SBA Life Insurance Requirements

Pursuant to SOP 50 10 8, SBA lenders must ensure that all appropriate insurance requirements are satisfied including hazard insurance, marine insurance, flood insurance and life insurance. With respect to life insurance, SOP 50 10 8 specifically states:

• If the SBA Lender determines that the principal is uninsurable, the SBA Lender must obtain written documentation from a licensed insurer of the same.
• For each policy required under this Paragraph, SBA Lenders must obtain a collateral assignment identifying the 7(a) Lender (for 7(a)), or the CDC/SBA (for 504), as assignee that is acknowledged by the Home Office of the Insurer. SBA Lenders must ensure that the Applicant/Borrower pays the premiums on the policy (13 CFR § 120.970(c)).
• SBA Lenders may accept the pledge of an existing life insurance policy. Credit life insurance or whole life insurance should not be required.
•  7(a) Loans
• For Standard 7(a), EWCP, CAPLines, International Trade loans and pilot programs (unless specified otherwise in the pilot program guide), 7(a) 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 in the amount of the collateral shortfall for the principals of sole proprietorships, single member LLCs, or for businesses otherwise dependent on one owner’s active participation.
• For 7(a) Small Loans, SBA Express and Export Express loans, SBA Lenders may follow their internal written policy for their similarly-sized, non-SBA guaranteed commercial loans.
• 504 Loans

CDCs must assess whether the viability of the business is tied to an individual or individuals. Life insurance is required for the principals of sole proprietorships, single member LLCs, or for businesses otherwise dependent on one owner’s active participation when the SBA Loan is not fully collateralized.

• If the CDC determines the principal is uninsurable, the CDC must obtain written documentation from a licensed insurer of the same.
• For each policy required under this Paragraph, CDCs must obtain a collateral assignment identifying the CDC/SBA as assignee that is acknowledged by the Home Office of the Insurer. CDCs must ensure that the Applicant/Borrower pays the premiums on the policy (13 CFR § 120.970(c)).
• CDC may accept the pledge of an existing life insurance policy. Credit life insurance or whole life insurance should not be required.
• When required, the minimum term of life insurance is:

1. 10 years for a 10 year debenture.
2. 20 years for a 20 or 25 year debenture.

• For the purpose of life insurance calculation, the loan is considered fully collateralized when the value of the discounted collateral is equal to or greater than the net debenture amount. When the loan is not fully collateralized, the amount of life insurance required is equal to the difference between the net debenture amount and the value of the discounted collateral.
• For life insurance only, the calculation of discounted collateral is as follows:

1. Improved real estate at 85% of fair market value determined in accordance with the appraisal requirements in Section C, Ch. 1, Para. E.2.b., Appraisals.
2. New machinery and equipment (excluding furniture and fixtures) at 75% of price minus any prior liens.
3. Used or existing machinery and equipment (excluding furniture and fixtures) at a maximum of 50% of Net Book Value or 80% with an Orderly Liquidation Appraisal minus any prior liens.

It is best practice for lenders to obtain the life insurance company’s written acknowledgement of the collateral assignment prior to disbursement of the SBA loan. Additionally, listing the lender as a beneficiary on the life insurance policy is not an acceptable substitute for the collateral assignment of the life insurance policy as the policy owner typically has the ability to change beneficiaries on the policy without notice to the beneficiaries.

Once the SBA loan has been fully disbursed, it is important that the lender continue to monitor the status of the life insurance policy as part of the routine loan servicing. For SBA 7(a) loans secured with life insurance policies, lenders must follow the guidance set forth in SOP 50 57 4, which states:

• Lenders should not modify or terminate the life insurance requirements in the Loan Documents unless the reason for requiring the life insurance policy no longer exists.
• If the assignment of a life insurance policy is required by the Loan Documents, in order to ensure that the policy premiums are paid, Lenders may set up an escrow account to collect the funds needed to pay the premiums. (See SOP 50 10 in effect when the Loan was approved for SBA Loan Program Requirements concerning escrow accounts for commercial real estate taxes and insurance.)
• If an assignment of life insurance is required by the Loan Documents and the Lender receives a notice that the Borrower has not made the required policy payments, the Lender should base its decision to continue the insurance coverage on Prudent Servicing practices on a case-by-case basis. The Lender’s cost to continue the coverage is a Recoverable Expense.
• Lenders should apply the proceeds from an assigned life insurance policy to the principal balance of the Loan. (Application of life insurance proceeds is not considered a voluntary Loan prepayment for subsidy recoupment fee determination purposes.)
• Depending on the circumstances, Lenders may release all or part of the proceeds of a life insurance policy if, in addition to meeting the requirements for release set out in Chapter 8 Paragraph E (Release of Lien Without Consideration) or Paragraph F (Release of Lien for Consideration) of this SOP, the death of the insured has no significant impact on the future management of the Borrower’s business and:

1. The proceeds are needed for a valid business purpose; or
2. The proceeds are needed to prevent a Financial Hardship; and
3. There is a reasonable and prudent expectation that the Borrower will repay the 7(a) Loan in full based on the financial strength of the business.

• If the financial strength of the Borrower’s business is insufficient to justify releasing the insurance proceeds to the Borrower, or weak enough to support applying the proceeds to the Loan balance, Lenders may place the insurance proceeds in an escrow account for distribution after the Lender has had the opportunity to observe the Borrower’s on-going business operations and is able to make a prudent decision.

Lenders must ensure that their routine loan servicing procedures include continued monitoring of life insurance policies, specifically the policy owner’s timely payment of the premiums to avoid cancellation of the policy.

If your lending institution has questions about SBA's life insurance requirements, or any other SBA lending matters, please contact us at SBAQuestions@JellumLaw.com.

This article is provided for general information and educational purposes only. It does not solicit, establish, or continue an attorney-client relationship. The contents should not be construed as legal advice or opinion. If the organization would like formal legal advice, our professional liability insurer (as well as the applicable attorney ethical rules) requires that we establish a formal attorney-client relationship. If you are interested in learning more about working with Jellum Law, please contact us at SBAQuestions@JellumLaw.com. 

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