Creditor Insurance
One of the ways that lending institutions protect themselves is by insuring the people they lend money to. Most people taking out a personal loan or mortgage are not required to take life insurance with it. This is not the case for businesses.
Most lending institutions can and may require Creditor insurance as a condition of the loan or line of credit. The procedure is simple: the lending institution owns a policy on the life of the borrower. If the borrower dies unexpectedly, the bank collects on the policy and pays off the outstanding balance or the loan.
Borrowers do not have to accept the insurance offered by the lender. They can apply for a policy to an insurer of their choice and assign ownership of that policy to the lender. The advantage to this method is that it is more likely that one will get a better insurance policy, and at a lower cost than the lender can offer.
Another way is to assign ownership of an existing personal policy to the lender. Assuming that the death benefit is sufficient to satisfy the borrowed amount, the lender will accept the policy. If the death benefit is more than the amount of the loan, the insurer issues a death benefit cheque for the bank to cover the loan and the rest goes to the named beneficiary of the deceased business owner.
The fact that the bank was assigned ownership and became beneficiary did not extinguish the rights of the existing beneficiary when the policy was assigned. If the business owner had used up $130,000 of his line of credit, that is all the bank would be entitled to as the rest would go to the spouse or beneficiary.
Please note that the premium paid on life insurance policies required by a lender are the only life premiums that can be written off as a business expense.
