You are taking a home loan. You are worried, who will repay the loan if you were not around? The lenders (the banks and NBFCs) are bothered about this too. And this is a genuine problem for every stakeholder. You, your family, and the lender. How will the loan be repaid if the borrower passes away? The family may not have enough resources to pay off the loan.
That’s why many banks and NBFCs insist that you buy life insurance along with your loan. Sometimes, they sell such insurance products along with the loan. While the Reserve Bank prohibits such bundling of products with loans, the applicants are given an impression that their loans will be approved only if they buy the insurance product. And many relent under pressure.
But why do banks push such products?
Firstly, it is a genuinely good thought. In case the borrower passes away, the proceeds from the insurance plan can be used to close off the loan. And the family gets to retain the underlying asset (home, car).
Secondly and more importantly, the banks also make hefty commissions from the sale of such products. In fact, these commissions are so lucrative to the banks that they were willing to offer another loan to pay premium for such products.
Well, this post is not about bashing the banks. It is about discussing a category of insurance products — Loan Protection Plans. And their nuances. We will get there in a bit.
But the Banks Are Not Insurers
We are talking about an insurance plan here. However, the banks don’t structure insurance policies. How can they sell insurance policies just to cover their loans? That’s where group insurance plans come into picture.
The banks enter into a master agreement with an insurance company and the insurance is offered to its borrowers as part of this master agreement (group insurance plan). This is not too different from group health insurance offered by your employer where you get coverage simply by virtue of being an employee.
Hence, there are 3 parties here — The Insurance company, the lender, and the borrower(s).
You can’t buy this plan directly from the insurer. You must buy it through the lender (and the lender must have entered into an agreement with the insurer). Since there is demand for such products, the insurance companies have structured products for the purpose.
One such product is SBI Life RiNn Raksha. In this post, let’s find out more about this product.
SBI Life RiNn Raksha: Important Features
- This is a group plan. You can NOT buy this directly from SBI Life. Can only buy through the lender. The features of the plan are also decided by the master policyholder (lender). You will get only those features that your master policyholder makes available to you.
- Even though the plan is from SBI Life, this does not mean only the State Bank of India will offer this product to its borrowers. SBI Life can tie up with any lender (bank or NBFC).
- This cover is available for a wide variety of loans: Home, Car, educational, and personal loans. Hence, your bank can offer this for different kinds of loans.
- It is NOT mandatory to buy this product when you take a loan (even if your bank insists). You can always say NO. And buy life insurance cover on your own (a private cover and NOT a group cover) and assign the plan to the lender.
- Death cover shall be the outstanding home loan amount as per the original amortization schedule. And this can be a problem sometimes. We will see how.
- This is a term insurance plan (rather expensive one). Hence, there is no maturity benefit.
- You can choose loan cover tenure as per your need. However, if the loan term is 15 years or more, the loan cover tenure should be at least 2/3rd of the loan tenure. Such features are offered because you may have plans to repay the loan much sooner. For instance, even though the home loan tenure is 20 years, you are keen to pay off the loan in the next 7-10 years. In that case, you may not want cover for the entire loan term. By opting for the lower loan cover tenure, you might be able to reduce the premium cost.
- Can cover up to 2 co–borrowers under this plan. Expectedly, the cost will go up if you cover more people.
- You can sign up for a single premium variant or choose 5 year or 10 year premium payment term. With my limited understanding, I think the banks will push for a single premium plan.
SBI Life RiNn Raksha: The Problem with Death Benefit Calculation
As per the base plan, the death benefit will be the outstanding loan amount as per the original amortization schedule. Not the actual outstanding amount. But the expected outstanding amount as per the amortization (repayment) schedule at the inception of the loan.
Easy to see that the life cover will go down over a period of time since the outstanding loan goes down over time (as per original repayment schedule).
And that the death benefit may be different from the actual outstanding loan amount. But how?
Let’s understand with the help of an example.
You take a home loan of Rs 50 lacs for 15 years at 9% per annum. You also buy the loan protection plan (let’s say SBI RiNn Raksha) along with your loan. Clearly, you believe that, if you are not around, the loan will be paid off from the insurance proceeds.
For illustration purposes, let’s assume the interest rates move up to 11% right after your loan sanction.
Let’s look at the loan situation after 8 years.
If the interest rate remained unchanged at 9%, you would have repaid principal worth Rs 18.47 lacs in those 8 years. Loan outstanding shall be Rs 31.52 lacs. And that would be life cover too under SBI RiIn Raksha. Because, as per SBI RiNn Raksha, the death benefit is as per original repayment schedule. And that’s how the premium is calculated.
However, if the interest rate increased to 11% and the EMI remained constant, the loan outstanding will be Rs 42.54 lacs.
The deficit = Rs 42.54 lacs – Rs 31.52 lacs = Rs 10.02 lacs. The coverage is not sufficient to close the loan amount.
The family must muster up this amount to close the loan.
I am not making this up. We have discussed a real life example in a previous post.
Hence, while products like SBI RiNn Raksha may not be a problem for fixed rate loans, families of floating rate loan borrowers may be in a fix if the rates were to go up later.
How to Work around This Problem?
Two ways to do this.
Option 1: Do not buy such products. Just buy a simple term life insurance plan from any life insurer. The insurance amount should cover the loan amount. Since the insurance coverage is fixed, the insurance cover will never be lower than the loan amount. Not just that, a term life cover will be much cheaper than Home Loan Protection Plans or Group Credit Insurance products such as SBI RiNn Raksha. Now, the banks may link sanction of loan to your purchase of group credit insurance product from them. Stand your ground. They cannot technically do that. Politely decline and ask them to assign your term insurance plan to them.
Option 2: SBI RiNn Raksha also has Gold and Platinum for floating rate loans. Of course, this comes at a higher cost. If you want to guard against the deficit problem as mentioned above, you can opt for one of these variants.
- Under the Gold Variant: As the interest rate for the loan changes, the original repayment schedule would be revised (considering the EMI same and changing only the rate of interest. And the death benefit would also change accordingly. If we consider the example in the previous section, the death benefit would be Rs 42.54 lacs.
- Platinum Variant: It is almost similar to the gold variant. The difference is that, under the platinum variant, there is a minimum in place. The minimum is the outstanding loan amount as per the original repayment schedule.Under the above example, the payout would be Higher (42.54 lacs, 32.52 lacs) = Rs 42.54. This variant may offer superior outcomes if the interest rates were to go down after taking the loan. However, I do not really see much merit in this variant.
A few other loan protection plans may offer a Level cover variant too. SBI RiNn Raksha does not seem to do that. Do check this post for more on this.
Option 1 (buying term life cover) seems such a simple solution. It will likely be much cheaper too.
While I have presented a simple picture of SBI RiNn Raksha, such plans come with tons of terms and conditions. And I make this comment not just for the SBI Life plan but for the entire category of Home Loan Protection Plans, loan insurance plans, or Group loan protection plans.
Hence, if you somehow find merit in such a plan (instead of a plain vanilla term life cover), do read and understand the terms and conditions thoroughly before signing up.
- SBI Life RiNn Raksha: Product page
- SBI Life RiNn Raksha Product Brochure
- SBI Life RiNn Raksha: Policy Wordings