Loan against a life insurance policy

What is a loan against a life insurance policy?

A loan against a life insurance policy, usually called a policy loan, is money the insurer lends to the policyholder using the policy itself as security. The loan amount is linked to the policy's surrender value, the insurer charges interest at a rate it sets, and the policy stays in force while the loan is outstanding. If the loan is not repaid, the insurer recovers it, with interest, from the claim, maturity or surrender amount.

A policy loan lets a customer meet a short-term cash need without surrendering a long-term policy and losing its cover and future benefits.

How policy loans work in India

Which policies offer loans. The Master Circular on Life Insurance Products (12 June 2024) requires that all non-linked savings products offering a surrender value have a policy loan facility based on the eligible surrender value. Insurers may also offer loans under annuity products with a return of purchase price option. Before this circular, loan availability depended on the product design.

Two kinds of policy do not offer loans:

• ULIPs. The master circular states plainly that loans shall not be allowed under unit linked products. ULIP customers can use partial withdrawals after the five-year lock-in instead.
• Pure risk plans. Term plans have no surrender value to lend against. The 2024 policyholder protection master circular confirms that loans are available in life policies except pure risk and linked policies.

How much and at what rate. The amount is a percentage of the surrender value stated in the policy document. The interest rate is set by the insurer under its board-approved policy and must be stated as the rate prescribed at the time the loan is taken. Insurers may change revival and policy loan interest rates through the use and file route without changing the product's UIN, so rates can move with market conditions. Interest that is not paid is generally added to the loan, as the policy terms set out.

Service timeline. Under the Master Circular on Protection of Policyholders' Interests (September 2024), a policy loan request must be processed within 7 days of receipt.

What happens at the end. On death, maturity or surrender, the insurer deducts the outstanding loan and interest before paying the balance. If the loan with accumulated interest grows to the point where it exceeds the surrender value, policy terms usually allow the insurer to foreclose the policy and adjust the dues from the surrender value. The policy document must set out these foreclosure terms.

Example

A customer has a 20-year endowment plan in its eighth year with a surrender value of ₹3 lakh. If the policy allows loans up to 80% of the surrender value, the customer can borrow up to ₹2.4 lakh. Suppose the insurer charges 9% a year and the customer pays the interest each year: the cover continues and the loan can be repaid whenever convenient. If the customer pays nothing, the dues grow each year and may eventually trigger foreclosure. The percentage and rate here are illustrations; each policy states its own.

What policy loans mean for distribution

Policy loans became a standard feature of traditional savings plans in 2024. They are a retention tool when advisers use them well.

• Offer the loan before the surrender form. Many surrenders are driven by a one-time cash need. A policy loan solves that without ending cover, and without the loss that early surrender usually involves. Service and renewal teams should check loan eligibility first.
• Explain the cost honestly. A policy loan is not free money. Interest accrues, and an unpaid loan reduces the death benefit. Advisers should state the rate and what the family would receive on a claim with the loan outstanding.
• Compare with other credit. Because the policy is the security, there is usually no separate credit appraisal. The customer should still compare the rate with other borrowing options.
• Track loan foreclosures. A policy foreclosed for unpaid loan interest is lost business. Reminders for loan interest due deserve the same attention as renewal premium reminders.
• Do not sell savings plans on the loan feature alone. The loan is a safety valve, not a reason to buy. Positioning a plan mainly as a source of future credit can mislead customers about its purpose.
• Watch assignments. A policy already assigned to a bank as loan security cannot normally be used for a policy loan without the assignee's involvement.