Are Home Loan Insurance Products Failing You?

Death in the family brings not just emotional trauma but can also bring financial agony to the family. If the deceased was the primary breadwinner, the family can struggle financially unless the deceased had bought adequate life insurance coverage.

If the deceased had taken a home loan, the loan needs to be repaid too. Since insurance remains a push product, not many buy adequate life cover. Therefore, when you apply for a home loan, the lenders try to push you to buy life insurance products. If something happens to you, the lender can use life insurance proceeds to square off the loan. Nothing wrong with the idea per se.

Mis-Selling of Life Insurance Products

However, in the financial services industry where mis-selling is rampant, things are never so easy. You can make mistakes even in buying a simple life insurance plan. The wrong products are sold by the banks. While I would not want to go into whether such sales are deliberate or by mistake, I think such mis-selling is deliberate due to flawed incentives at the bank. Such cross-selling of financial products results in quick fee income for the bank. When ICICI Bank sells an insurance plan from ICICI Prudential Life or ICICI Lombard, it is paid commission just like any other agent would. Conflict of interest. Your interest can take a backseat.

Why are we talking about this today? Almost everyone has lost a family member or a friend or at least an acquaintance in the Covid crisis. If the deceased borrower had bought a loan insurance plan from the bank, you would assume that the family would at least not have to struggle with the home loan repayment. Not exactly. The Economic Times carried an article recently, where the family of the deceased would still struggle since the borrowers were sold convoluted products. They looked like life insurance products but were not.

Is the Bank’s Action Justified?

The bank is justified in asking you to purchase life insurance equal to the amount of your home loan. From the lender’s point of view, in your absence, it can ask your family to assume repayment responsibility. If the family cannot (or does not) repay, the lender can seek legal recourse and auction the property. However, the entire process is not easy and is time-consuming. Thus, the banks prefer to take a simple route. Ask you to buy a life insurance cover equal to the loan amount. If the borrower passes away, the bank can utilize the life insurance proceeds to square off the loan. Making a life insurance policy claim is much easier and quicker process than auctioning the property.

Even from the borrower’s point of view, this is NOT a bad proposition. For most borrowers, it is a good choice to have a life cover sufficient to square off the home loan. This ensures that your family continues to live in the house.

Where Is the Problem Then?

It is good to purchase life insurance that backs up your home loan, whether the bank insists on it or not. However, that does not mean that you buy it through the bank. When the bank sells you insurance policies, it acts as an insurance agent. Custom policies for bank customers. Captive customers. Forceful banks. You can expect that such policies are quite expensive by design.

I have written about Home Loan Protection plans (HLPP or loan insurance plan) in an earlier post. Mostly single premium plans. Big upfront outgo. The banks even go to the extent of offering you a separate loan for paying insurance premium. You could have bought a term insurance plan on your own. And you could have got the insurance plan assigned to the bank. Would have served both your and the bank’s purpose. This is likely a much cheaper option too.

However, the premium cost here is a lesser problem. There are two even bigger problems when you buy a policy from bank.

#1 Bank Might NOT Sell You a Life Insurance Plan

They might sell you a useless policy such as ICICI Lombard Home Safe Plus. The ICICI plan is NOT a life insurance plan. It can’t be since ICICI Lombard is not a life insurance company. It cannot sell plain vanilla life insurance plan. ICICI Home Safe Plus is a bundle of critical illness, personal accident, and property insurance plans.

Therefore, the insurance company will honour the death claim only if it happens due to a critical illness or in an accident. Is there no other way in which people can lose their lives? In fact, if you know a friend or family who passed away recently due to Covid, this policy will not accept your claim. And as per the policy terms, they must NOT. Who will pay off the home loan then?

Ideally, a home loan insurance plan must at least cover death due to any reason. However, the banks sell such insipid products to earn fee income. They care the least about you or your family. And the blame does not lie with the insurance company. It lies with the banks who sold it, despite knowing that it does not completely serve the required purpose. And with you for not understanding this.

#2 Life Insurance Plans Come in Multiple Variants

There is a Level Cover Plan and a Reducing Cover Plan.

Under the level cover plan, the coverage remains constant throughout the loan tenure. So, if the original loan amount is Rs 50 lacs, your life cover will be Rs 50 lacs throughout the policy term.

On the other hand, in a reducing cover loan, the coverage goes down as per the original loan amortization schedule. Let us say the original loan amount is Rs 50 lacs. At the time, the coverage will also be Rs 50 lacs. After 10 years of loan repayment, the outstanding loan amount would have fallen to Rs 30 lacs (as per the original amortization schedule). And that will be the coverage amount at the time.

And therein lies the problem. What if the actual outstanding amount at the end of 10 years is higher than the outstanding amount as per original amortization schedule? The insurance payout will not be sufficient to square off the loan. The family needs to shell out more money to close the loan.

You may ask, why will the actual outstanding amount be different? This can happen if the interest rates rise during the loan tenure. If the interest rates rise, a bigger (than expected) portion of the EMI will go towards interest payment. Thus, principal repayment will be slower. This is not uncommon. I wrote about a real-life instance in an earlier post.

Right now, we are at decadal lows in terms of interest rates. While I do not know what trajectory interest rates will take, you need to be cautious if you are going for a reducing cover plan. Reducing cover plans are not bad per se. Such plans are cheaper than Level cover plans. Hence, there is a cost advantage. However, you must know what you are getting into.

What Should You Do?

Your loan repayment can be affected due to various reasons. I list down the events in order of impact (High to Low):

  1. Demise (life insurance will cover that)
  2. Disability (temporary or permanent)
  3. Critical illness that renders you unable to work for months or even years
  4. Loss of job/salary cut

Therefore, in addition to a life insurance plan, you must also consider buying a disability cover (personal accident plan). Whether you should have a critical illness plan or not is debatable. There are pros and cons. And there is cost. In my opinion, a good health insurance plan supplemented by a robust medical fund is sufficient.

I do not think there are plans to cover loss of job or salary cut. Hence, you cannot do much about it. In any case, the impact should be temporary, and a robust emergency fund should help you tide over the crisis.

The problem with ICICI Home Safe Plus was that it failed to cover the highest impact event.

Here is what you need to do.

  • Assess your life insurance needs on a regular basis. Your life insurance requirement will likely go up once you take a home loan.  Purchase adequate term life coverage.  Augment coverage with a disability insurance plan and a critical illness plan, if required. Maintain adequate contingency fund and medical fund.
  • If the bank insists that you buy a life insurance plan from them, stand your ground. RBI does not permit banks to link your loan sanction to your purchase of an insurance product. Instead, get one of the existing policies assigned to the bank.
  • If you think insurance is a waste of money and won’t buy on your own, it is good that you buy through the bank. Something is better than nothing. However, keep a few things in mind.
    • The plan should cover all kinds of death i.e., it should at least have plain vanilla life insurance component.
    • Understand whether you are buying a Level cover or reducing cover. If it is a reducing cover, keep an eye on the difference between actual outstanding amount and outstanding as per original amortization schedule. If required, buy a separate plan to cover the deficit.
    • Disability and critical illness insurance are an added advantage. Consider the cost and associated benefits.

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