Life insurance is a contract between a policyholder and insurer where the insurer promises to pay the insured's beneficiary an agreed amount upon their death. The most common application is between heads of household and their dependents.
Life insurance is also used by commercial lenders as a risk mitigation strategy for loan applicants of privately held, family owned businesses.
In the same vein the SBA requires that loan applicants obtain a collateral assignment of life insurance for the lender's benefit when the business is formed as a sole proprietorship or single member LLC and is otherwise dependent on one owner’s active participation.
Examples of businesses dependent on one owner's participation include businesses where special training or licenses are required such as doctor's offices, assisted living facilities, contractors, mechanic shops, etc.
The required face value amount of the insurance policy for 7(a) loans is determined by the operating businesses industry classification code, loan amount, length of loan term and available collateral.
On the other hand, Certified Development Companies (CDC) which fund the 504 2nd Deed of Trust, also known as the Debenture, are mandated to require a collateral assignment of life insurance with a face value amount equaling the Debenture minus the available collateral's discounted liquidation value based on the following schedule:
Now, pay close attention to these three important points.
As a best practice, I recommend loan applicants discuss the requirement to obtain life insurance with their loan broker or SBA business development officer upon or before the loan is submitted to underwriting or is scheduled to be presented at loan committee.
The length of time it takes to obtain life insurance is between one to six weeks, or more depending on the life insurance company’s pipeline density, underwriting practices and the loan applicant's age and health status.
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