We know that insurers provide loans against insurance policies. Therefore, if you have a traditional insurance policy and need short term funds, you can approach your insurance company to offer you a loan. The maximum loan amount is 80-90% of the prevailing policy surrender value. If you can’t repay the loan, the insurance company can close your policy and recover the amount.
There are a few benefits with such loans. Firstly, since the loan is secured and thus you can expect the rate of interest to be lower than a personal loan. Secondly, the process is likely to be quick. Thirdly, the insurer does not pay much attention to your credit score or repayment ability since it has complete hold over the security (your policy) and can easily recover money in case of default.
Note: Insurers don’t offer loans against Unit Linked Insurance Plans (ULIPs). There are no loans against term insurance plans either (since there is no surrender value).
Availing a Loan to Pay Your Insurance Premium
I read an interesting article recently which mentioned that the insurers are using the loan feature to prevent customers from surrendering their plans. So, if a policyholder is struggling to pay the premium, the insurers are quite willing to extend them a loan against their traditional policy. The policyholder can use the loan amount to pay the premium. Such an arrangement can be a win-win for both. For the policyholder, it helps him continue the policy and be on track for his financial goals. For the insurer, it helps them get the renewal premium. Moreover, it is virtually a risk-free loan for them and helps them earn interest income too. Helps improve their persistency ratios. Clearly, a bigger win for the insurance company.
Insurance companies will do what they want to do. The key is, what should you do? Should you avail a loan to pay your insurance premium? By the way, I am not just talking about the loan from insurance companies. You can even take personal loan to pay the premium.
Why Would You Not Renew Your Insurance Plan?
You do not renew our insurance plans for the following three reasons or a mix of these reasons.
- You forget about the annual premium since nobody followed up with you. Since the bulk of the commission is upfront, the intermediary may not have much of an incentive to follow up. Loans are no use in this case. You need discipline.
- You realize that you purchased the wrong product/policy. You don’t want to continue. By the way, this happens more often than you think. Loans have no role in this case either.
- You think you are in the right policy, but can’t afford the premium. In such cases, a loan to pay off the premium can be useful. However, you need to see if this affordability is a one-time issue or you had in fact purchased an insurance plan beyond your means.
If the affordability is a one-off issue due to some unplanned expenses, you can borrow to pay the premium. However, if you purchased a plan beyond your means, it is better to surrender the plan. I understand surrender of plans (especially traditional) might have heavy penalty involved. Moreover, the bulk of the hit comes in the initial years. Due to this, you might want to continue with the plan. I suggest you sit with a financial advisor to help you with the cost-benefit analysis. At the same time, you must understand you can’t keep applying for a loan every year to pay this premium. After all, the loan needs to be repaid too. You must understand traditional plans give you a return of about 4-7% p.a. A loan would cost you much more.
Taking a Loan for the First-Time Purchase
Remember, taking a loan to purchase the policy for the first time is outright nonsense. So, this question of loans for paying insurance premiums shall not arise for the first-time purchase. If you must take a loan to purchase a plan, then you must not make that investment. The only exception could be when you want to purchase a term insurance and have run out of money due to some unexpected expenses. Since the premiums are not high, you can also use your credit card to pay those premiums.
Do note, for first time purchases, you must apply for a personal loan. An insurance company can offer you a loan only when you have a traditional plan with them (and not before that). It is another matter if you take a loan against an existing policy to purchase a new policy. Still quite stupid.
What Should You Do?
Avoid mixing investments and insurance. Not only can these investments be less optimal but can increase your premium liability. Bigger and binding annual premium take away the flexibility. Had you kept your investment and insurance separate; you wouldn’t likely find yourself in such a situation. Why? Because you can simply pay the insurance premium from your pocket and reduce the investment amount for the year.
Consider this. If you want to take a cover of Rs 50 lacs in a ULIP, your annual premium (before taxes) will be about Rs 5 lacs per annum. A term plan of Rs 50 lacs will cost you approximately 8,000-10,000 per annum. It is unlikely that you will have to take a loan for paying term plan premium.
Purchase term insurance plans. Keep your investments separate. You will get better and cheaper coverage and retain flexibility. It is less likely that you will require a loan to purchase or renew a term insurance plan. If you do, you have got your finances seriously messed up. Seek professional assistance.
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