Tennessee Insurance Practice Exam

What is the action taken when a policyowner uses a Life Insurance policy as collateral for a bank loan?

1. Collateral assignment

2. Absolute assignment

3. Policy transfer

4. Pledge agreement

The correct answer is: Collateral assignment

When a policyowner uses a Life Insurance policy as collateral for a bank loan, the action taken is referred to as collateral assignment. This process allows the policyowner to designate the bank or lender as a temporary claimant to the policy benefits, up to the amount of the loan. In the event of the insured's death before the loan is repaid, the lender has the right to receive the outstanding balance of the loan from the death benefit. This practice is beneficial for both the policyowner and the lender: it provides the lender with security for the loan while allowing the policyowner to potentially access funds without having to liquidate assets or forgo their life insurance coverage. The designation as collateral doesn't transfer ownership of the policy; the policyowner retains all the rights and benefits associated with the policy unless the loan is defaulted upon. In contrast to collateral assignment, absolute assignment involves a complete transfer of ownership of the insurance policy to another party. Policy transfer also suggests a change in ownership rather than a temporary arrangement as seen with collateral assignments. Lastly, a pledge agreement is a more general term that can apply to various types of collateral beyond life insurance, but it does not specifically denote the insurance context like a collateral assignment does. Understanding these distinctions helps clarify the