I have never been a big fan of traditional life insurance plans such as endowment plans, money back plans etc. Traditional life insurance plans provide low life coverage and poor investment returns. Hence, such plans are better avoided. When we talk about life insurance plans, the first name that typically pops up in your mind is that of LIC (Life Insurance Corporation of India). The name and trust of LIC is so deeply rooted in our minds that for many people, life insurance means LIC. An interesting aspect of LIC plans (and even traditional life insurance plans from other insurers) is that you can take a loan against such insurance plans.
In this post, I will discuss the loans from context of LIC New Jeevan Anand, one of the most popular endowment plans from LIC. LIC New Jeevan Anand is a participating non-linked life insurance plan which offers dual benefit of insurance and investment. You can read the policy wordings on LIC website. I am not particularly a fan of this product. Read my take on LIC New Jeevan Anand here. However, the purpose of this post is not to assess how good or bad LIC endowment plans (or LIC New Jeevan Anand) are. In this post, I will focus on how to avail loans against LIC policies, terms and conditions of such loans and whether it makes sense to go for such loans.
Conditions for Taking the Loan (LIC New Jeevan Anand)
- The loan can be availed only after you have paid premium for three years.
- The maximum loan amount is 90% of the Surrender Value (85% in case of paid up policies) of the policy at the time of making application.
- LIC New Jeevan Anand acquires Surrender Value only after 3 years. If you surrender before 3 years, nothing is payable. Hence, no loan is possible before 3 years.
- The policy shall be assigned to LIC as security for the loan.
- Interest on loan shall be paid on half-yearly basis. Interest is charged for a minimum period of 6 months.
- LIC can call for repayment of loan and interest by giving 3 months notice. If the loan is not settled, LIC can foreclose the policy and use policy proceeds to settle the loan.
- LIC can also foreclose the policy and use proceeds to settle the loan if you do not pay interest within 30 days from the due date.
- In the event of death of the policyholder during the term of the loan, LIC will deduct the outstanding loan amount (and interest thereon) from the claim settlement amount.
What Is the Applicable Interest Rate and Loan Tenor?
Minimum period of loan is six months. You can continue the loan up to maturity of the insurance plan. Even if you want to repay loan within six months from the date of loan, you will have to pay at least six months interest. You have to pay interest every 6 months. You have to option to repay principal along with interest. Or you can only pay the interest and let the principal amount be set off against claim amount (death/maturity). Or you can pay only interest for a few years and when you have excess cash, you can repay principal. You do not have to follow EMI like repayment schedule. So, you have a lot of flexibility in repayment.
The rate of interest is declared by LIC every year and may vary according to plan. As I understand, the prevailing interest rate is 10.5% per annum.
What Is Surrender Value Under LIC New Jeevan Anand?
To assess loan eligibility, LIC assesses the Surrender Value of the plan. Do note, even though I have mentioned Surrender Value at many places, you DO NOT have to surrender the plan to avail the loan. In fact, LIC will not even offer the loan if you surrender the policy. You (or LIC) need to find the Surrender Value to assess how much you can borrow against your LIC policy.
Surrender Value of the plan = Guaranteed Surrender Value of the plan + Surrender value of vested Reversionary bonuses
There is an additional concept of Special Surrender Value (SSV). However, let’s ignore SSV for the purpose of this post.
Guaranteed Surrender Value (GSV) is a percentage of total premiums paid (net of any taxes or premium for riders). The percentage depends on policy term and the policy year in which the policy is surrendered. For instance, for a 20 year policy, GSV is 50% in 5th policy year and 70% in 15th policy year. For a 30-year policy, GSV is 50% in the 5th policy year and 60.91% in the 15th policy year. The table for calculating GSV is provided in the policy document.
Surrender Value (SVB) of vested bonuses is a percentage of bonuses that have been applied in the policy. The applicable percentage depends on the policy term and the policy year (of surrender). You can find out the SVB from tabulation in the policy document.
You are 30 years old and purchase New Jeevan Anand plan with Sum Assured of Rs 15 lacs for a policy term of 20 years. The annual premium will be Rs 83,873 (before service tax). With service tax, it will be Rs 86,705 in the first year. Subsequent annual premiums will be Rs 85,340. Let’s assume, for each of the years, LIC announced Simple reversionary bonus of Rs 40 per thousand of Sum Assured. That makes it a bonus of Rs 60,000 per annum (Rs 15 lacs/1,000 * 40). For the purpose of calculating surrender value, service tax paid is ignored. You have paid premium for 10 years.
GSV = 54.09% (from GSV table) * 10 (no. of years) * 83,873 (annual premium before taxes) = Rs 4.53 lacs
If you have paid premium for 10 years, you would have received bonus 9 times. Total vested bonus will be Rs 5.4 lacs (Rs 60,000*9).
SVB = 15.55% (from table) * Rs 5.4 lacs = Rs 83,970
Surrender Value = Rs 4.53 lacs + RS 83,970 = Rs 5.37 lacs
Total loan eligibility = 90% of Surrender Value = 90% * Rs 5.37 lacs = Rs 4.83 lacs
Your loan eligibility will increase as you stay longer in the policy.
What Are the Benefits of Loans Against LIC Policies?
- The interest rate is quite low as compared to interest rate for personal loans.
- You get a lot of flexibility in repayment. You do not have to follow EMI like repayment schedule. You merely need to pay requisite interest at 6 month intervals. There is no compulsion to repay principal. If you do not repay principal, LIC will automatically settle the principal against claim settlement amount. So, these loans can be immensely useful if you are feeling cash flow pressure.
- You can even borrow against your LIC policy to repay expensive loans (especially credit card debt).
- Since you are borrowing your own money, the loan disbursal is likely to be very swift. There will be no credit appraisal for loan issuance.
Do note, at 10.5% per annum, loan against LIC policy is more expensive than a home loan. Moreover, effective cost of home loan can be much lower due to tax benefits. So, loan against LIC policy may not be a good alternative to a home loan.
What Are the Issues?
Surrender value of LIC endowment plans is quite low in the initial years. As you can see in the previous examples, after paying premium for 10 years, surrender value is only Rs 5.37 lacs and loan eligibility is Rs 4.83 lacs. Hence, do not pin hopes on taking out a very big loan against your LIC policies.
Points to Note
- Loans are typically offered only against endowment plans.
- Even a few banks and financial institutions offer loans against LIC endowment policies. However, such banks and financial institutions are likely to offer loans against LIC policies at slightly higher rates. You can check the rates on BankBazaar website.
- It is mentioned in the policy document if the policy is eligible for requesting loans.
- You can request a second loan while the first loan is still not repaid. However, the cap of 90% of Surrender Value (or 85% in case of paid up plans) will still apply to the combined loan amount. The outstanding principal of the first loan (and not the original loan amount) will be considered for the purpose.
- There is no tax benefit for repayment of such loans.
How to Apply for Such Loans?
You need to fill in and submit Form 5196 or 5205 with your agent or the nearest LIC branch. Form 5196 is for taking out a fresh loan. Form 5025 is applicable for a follow-up loan where the policy is already endorsed in the name of LIC.
Traditional life insurance plans are poor financial products. You must not purchase these plans in the first place. Commissions are front loaded and surrender penalties are very high throughout (especially in the initial years). Hence, an exit from these plans is painful. However, if you have already purchased the plan and continued for a few years, it may make financial sense to continue the plan (rather than surrendering the plan or making the plan paid up).
In such cases, if you are in need of funds, it may make sense to borrow against your LIC policy. Loans against LIC plans can be a good alternative to expensive personal loans or credit card debt. You have a lot of discretion in loan repayment. As with any kind of debt, do not borrow just because you can borrow. Exercise discretion.