Life Insurance as an Asset: Collateral Assignment

A true story, which occurred more than a century ago:

John C. Burchard was the owner of a life insurance policy on himself. Burchard had made two premium payments on the policy, but was under financial duress and currently late on the third payment. Burchard also needed a surgical operation, but had no money for the procedure.

In an effort to solve both his financial and health issues, Mr. Burchard made the following proposal to Dr. A.H. Grigsby: Burchard would sell his life insurance policy to Dr. Grigsby in exchange for $100 and the operation. Dr. Grigsby also would assume the responsibility for paying future premiums. In doing so, Dr. Grigsby, as the new owner, could determine the beneficiary and take control of policy benefits, including the cash values. The two parties agreed to the arrangement, defined the terms, and executed the agreement.

About a year later, Burchard died.

Dr. Grigsby, as owner of the policy, attempted to file a claim and receive the death benefits, the insurance company initially declined the claim, saying Dr. Grigsby did not have an insurable interest. Then the executor of Burchard’s estate, R.L. Russell, filed suit to have the proceeds be paid to the estate.

Eventually the case went all the way to the Supreme Court, and on December 4, 1911, returned a decision – in favor of Dr. Grigsby. Justice Oliver Wendell Holmes Jr. delivered the majority of the court. The essential issue at the heart of his opinion is contained in this brief excerpt:

“…(L)ife insurance has become in our days one of the best recognized forms of investment and self-compelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property…To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”

(You can read the entire opinion HERE.)

The Impact of Grigsby vs. Russell

Justice Holmes’ decision formally established an important characteristic of life insurance: even though a relationship of insurable interest must exist between the insured and the owner of the policy at the time it is issued, ownership privileges can be transferred or assigned at a later date to parties who do not have a relationship of insurable interest.

While most consumers have awareness of the primary life insurance benefits (the death benefit, and in some instances, cash value accumulations), they may not be aware of the “property” advantages of life insurance. Not unlike real estate, gold bullion, a nice vehicle, or other tangible assets, life insurance has additional advantages for the owner:

1. The owner can name or change the policy beneficiary.

2. The owner can borrow against the policy. (Oftentimes policy-owners believe they are actually borrowing their cash value itself when they borrow from an insurance company, but in reality, they are borrowing against it, while the cash value stays in the policy, earning dividends.)

3. The policy can be sold to another party. (In many situations, but not all. Caution – this is not a do-it-yourself matter!) For more on why and how seniors are selling life insurance policies, see our articles on “Life Settlements: Why Seniors are Selling Their Life Insurance Policies” and “The Controversy Over Life Settlements.”

4. The policy can be assigned as collateral for a loan. In this post, we’ll explore Collateral Assignments in more detail.

Collateral Assignments

Collateral assignments commonly appear in transactions involving financial institutions, and they can also figure prominently in transactions with private lenders. In a collateral assignment, the policy serves as collateral for a loan, ensuring the lender will be repaid if the borrower dies before making full repayment. Collateral assignments can be attached to any type of life insurance policy, and the terms are subject to negotiation.

The inclusion of a life insurance policy in a transaction may have a significant impact on one’s ability to borrow, because the policy can be used as collateral. Especially if the loan is unsecured by other assets (such as a house or auto) the inclusion of life insurance can be crucial to loan approval. If there is no life insurance, the lender may even require it as a condition of the loan.

Absolute vs. Conditional Assignments

There are two types of policy assignment: absolute and conditional. An absolute assignment transfers all the rights in the insurance policy to the assignee, including the responsibility to pay any remaining premiums. It essentially transfers ownership to a new party. A conditional assignment is temporary, and the transfer of ownership rights and interest in the policy is limited to the terms of the agreement, such as until the repayment of a loan. When the conditions of the agreement have been fulfilled, the assignment is terminated.

Most life insurance assignment agreements focus on the insurance benefit, and make the lender the primary beneficiary, even ahead of a policy owner’s spouse and/or children. The assignments will typically specify the amount of money the lender is entitled to if the borrower dies. If the policy’s death benefits exceed the loan amount, the excess money would be distributed to the owner’s beneficiaries per the original provisions of the policy.

A policy’s cash values may also serve as collateral for a loan. For example, an assignment may specify that the lender can withdraw a pre-defined sum from the cash value in the event the borrower defaults on the loan. Cash value assignments typically limit the lender’s entitlement to accumulated cash value, the borrower’s heirs still protected by the policy death benefit.

As property, a life insurance policy has some unique characteristics. When integrated with other assets as part of a comprehensive strategy, the collateral value of an insurance benefit can enhance other aspects of your financial life while providing essential financial protection.

Note: There may be potential tax consequences involved in the transfer or assignment of a life insurance policy, so always consult a financial professional!

ARE YOU MAXIMIZING YOUR LIFE INSURANCE ASSETS? To learn more about the many ways that life insurance can be used in your financial strategy, we recommend Kim D. H. Butler’s booklet, Live Your Life Insurance.  It’s a quick read that outlines many powerful strategies for using your life insurance now, while you can enjoy the benefits!

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