How Insurance Requirements Differ for SBA Loans: What Borrowers Need to Know

Introduction

Around 45% of SBA loan applications get rejected. Want to feel confident about your application instead of constantly refreshing your SBA loan status page? SBA loans support small businesses by providing them with valuable funding, but these government-backed loans have strict insurance requirements. Every business also faces different insurance requirements. What gives?

In this guide, we will go over how to increase your chances of qualifying for an SBA loan. Learn about insurance requirements, how to speed up SBA loan approval, and ways to protect your business.

Why the SBA Has Insurance Requirements

Insurance is meant to protect both the lenders and the Small Business Administration (SBA) from risks. If a peril happens (e.g. a fire or lawsuit), insurance can kick in and provide financial compensation.

SBA loans already greatly mitigate lender risks. They guarantee a large portion of the loan. Most loans require you to put down collateral to qualify. Insurance is an additional security layer that protects the collateral and the SBA’s investment. It can also improve your business continuity and risk management, since the insurance won’t only be for the loan–it can benefit your business as well.

What happens if you don’t have insurance for an SBA loan?

Essentially, no insurance coverage, no SBA loan. You have to meet the requirements for insurance if you want your SBA loan to get approved. Going over your insurance ahead of time is preferable because it can save money, stress, and time. Insufficient coverage delays loan disbursement and can lead to denial.

If you apply without insurance coverage, it will cause a denial. Yes, you can still apply for an SBA after an application gets rejected since it usually does not permanently disqualify you. However, there will be months of delays since there is a waiting period after an SBA loan denial. This can be a huge problem for your business, forcing you to miss out on time-limited business deals. Many opportunities are also sensitive to market changes and competitors, so securing the funding you need on time is crucial.

Common Types of Insurance Required for SBA Loans

Let’s go over the most common types of insurance that SBA loans may require you to carry.

Hazard Insurance (AKA Property Insurance)

Do you have any physical property, especially something you plan to use as collateral for the SBA loan? Then you would need hazard insurance that covers this property. The SBA hazard insurance requirement comes with SBA loans such as 7(a) and 504 loans. It applies to property that you choose to pledge as collateral, which is reasonable since the collateral is necessary for approval.

Collateral examples that require hazard insurance include:

• Commercial real estate
• Equipment
• Business inventory

If a covered loss occurs, then hazard insurance would provide sufficient money in order to repair or replace the lost property.

Liability Insurance

Running a business without liability insurance is usually legal federally, but it is highly ill advised. Around 45% of small businesses are involved in litigation at any time. An injury or liability lawsuit can easily sink the business, especially if the business is just getting started with minimal cash flow and significant loans.

General liability and/or product liability insurance will be required depending on your business type. General liability is for most businesses as it covers third-party risks, such as injuries and damage to property.

Product liability insurance is needed if your business is distributing, manufacturing, or marketing any product. Retailers, for example, need to carry sufficient product liability coverage. Otherwise, what if the product malfunctions and injures buyers?

Life Insurance

If your business relies on any key owners or partners, it is possible that you will be required to carry life insurance on you (or them). This means if the business and loan depend on the health, skills, and life of a specific individual within your business. Life insurance that depends on a single individual for business operations is known as key person insurance.

Note that the lender would need to be listed as the policy’s assignee as required by the lender’s terms. Adding a lender to a life insurance policy is a special process. You may need to go through the collateral assignment of life insurance, adding your lender as the death benefit collateral assignee until the loan is fully repaid.

Flood, Earthquake, and other Natural Disaster Insurance

Flood insurance and earthquake insurance may be required, but not for every SBA loan. This is location-based. If your collateral is in a FEMA designated flood zone, like a building in Florida, then flood insurance becomes mandatory.

Have property or hazard insurance already? It’s not enough for natural disasters. Most property insurance policies exclude certain perils and situations, such as floods. Check your state and location to see if there are special insurance requirements due to increased local risks.

Liquor Liability Insurance

Any business that handles or sells liquor should meet liquor liability insurance requirements. This is a very serious kind of coverage that protects the business from liquor-related lawsuits and incidents. Some states and types of business have greater liquor liability risks.

Workers’ Compensation Insurance

Don’t forget about Workers’ Comp. It is required for businesses with employees in most states and by the SBA. You likely need it to stay compliant with the law in the first place, long before the SBA gives you this requirement for a loan.

Workers’ Compensation covers incidents where an employee gets injured or ill (or passes away) due to the job.

How Requirements Differ from Traditional Business Loans

Proof of insurance

SBA loans and bank loans typically require proof of insurance before loan closing. Insurance companies provide proof of insurance once you purchase.

Some commercial loans do not require you to carry insurance, but they may not be suited to your financial needs.

Coverage limit requirements

The coverage limit is how much the insurance company would pay out maximum, either per year or per claim. Greater coverage will cost more, but it can help your business stay afloat in case of a major incident or lawsuit. When applying for an SBA loan, it’s a good idea to carefully think about your risks and how much coverage is needed.

SBA loans may have higher minimum coverage limits compared to traditional lenders. This can be a problem if you are struggling to afford greater coverage, but comparing top quotes should be able to help you find the best affordable insurance for SBA loans.

Multiple policy requirements

Some lenders might just require you to have a general BOP or liability insurance policy. However, SBA loans can be strict because they may mandate various types of coverage depending on your situation. You may need key person insurance, for example, if the SBA determines an individual is crucial to your business operations.

Lender naming requirements

You will likely be expected to name the lender as a Lender’s Loss Payable, Loss Payee, or Additional Insured. This could cost more, but the requirements can be stricter for SBA loans than other types. A Lender’s Loss Payable clause is typically required by SBA lenders since it comes with more protection for the lender even if the borrower voids the policy.

How to Prepare for SBA Loan Insurance Requirements

Review an SBA SOP (Standard Operating Procedure)

Go over SBA insurance guidelines or lender-provided checklists before you apply for your SBA loan. Knowing what coverage you need in advance can help you avoid an application rejection. Check all insurance requirements carefully.

Work with an insurance broker

A broker who is familiar with SBA lending can help you prepare your application, including getting the necessary insurance. This helps ensure your business is well protected and compliant as you pick collateral and insurance policies.

If your business has complex goals and financial requirements, consult with a financial expert, insurance broker, and/or a legal attorney to ensure you are going through the steps of taking out an SBA loan properly and legally.

Secure coverage early

Getting competitive SBA insurance quotes and finding the right coverage early can help you avoid delays in funding. Applying for an SBA loan and getting rejected can mean months of delays in your funding, which can be devastating for any small business. Your business could lose out on critical opportunities because of these funding delays.

Ensure policy language meets lender-specific conditions

Your lender probably has specific requirements regarding insurance, such as how you put them on the insurance policy. This is often Lender’s Loss Payable, Loss Payee, or Additional Insured.

Common Mistakes to Avoid

Waiting until the loan is approved to shop for insurance

This is a mistake too many small businesses make. A critical mistake, because… the ideal scenario here can’t really happen. Practically all SBA loans require you to carry the right insurance before you can get approved. Don’t sit around thinking you can get the approval for the loan first, this can be a costly mistake.

Underinsuring property

Make sure that you have sufficient coverage so that the insurance doesn’t leave you paying a lot out-of-pocket. Insure any property (e.g. buildings, inventory, or other collateral) enough so there won’t be a problem in case of an incident.

Failing to list the lender as required

When buying insurance, make sure to list the lender properly accordingly to their mandates. For example, SBA lenders may require you to endorse them under Lender’s Loss Payable.

Overlooking specialty coverage requirements

You may need specialty business insurance depending on your business operations and property. For example, restaurants that sell or provide liquor need to have liquor liability insurance.

Not considering non-mandatory insurance

So you plan to get the minimal coverage for your SBA loan. This is great, but not excellent. Small business owners should consider other insurance policies that may be relevant, such as:

• Business interruption insurance
• Event insurance
• Commercial auto insurance

Real-World Examples

Let’s discuss some real-world scenarios where small businesses succeeded or failed because of their insurance choices.

Flood coverage

A manufacturing business is based in a FEMA zone in Florida. They apply for an SBA loan after realizing they need the funds. Unfortunately, they were under the misconception that hazard insurance was enough to cover their collateral and property. Their application was denied due to not having the necessary flood coverage

They are forced to reapply for an SBA loan 90 days later, resulting in unpleasant financial losses.

Solo consultant

A consultant works solo for the business. The SBA mandates life insurance for her because even as she expands, she is the key person for the business. Wanting to be prepared, she buys the requisite life insurance and liability insurance policies. She then closes the SBA loan successfully. The loan is given, and while nothing goes wrong, but she rests assured that everything is covered by insurance in case of an incident.

Conclusion

SBA loans are a powerful funding tool, but insurance compliance is non-negotiable when applying for one. Secure enough insurance early to ensure there are no problems with lenders or insurers.

Check out the best business insurance companies to get the right coverage for your SBA loan today.