A policyowner uses their life insurance policy as collateral for a bank loan. What is the effect on the death benefit if the insured dies while the loan is still outstanding?

Question: A policyowner uses their life insurance policy as collateral for a bank loan. What is the effect on the death benefit if the insured dies while the loan is still outstanding?

Answer options: ✅ The lender has priority over the beneficiary to the extent of the outstanding debt.

• The lender becomes the new owner and beneficiary of the entire policy.
• The beneficiary designation is automatically cancelled.
• The lender can only claim the Cash Surrender Value, not the death benefit.

Correct answer: The lender has priority over the beneficiary to the extent of the outstanding debt.

Explanation: Under a Collateral Assignment, the policy is used as security for a debt (like a loan). The assignee (the lender) has a priority claim on the death benefit, but only to the extent of the balance of the debt at the time of the insured's death. The remaining benefit goes to the named beneficiary.