What Advisors Need to Know About Insurance Requirements for Business Loans

Insurance Policy Requirements for Business Loans

Business loans require the borrower to have a handful of insurance policies in place. Lenders vary in these insurance policy requirements.

Each lender has their internal policies regarding required borrower insurance including different insurance policy types, coverage amounts, certificates and document specifications, and ongoing policy requirements.

SBA lenders have both their internal policies and SBA requirements to contend with. While SBA requirements are of course not applicable to commercial non-SBA lenders, their policy requirements can be just as extensive and in some cases, even more, cumbersome than what SBA lenders require.

Insurance Policy Requirements

Borrowers will have a handful of insurance policies that will be required for their loan to close. Lenders have different requirements for the different policies required. For acquisition loans, there also may be other insurance policies required to comply with the purchase agreement.

A best practice is to request the insurance requirements needed once a term sheet is executed. Be sure to provide your agent, or your carrier if you are the agent, the exact requirements of the bank.

Check to see if your current insurance policy meets all requirements and if your current carrier can provide the exact documents required by the lender. Not all life insurance carriers, for example, offer collateral assignments.

Lenders have not only initial policy requirements but have ongoing requirements for these policies also.

Typical Insurance Policies Needed for Business Loans

For advisor borrowers, the primary insurance policies typically required are:

  • Life Insurance
  • General Liability
  • Errors & Omissions
  • Workman’s Compensation
  • Hazard Insurance

 

Life Insurance and Collateral Assignment

Most all business loans will require a key man or life insurance policy to protect the lender if the borrower passes away during the term of the loan.

The amount of life insurance needs to match the amount of the loan. There are numerous important considerations in ensuring your insurance requirements are completed correctly and quickly, so they do not delay your loan closing. 

While other required policies will need your attention, the life insurance policy needs your focus.

The life insurance policy (and corresponding requirements) should sit on top of your insurance priority list.

The life insurance policy must be obtained and then provided to the lender.

Borrowers will need to obtain:

  • Life insurance policy for the amount of the loan
  • Collateral Assignment to the lender

Borrowers will need to provide:

  • Life Insurance Collateral Assignment Acknowledgment Letter
  • Copy of the life insurance policy

Why the life insurance policy needs to be the first focus:

A life insurance issue is one of the most common culprits causing loan closing dates to be pushed back.

The lending process often moves faster than the life insurance carrier’s normal process. Not only will you need to start the life insurance process immediately, even when you do, but you may also still need to be the squeaky wheel to get everything needed on time.

Collateral Assignments are an added life insurance requirement that is not needed in other policy types typically required for advisors. This takes additional time, eating up more days in the process.

For most loans, the life policy and collateral assignment are pre-closing requirements and are difficult to get approval to make it a post-closing requirement. Some commercial lenders we work with will require the policy to be in place but will provide a 30-day window to deliver the assignment.

This policy has more important considerations and consequences than other policies. This policy can impact your loved ones regarding the benefits received from life insurance upon your death. More thought may be needed, depending on your current life insurance coverage and amount insured.

There are more variables and moving parts with life insurance than the other policy types required. This policy type takes a little more due diligence and follow up than other policies.

Life Insurance Collateral Assignment

Obtaining the life insurance policy for the amount of the loan is step one. The next step is getting the insurance carrier to assign your policy to the lender so, in case of death, the lender receives the policy amount assigned to pay off the loan.

The structure used to achieve this is the Collateral Assignment and the form document needed is a Collateral Assignment Acknowledgement Letter.

Unlike an Absolute Assignment that assigns the policy as is, the Collateral Assignment specifies that upon death, the policy will pay the lender the current outstanding balance (not the original starting loan balance) of the loan and any fees, and the balance of the policy to your beneficiary.

Once the loan is paid off the assignment becomes void. The policy can be then canceled or kept as additional coverage for your loved ones.

Collateral Assignment Considerations:

  • Not all insurance carriers provide collateral assignments.
  • Each lender will have a collateral assignment acknowledgment letter template, but many insurance carriers will use their own company approved assignment letters. In this case, you will want to get the template to your lender to verify the insurance carrier’s form meets the lender’s form requirements.
  • Don’t assume your current policy and carrier is “good as is” but contact them right away to verify.
  • It is imperative that you verify with an existing or potential insurance carrier that they will be able to provide a collateral assignment.
  • If you have an existing policy with a carrier who will not provide collateral assignments, you’ll need to obtain a different policy with a carrier that does.
  • Insurance carriers vary significantly in how quickly they can produce the needed collateral assignment acknowledgment letter. Some can complete in a week while others can take several weeks.
  • You may need to be the squeaky wheel to ensure your assignment is provided in time not to delay the loan process or closing.
  • As long as the policy amount is large enough, borrowers can have multiple collateral assignments on the same insurance policy, including two different lenders.

Use Collateral Assignment and not a Beneficiary Assignment

Some lenders may ask for a Beneficiary Assignment structure; however, in most all business loans and with all of the lenders in our network, the Collateral Assignment is what is used.

The Collateral Assignment is the better structure for advisors. We recommend that even if the beneficiary structure is allowable, and may be obtained slightly faster, that advisors stick with the Collateral Assignment.

If a borrower merely assigns the lender as the beneficiary than the entire amount of the policy instead of the loan balance is paid to the lender. While the beneficiary structure can have special wording to make it closely resemble a collateral assignment, this process is not necessary. All lenders will accept a collateral assignment, and we advise advisors only to use the collateral assignment structure.

Existing Life Policy vs. New Life Policy 

Most advisors have existing life insurance policies with their loved ones as the beneficiaries. Advisors vary greatly however in how much coverage they have for their families. Life insurance plays a different role in different advisor’s unique estate and succession planning needs and strategies.

For some borrowers, this is a much easier process than for others. If there is a more than adequate amount of life insurance that would be available for loved ones after the loan amount would be assigned to the lender, then an assignment is all that is needed.

However, there would not be adequate coverage for both business and family, then the policy amount would need to be raised to meet that delta, or a new insurance policy issued for the loan amount would be needed.

Don’t assume your existing insurance carrier is the path of least resistance. You’ll want to first verify with them that the requirements for the lender can both be met as well as completed and delivered in less than two to three weeks.

It’s not as a “rush” for loan closings scheduled out 45 days or longer. If you are trying to close a loan in about 30 days to meet an acquisition closing date, then life insurance timeline management becomes more critical.

If you have a current policy large enough then you can assign insurance matching the outstanding loan amount to the lender. If not, you’ll need to add to your existing policy or get a new policy.

While we have seen life insurance carriers turn around the assignment form in a week or less, others take several weeks. Depending on your age, health, and policy size, a new life insurance policy may require a complete physical that has to be scheduled.

When a new life policy is needed

The easiest, cheapest and fastest life insurance policy to get is a ten year term policy for the amount of the loan.

However, if you have a significant cash value in a permanent life policy, in either a universal or whole life policy, this can be used as collateral as well.

Speed beats price. Don’t miss a million-dollar acquisition closing date because you wanted to save $30 per month on your rate. If the carrier is the best rate and can underwrite and process the assignment in time, then pat yourself on the back.

Request, receive and send the lender’s requirements to the insurance carrier you are considering. Before you start the process make sure the insurance carrier can meet all requirements and fulfill in time.

Not all insurance carriers will provide collateral assignments, so this is the “deal breaker” that is the starting requirement to address. Providing collateral assignments isn’t enough, they also need to commit to you that they can deliver it on time as well.

If you need a new policy and would be considered “high risk” due to health or age for instance, you could be adding weeks to the process if you aren’t careful in choosing the right carrier with the right high-risk product that still gets through underwriting, approval, and delivery of the collateral assignment acknowledgement letter. 

Life Insurance Requirements

Lenders will typically require a life insurance policy with the policy amount coverage matching the loan amount and assigned to the lender.

Lenders can vary in their requirements concerning approved insurance companies, minimum insurance carrier ratings, the certificates of insurance and collateral assignment forms.

Commercial non-SBA Life Insurance Requirements

While each lender has different requirements, these are typical life insurance requirements:

  • Life insurance insuring the life of Guarantor(s) for the amount of the Loan and the life of the Loan, beginning on the Closing Date.
  • Such policy must be from an insurer that is acceptable to Lender and rated at least “A” by A.M. Best Company.
  • Provide assignment of life insurance policy to Lender for the amount of the loan, which assignment shall entitle “Lender” upon the death of the Guarantor to retain the proceeds of the policy in an amount not to exceed the lesser of the outstanding obligations or loan balance and any fees.
  • Guarantor(s) will furnish Lender with evidence of such insurance upon the issuance or renewal of any binder or policy, annually or more frequently upon Lender’s request.
  • The policy shall require that the insurers send Lender notice of any requested change in beneficiary.
  • Any proceeds received by Lender under this policy shall be used to satisfy Guarantor’s Obligations, and any excess proceeds shall revert to Guarantor(s) or the named beneficiaries on the policy.

SBA Life Insurance Requirements

SBA has their minimum requirements for insurance but mostly defer to the SBA lender’s internal policies for similar sized non-SBA loans on their commercial lending side.

SBA Loans over $350K

SBA lenders may follow their internal policy for similarly sized non-SBA guaranteed commercial loans, except:

  • If the loan is not fully secured, life insurance is required for the principals of sole proprietorships, single-member LLCs, or for businesses otherwise dependent on one owner’s active participation, consistent with the size and term of the loan.
  • The amount and type of collateral available to repay the loan may be factored into the determination of the appropriate amount of life insurance.
  • If the lender determines that the principal is uninsurable, the lender must obtain written documentation from a licensed insurer of the same.

SBA Loans under $350K

Most of the time for loans under $350,000 many of the SBA lenders we work with will consider waiving all or part of the life insurance requirement.

  • If you do have a property, the SBA is going to put a second lien on, and the amount of equity is as large as the loan amount then we can typically get the life insurance requirement waived.
  • If the equity amount is only a portion of the loan amount, then we can typically get the life insurance required amount reduced to cover the difference.
  • Succession plans, contingency plans, and continuity agreements are other workarounds that can be utilized to reduce the amount of life insurance required.

 

General Liability Policy

  • This is typically always required for business loans even though you already have E&O insurance.
  • Commercial General Liability insurance policy is required to cover bodily injury, death and property damage. Is also required by lenders for businesses and assets comparable to the property, business and collateral.
  • Most lenders require a combined single limit of at least $1,000,000 per occurrence and $2,000,000 in the aggregate. We have seen some lenders require a $3,000,000 aggregate.

 

Errors & Omissions Policy

Certificate of Errors and Omissions (E&O) insurance in an amount of not less than the loan amount for protection against claims relating to the professional services provided by the Guarantors and the Borrower.

 

Workers’ Compensation

Certificate of Statutory workers’ compensation insurance required for employees in connection with the advisory business.

 

Hazard Insurance Policy

Various forms of hazard insurance and clauses may also be required. Commercial non-SBA lenders will typically have fewer requirements than with SBA loans.

SBA Requirements:

  • The SBA requires hazard insurance on all assets pledged as collateral.
  • If the borrower is located in a state that requires additional coverage including wind, hail, earthquake or other, on the hazard insurance, the borrower must provide a separate policy.

Real Estate Used as Collateral:

  • Coverage must be in the amount of the full replacement cost.
  • If full replacement cost insurance is not available, coverage must be for the maximum insurable value.
  • Insurance coverage must contain a Mortgage Clause (or substantial equivalent) in favor of the lender. This clause must provide that any action or failure to act by the mortgagor or owner of the insured property will not invalidate the interest of the lender.
  • The policy or endorsements must provide for at least ten days prior written notice to the lender of policy cancellation.

Personal Property:

  • Coverage must be in the amount of full replacement cost.
  • If full replacement cost insurance is not available, coverage must be for maximum insurable value.
  • Insurance coverage must contain a “Lender’s Loss Payable Clause” in favor of lender. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of the lender.
  • The policy or endorsements must provide for at least ten days prior written notice to the lender of policy cancellation.

Flood:

  • SBA flood insurance requirements are based on the Standard Flood Hazard Determination (FEMA Form 086-0-32).
  • If any portion of a building that is collateral for the loan is located in a special flood hazard area, the lender must require Borrower to obtain flood insurance for the building.
  • If any Personal Property Collateral is in a building, any portion of which is located in a special flood hazard area in that building is not collateral for the loan; lender must require Borrower to obtain available flood insurance for the Personal Property Collateral. The lender may waive this requirement when the building is not collateral for the loan if it:
    • Insurance coverage must be in amounts equal to the lesser of the insurable value of the property or the maximum limit of coverage available.
    • Insurance coverage must contain a MORTGAGEE CLAUSE/LENDER’S LOSS PAYABLE CLAUSE (or substantial equivalent) in favor of the lender. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of the lender.

Your Business Loan Also Has Ongoing Insurance Requirements

Getting the initial policies and documents required doesn’t end the borrower’s insurance obligations or requirements. Lenders have their individual sets of ongoing insurance responsibilities as well.

Ongoing insurance requirements can include:

  • The Borrower may be in default of loan covenants if required insurance policies lapse.
  • The Borrower, at least annually or upon request of Lender, to deliver to Lender the policies or certificates of insurance in a form satisfactory to Lender.
  • Stipulations that coverages will not be canceled or diminished without at least ten (10) days prior written notice to Lender.
  • The requirement to include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Borrower or any other person.
  • In connection with all policies covering assets in which Lender holds or is offered a Security Interest for the Loans, Borrower may be required to provide Lender with such lender’s loss payable or other endorsements, at closing and thereafter, as Lender may require.
  • Furnish to Lender, upon request of Lender, additional reports on each existing insurance policy showing such information as Lender may reasonably request.
  • The lender may request or require that on an annual basis, that the Borrower will have an independent appraiser satisfactory to Lender determine, as applicable, the actual cash value or replacement cost of any Collateral. No surprise that the cost of such appraisals are always paid by the Borrower.

Forced Placed Insurance Provision

Most lenders will have a “Forced Placed Insurance” provision (or something similar) in the loan agreement. This is a provision that essentially states that if the borrower doesn’t provide evidence of the correct and required policies and requirements, then the lender has the right to purchase the insurance for you.

Provision Language Could Include:

  • The Borrower is hereby notified that unless Borrower provides Lender with evidence of the insurance coverage required by this Agreement, Lender may purchase insurance at Borrower’s expense to protect Lender’s interest in the Collateral securing the Indebtedness.
  • This insurance may, but need not protect Borrower’s interests. The coverage the Lender purchases may not pay any claim that Borrower makes or any claim that is made against Borrower in connection with the Collateral securing the Indebtedness.
  • The Borrower may later cancel any insurance purchased by Lender but only after providing Lender with evidence that Borrower has obtained insurance as required by this
  • If Lender purchases insurance for the Collateral, securing the Indebtedness, Borrower will be responsible for the costs of that insurance, including interest and any other charges that Lender may lawfully impose in connection with the placement of the insurance, until the effective date of the cancellation or expiration of the insurance.
  • The costs of the insurance may be added to the total outstanding Indebtedness. The costs of the insurance may be more than the cost of insurance that Borrower may be able to obtain on its own.

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