ADVISOR LOANOLOGY
Bank Required Insurance Policies
Business loans require the borrower to have a handful of insurance policies in place. These requirements vary depending on a number of factors including but not limited to lender credit guidelines, loan type, loan amount, industry type, etc. These factors will in turn dictate the insurance policy requirements, including coverage amounts, certificates and document specifications, and ongoing policy requirements.
SBA lenders have both their own internal policies, along with 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.
Borrowers will have a handful of insurance policies that will be required for their loan to close. For acquisition loans, there may be a different set of insurance policies required to comply with the purchase agreement. A best practice is to request the preliminary insurance requirements needed once a term sheet is executed. Be sure to provide your agent / carrier with the exact requirements so they can get a head-start on the required items. It will be important not only to determine whether your current insurance policy(s) meet all requirements of the lender, but that you make that determination quickly in case additional items are needed. Not all life insurance carriers, for example, furnish collateral assignments that will comply with lender and/or SBA guidelines.
Typical Insurance Policies Needed
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 business loans will require a life insurance policy (typically known as key-man or loan guarantee coverage) to protect the lender should the borrower pass away during the term of the loan. The process of obtaining life insurance for a business loan can be a bit tricky and should not be confused with the process that is needed to obtain life insurance for other personal or business purposes. Often there is a closing deadline, which necessitates a sense of urgency for the borrower to fulfill the required documentation to the lender.
General Liability Policy
This is typically always required for business loans even though advisors 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 conventional 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
Workers’ Compensation Certificate of Statutory workers’ compensation insurance required for employees in connection with the advisory business.
Hazard Insurance Policy
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.
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 $500K
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 $500K
Most of the time for loans under $500,000 many of the SBA lenders we work with will consider waiving all or part of the life insurance requirement if:
Borrower has 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.
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 or eliminate the amount of life insurance required.
Life Insurance and Collateral Assignment
Most business loans will require a life insurance policy (typically known as key-man or loan guarantee coverage) to protect the lender should the borrower pass away during the term of the loan. The process of obtaining life insurance for a business loan can be a bit tricky and should not be confused with the process that is needed to obtain life insurance for other personal or business purposes. Often there is a closing deadline, which necessitates a sense of urgency for the borrower to fulfill the required documentation to the lender.
While other types of policies will require your attention, the life insurance policy needs your focus and should sit on top of your insurance priority list because of a few factors which can cause delay:
Not every carrier can fulfill the Lender’s life insurance requirements, whether that’s due to product limitations, underwriting guidelines, or collateral assignment issues.
Not every agent/broker can secure the Lender’s life insurance requirements in a timely manner due mainly to lack of familiarity with the loan closing process.
For these reasons (and more), it is important that borrowers engage with an insurance agent/broker who is well-versed in the nuances of obtaining life insurance quickly and compliantly in order to mitigate the risk that this important requirement will cause a delay for closing.
The amount of life insurance typically matches the amount of the loan, and in some cases may be less. Borrowers will ultimately need to obtain the following documents, which lenders will typically require on file and in good order 7-10 days in advance of closing:
Life Insurance Policy
Executed/Recorded Collateral Assignment
Life Insurance Collateral Assignment Acknowledgment Letter
Verification of Coverage
Why should a life insurance policy be the first focus?
The lending process can often move faster than the life insurance carrier’s normal process. For most loans, the life policy and collateral assignment are pre-closing requirements which means the documentation must be in place before the loan is closed. In many cases, life insurance has more important considerations and consequences than other types of coverages. Your loved ones, business partners, and employees all stand to be impacted by the decisions that are made with life insurance which means a little more due diligence and follow up may be required.
Think about prioritizing the life insurance requirement not only for the factors already noted, but more commonly than other types of required coverages, there are a few factors that can also cause delay in obtaining the proper documentation. Even if you start the process early, you may still need to be the squeaky wheel to get everything needed on time. Here are a few important factors to consider:
Collateral Assignments are added life insurance requirements that are not applicable for most other life insurance purchases that you might make for your family or your business. Because they are less frequently used, many agents and brokers are less familiar with the nuisances and details that can be the difference between getting them recorded and documented properly for closing. Some life insurance carriers are also less proficient in recording them quickly and compliantly (compliantly in terms of lender standards). The satisfactory recording of the assignment can sometimes add an extra few weeks (and in some cases longer) to the process.
Your medical history can play an important role in the time it takes to get your policy approved. It is not uncommon for life insurance underwriters to require medical records in cases where applicants have history that requires additional documentation. Common examples of histories that may warrant medical records are cancer, diabetes, heart, etc. Carriers and agents all have different processes for obtaining records but having to get doctors offices and/or medical records copy services involved can add weeks if not months to the process. It is important to let your agent/broker know about your history up-front, and getting a clear expectation of timelines so you can better manage the closing process, and pivot if/when necessary.
Like any other transaction, some agents/brokers are familiar with the nuances of obtaining coverage for a loan, and some are not. The same goes for carriers. Working with experienced agents/brokers and carriers can be the difference between closing on time vs. having a delay. Where we commonly see delays are when borrowers initiate this process with their personal or business agent who is unfamiliar with the lending process. To boot, that agent may work with a carrier(s) who are unfamiliar with the process. We recommend working with professionals who have the expertise needed to get you to the finish line.
Many borrowers are inclined to collaterally assign an existing policy to the lender for closing. What many borrowers do not consider is the fact that the existing policy was intended to protect their spouse, children, or business partner(s). Assigning the existing policy can have the result of disinheriting those that you care about most. Give careful thought to this dynamic. A qualified agent/broker should be able to guide you through these considerations, ensuring that you have the right lines of protection in place for all of your needs.
Life Insurance Collateral Assignment
Obtaining the life insurance policy for the amount specified in your loan commitment letter 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 form document needed is an executed or recorded Collateral Assignment form.
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 obligation on your loan (not the original starting loan balance), with the balance of the policy payable to your beneficiary(s). 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. Not all insurance carriers that provide them use forms that comply with lender and/or SBA guidelines. It is critical to understand this at the beginning, before beginning down the path with a carrier that may not be deliver what you need in the end.
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. As an example, you may have a policy death benefit that will meet the lender’s requirement, but it is possible that the term/duration will not (i.e. you have 5 years left on a 10 year term policy, and a new 10 year loan obligation).
It is imperative that you verify with an existing or potential insurance carrier that they will be able to provide all of the assignment documentation required (your lender will be able to verify what is needed).
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 explore having multiple collateral assignments on the same insurance policy. However, it is important to verify with the carrier, as not every carrier allows multiple assignees on a policy.
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 advisor or any other person.
In connection with all policies covering assets in which Lender holds or is offered a Security Interest for the Loans, the 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 is 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.