Taking out a loan for your business often involves obligations and risks. Loans usually require regular payments on a fixed schedule; company assets and personal assets are often used as collateral. But what if something were to happen to you before the loan has been paid in full?
If you became incapacitated or died unexpectedly, the business would need to continue loan payments. In the event that the business couldn’t make the payments, the lender would seize the collateral. If the collateral doesn’t cover the lender’s investment sufficiently, the lender would then exercise the guarantee and seize your personal assets.
Fortunately, proper business loan insurance policies can help prevent those losses.
What Is Business Loan Insurance?
The purpose of a business loan insurance policy is to help the company recover from financial disruption as a result of the untimely loss of a working owner or any employee who makes a substantial contribution to the business. The company owns the policy and pays the premiums with the lender as the beneficiary. In the event, something happens to the owners or a key employee, the loan insurance policy would step in and make the loan payments up to the terms and limits of the policy.
Loan insurance policies can be set up to make payments for a certain period, or they could be life insurance policies that pay off the remaining balance of the loan. Most companies select term insurance because of the lower premium cost.
When Is Business Loan Insurance Needed?
Business loan insurance makes sense if:
- The company’s reputation or financial health depends substantially on the unique skills or reputation of an owner or key employee.
- A lender requires the policy to lower the loan risks in the event of losing a key employee or owner.
- The death of a key employee, such as a top salesperson, would have an immediate financial impact on the company.
- Funds are needed to buy out another partner’s shares in case of an unexpected death.
What Are the Benefits of Business Loan Insurance?
In times of financial crisis, business loan protection policies provide much-needed funds to:
- Run the company if cash flow is interrupted when an owner or key executive dies, becomes ill, or incapacitated.
- Support working capital needed to continue operations if your bank won’t make further loan advances because of the circumstances.
- Pay off outstanding loan balances.
- Meet the personal needs of owners, family members, and employees.
- Cover personal guarantees on loans or bank lines of credit.
What Are the Qualifications?
The insurance company will consider the applicant’s age, occupation, lifestyle, medical history, and general health to determine the risk level and cost of premiums. Insurance for older employees who smoke and have health problems may be difficult or impossible to obtain.
How Does the Insurance Work?
Consider this example. ABC Landscapers has a $250,000 equipment loan with payments of $4,000/month, guaranteed by the owner. The company has a two-year business loan insurance policy and a key-person life insurance policy in the amount of $250,000 on the owner, with the lender named as the payee.
The owner suffers an illness and is unable to work for 18 months. He eventually passes away.
The loan has been paid down to $175,000, but the equipment has depreciated in value and now is only worth $110,000. Because the lender can’t sell the equipment for enough money to pay off the loan balance, they’ll probably seize personal assets, such as the owner’s home and savings accounts.
Fortunately, here’s where business loan protection insurance policies save the day. The two-year term policy has made payments for 18 months and the key-person insurance pays the face amount of $250,000: The lender receives $175,000 to pay off the loan balance and the remaining $75,000 goes to the business to cover operating expenses.
The owner’s family gets to stay in their home, and the managers of ABC Landscapers get working capital to continue running the business.
Business loan protection insurance isn’t necessary for every business, but if day-to-day operations depend heavily on one person, it may be an option for owners to consider.