You must have heard that you can get a loan against your life insurance policy. Are you aware that all life insurance policies are not eligible for a loan facility? Yes, only a certain category of life insurance products are eligible for a loan against policy facility.
Types of Life Insurance Products
There are broadly 3 kinds of life insurance policies.
- Traditional life insurance plans (participating or non-participating plans). Also commonly known as Endowment plans. These are the kind of plans that LIC usually sells (LIC Jeevan Anand, LIC Jeevan Utsav). All private insurers also sell such policies.
- Unit Linked Insurance Plans (ULIPs).
- Term Life Insurance Plans.
Of the three types of life insurance products, you can take loan against the policy only in case of Traditional life insurance plans. IRDA regulations do not permit loans against Unit Linked Insurance plans.
Loans against Insurance Policies Are Secured Loans
Loans against insurance policies are secured loans. These loans are offered by insurance companies against the wealth you have accumulated in the insurance plan.
In the case of term life insurance plans, there is no wealth accumulated in the policy. Even the insurance company payout is contingent. If the policyholder does not pass away during the policy term, the insurer will not pay anything. Hence there is no concept of loan in a term life insurance plan.
The policy loans come into picture only for investment and insurance combo products.
In the case of traditional life insurance plans, the value of your investments moves in just one direction as the time passes. Up. Over the years, as you accumulate bonuses in your plan, the value of your investment keeps growing. The value never goes down. Moreover, the loan amount is usually capped at 90% of the surrender value.
Here, the surrender value is often a small percentage of the total paid premiums + vested bonuses in the policy. Starts from 30% of total premiums paid in the third year and can go up to 90% of the premiums paid after the 15th policy year. Hence, the insurers have a big cushion even if the policyholder defaults on the loan payment. In fact, IRDA, the insurance regulator, has now made it mandatory to offer the facility of policy loans in all traditional life insurance plans.
If the loan is given against the wealth accumulated in the insurance policy, why can’t the loan be given against a Unit-Linked Life Insurance plan (ULIP)? Because IRDA says so. The insurance regulator has clearly specified in the regulations that the loans shall not be allowed under the Unit Linked Insurance products (ULIPs).
I do not know the exact reason why IRDA has disallowed loans against ULIPs. I can only take a few guesses.
ULIPs are market-linked products. Your money is invested in ULIP equity and debt funds whose value can fluctuate. And the fund value can go up and down based on the market conditions. Perhaps, IRDA is not comfortable in allowing insurers to lend against products where the investment value can fluctuate sharply.
Additionally, in ULIPs, some of the charges (say mortality charges) are recovered through cancellation of fund units. Consider a scenario where there is no change in the NAV of your fund units, but the fund value (value of your investment) can still decline after the insurer cancels a few units to recover its charges. IRDA may not want that, in some corner cases, the insurer ceases the life cover to the policyholder because of non-payment of loan dues.
It is not that you cannot get loans against investments whose value can fluctuate. You can get loans against your shares and mutual funds units even though RBI caps the loan amount at 50% of the market value. Gold loans are quite common too, RBI has set the LTV of gold loans at 75% of the gold in the jewellery.
Whatever its reasons, IRDA does not allow loans in ULIP policies. IRDA permits loans only against traditional (endowment) plans.
How Do I Figure out What I Am Buying?
You can find this in just a couple of minutes by searching for specific terms in your life insurance plans.
Traditional plans will have the keyword “Non-Linked” in the policy documents or brochures. Traditional plans will further have the keywords “Participating” and “Non-participating” depending on the type of plan.
ULIP will have the keywords “Linked” and “Non-participating” in the policy document.
By searching for these keywords, you can figure out what kind of life insurance plan you are buying.
Alternatively, if you want to check if a specific life insurance product offers loan facility, you can simply search for keyword “Loan” in the policy wordings and find out.
While I have written about the loan facility in a life insurance policy, I do not mean that the loan facility is a desirable feature in a life insurance product. OR that traditional life insurance plans are better than ULIPs because traditional (endowment) plans offer loan facility that ULIPs do not.
Ideally, your financial planning should be so robust that you never need to take out loan from your insurance company. And when it comes to life insurance, term life insurance is the best and the cheapest way to buy life insurance.