Why Does the SBA Require Life Insurance?
The SBA's current life insurance requirements continue to bedevil lenders. Over the past 
two years, NAGGL members have brought the myriad difficultieswith current policy to the association's attention time and again, and the issue remains at the top of the association's Technical Issues Committee 'hot' list.
Under standard operating procedure, the lender must determine if the viability of the business is tied to an individual or individuals. In these situations, the lender must require life insurance. Suppose the experienced SBA lender determines that the viability of the business is not tied to an individual or individuals and therefore does not require life insurance. After disbursement, the principal suddenly dies and the loan defaults. Even assuming that the lender's decision was prudent, the SBA may still question the decision and deny the guarantee purchase request.
How much life insurance is needed for an SBA Loan?
The current standard operating procedure further requires lenders to make sure that life insurance must be consistent with the size and term of the loan. The amount and type of collateral available to repay the loan in the event of the death of the borrower may be factored into the determination of the appropriate amount of life insurance. Does this mean that on a $900,000 SBA loan with three key individuals and a collateral liquidation value of $600,000, the lender must require life insurance of $100,000 on each or $300,000 on each key individual?
What if the value of the collateral decreases due to unpredictable economic forces? Again, the measure seems to be one of absolute liability, not whether or not the lender acted prudently.
Some Problems with the requirements
The approach drives up borrower costs and may deprive the small business of needed working capital. Under these circumstances, the costs imposed on borrowers to protect the lender's SBA guarantee will be consistently high; yet the occasions when a principal dies and the lender had no key man insurance, inadequate collateral, and no succession plan will be relatively rare.
Because of confusion in interpreting and applying the current policy in SOP, lenders of all types and sizes are interpreting the SOP differently. Auditors and regulators are not likely to recognize the issues.
While the SBA has granted "delegated authority" to lenders in credit decisions, the current life insurance policy undercuts that authority by not allowing lenders to use prudent lending standards in making this credit decision.
This policy may have the inadvertent effect of unfairly discriminating against certain groups of people, who are uninsurable (e.g., breast cancer survivors, older borrowers).
In cases when life insurance was unavailable or prohibitively expensive, lenders had full discretion to proceed with financing if there was a viable succession plan and strong collateral available. At NAGGL's recent SBA Lender Management Retreat (February 2010), lenders in attendance were vocal in expressing a desire to return to the former policy that allowed lenders to make prudent credit decisions when determining whether life insurance should be required. Let us help you get affordable life insurance and keep this process simple.
Since the SBA appears adamant about sticking with the current rule, lenders must take all appropriate action to protect the guarantee. Whenever possible, a lender should obtain life insurance on all owners for the full loan amount. If a lender takes a lesser sum on each person, they must substantiate the collateral available at the time the loan is made, and explain the ability of the remaining owners to operate the business successfully.
What if You cannot get Life Insurance for Your SBA Loan? Do I have to have life insurance for my SBA loan?
If life insurance cannot be obtained on any one individual, then submit the loan through regular processing (although that submission may well be denied). Recognize that failure to have insurance on all key individuals to cover the bank and SBA in the event of a default will leave the lender with some exposure. In such a case, lenders may have a fight with the National Guaranty Purchase Center to try and recover under the SBA loan guarantee. So, no, you may not have to have life insurance for your SBA Loan, but getting the loan approved may be much more difficult. If you need the insurance, start the application process as early as possible with a qualified broker with experience in getting what you need as fast as possible (including assignment forms).
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