
Universal Life Insurance: Universal life is a type of permanent life insurance – it stays in force as long as you live and pay your premiums. This is probably not the best choice for SBA coverage because it is more expensive than term life, but some people like the idea of having a policy for their lifetime. There are three different types of Universal Life: Guaranteed, Indexed, and Variable. Of these three, Guaranteed Universal Life is the most inexpensive available.
No Exam Life Insurance: If you need a policy in a hurry and want to skip the medical exam, a no medical exam policy is the way to go. If you qualify – meaning you are in fairly good health, you can get approved for a policy in less than a week. Most companies offer up to $250,000 to $500,000 of coverage without a medical exam but they do require a medical questionnaire to be completed over the phone or online.
There are a few companies that will go up to $1,000,000 of coverage. If you need more than one million dollars of coverage, call our office at: 914-633-1717 and we can help design a no medical exam policy stacking plan for you.
Final Thoughts for SBA Borrowers
When applying for life insurance for as collateral for an SBA loan, most people need a policy and they need it fast. Don’t be afraid to shop around with different agents but be sure to work with one that is knowledgeable and represents more than one insurance company.
It’s also important your insurance policy be set up in such a way that it doesn’t go entirely to paying off your loan. Have some additional coverage so the loan can be satisfied and your family can have funds to pay outstanding debts, cash to keep the business running and money to keep them in their current lifestyle.