Has your bank tried to push an insurance policy along with the loan you are taking or already have? Recently Money Matters found three cases (all within the Mint Delhi office) of banks forcing consumers to buy specific insurance policies on existing and new mortgage products. At least one bank said that the cover was “mandatory”.
However, the banking regulator, the Reserve Bank of India (RBI), says there is nothing mandatory about this “best practice” guideline. Says an RBI’s official spokesperson: “There is no directive issued by the RBI to offer insurance with mortgage loans. Banks should not adopt any restrictive practice of forcing its customers to go in only for a particular insurance company in respect of assets financed by the bank. Customers should be allowed to exercise their own choice. There should be no ‘linkage’, direct or indirect, between the provision of banking services offered by the bank to its customers and use of insurance products.”
What’s going on?
It is a global best practice to cover the life of a borrower. Imagine this: You take a Rs50 lakh home loan and die the next year. Who will pay the equated monthly instalments after you die? What happens to your family who is still living in a house that belongs to the lending bank? To take care of such situations, it is a prudent financial planning step to cover your loan with an insurance cover of an equal amount.
But here is where reality begins to diverge from theory. What we find, tucked under the loan insurance platter offered by banks, are instances of arm twisting borrowers to take specific insurance policies. Some of these are more expensive and serve little purpose.
The basic idea is to recover the debt from you in case of an eventuality. Says Anand Pejawar, executive director (marketing), SBI Life Insurance Co. Ltd: “Offering insurance is a value-add since banks can then avoid getting into the legal problems of recovering their dues by liquidating the assets.” However, some banks working with the idea of selling products of their sister companies, look at pocketing commissions and meeting targets.
Here are insurance covers that you would be usually forced to buy and how you should deal with such tactics.
Reducing term cover
What is it? Under this, the tenure of the loan as well as the insurance remains the same. But, over the years as you keep paying EMIs and the debt liability goes down, the sum assured also reduces in tandem. You can choose to pay a single premium for the cover or pay regular premiums like in a normal insurance cover.
What doesn’t work? Banks tend to sell the single-premium version of this policy with the loan and pay the premium on the customer’s behalf. The amount of premium gets added to your total debt liability, which you repay through an increased EMI.
Clubbing the premiums with the loan works out more expensive for you. For example, the single premium for a reducing term policy of a Rs50 lakh loan comes to about Rs95,230. The bank pays this premium, which means your loan increases to Rs50.95 lakh and your EMI increases to Rs51,679 from Rs50,713 and you end up paying Rs1.7 lakh as premium.
Illustration by Jayachandran and Graphic by Yogesh Kumar/Mint
What should you do? For a small-ticket loan, like a personal loan or a car loan, you may not need this cover if you have sufficient life insurance cover already. As a rule of thumb, financial planners recommend that you should have an insurance cover equal to 12-15 times your annual expenses or 8-10 times your annual income.
However for large loans, such as home loans, you need to review your insurance cover and take additional insurance. You could consider a reducing term plan if you want to cover only your debt liability. But don’t let banks bundle insurance with your loan. If you are confident of prepaying your loan, go for the regular premium option. Says Veer Sardesai, Pune-based financial planner: “A regular premium policy lends flexibility as you can stop paying premiums once you are sure of prepaying your loan.”
Alternatively, you could look outside for a cheaper rate. Says Vikash Khandelwal, director, Religare Enterprises Ltd, an insurance broking firm: “You can buy a policy and assign it to your lender, or you could assign your existing policies to the lender. Banks insist on assignment so that it is easier for them to recover the dues and they do not have to approach the survivors.”
What is it? Insurance companies also tailor products to cover your debt liability in case you are diagnosed with a critical illness or suffer a permanent disability. These plans are made up of three essential covers. One, a personal accident cover that gives a lump sum benefit in case of your death or a permanently disability due to an accident. Two, critical illness, which gives a lump sum benefit if you suffer from a critical illness, such as cancer, heart ailment, organ transplant and paralysis. Third, a householder’s insurance that covers the building and its contents against any damage from natural perils, such as fire or flood. It also covers the contents of the house against burglary. Some plans also fund up to three EMIs in case of a layoff.
What doesn’t work? It’s a useful concept, but terribly misplaced in terms of execution. The fine print in these products don’t work. Most of these are available only for five years and do not cover any pre-existing ailment or one acquired within three months of buying the policy. Karan Chopra, business head (retail), HDFC Ergo General Insurance Co. Ltd, says: “The policy would become very expensive if we increase the tenure. Typically, people repay their loan in about five years.”
The householder’s policy, which you must have to cover your asset, becomes pointless if your house is under construction. Pranay Shah, product head (business intelligence group), ICICI Lombard General Insurance Co. Ltd, says: “The householder’s insurance covers the building, for which a loan is taken, once it is constructed.”
Says Pejawar: “You need to cover your assets and your life. All other products are pure gimmicks. For instance, accident covers restrict the policy’s liability to death only on account of accidents. Claims out of medical or accident insurance are nil or negligible.”
What’s more, these policies come at a steeper cost. For instance, a policy that covers nine critical illnesses, householder’s insurance and personal accident cover charges 3.25% of the loan amount for a loan of Rs30 lakh for a 35-year-old for 15 years. So, you pay Rs97,500 for a policy that runs for five years. The amount goes up to Rs1.78 lakh if you club it with the loan.
What should you do?If you have a constructed house, for which you required a loan, you need to insure your property. You can do so by buying a fire insurance policy, which is the basis of a householder’s policy. You could also take a critical illness plan and a personal accident cover independently. A householder’s policy that covers the building and contents of your house against natural perils and burglary comes to about Rs190 per lakh of sum insured. A personal accident cover would come to about Rs60 per lakh of sum insured and a critical illness plan to about Rs200 per lakh of sum insured for an individual in his 30s. However, critical illness plans may not be available for very high sums insured. These plans need to be renewed every year.
If you have sufficient insurance or you can shop for a cheaper policy, you needn’t succumb to the banks’ sales pitch that makes insurance sound mandatory. You are within your rights to register a complaint.
Says the RBI spokesperson: “If the borrower is forced by his bank to take an insurance policy which is bundled with the loan, the customer should first approach the customer grievance cell of the concerned bank. If the customer’s complaint pertaining to any deficiency in banking service is not attended to by the bank within one month from the date of representation, he can file a complaint under the Banking Ombudsman Scheme, 2006, with the banking ombudsman having jurisdiction over the region in which the concerned bank branch is located.”