Buying insurance to cover loan

Guarantors for home loan borrowers are no longer required. Insurance covers, which ensure payment in case of a default, have replaced these. Similarly, if you have lent money to a family member or friend, you can buy an insurance plan to cover the loan.

Sushil Kumar requested his friend, Chandan Parekh, to lend him Rs 15 lakh for five years. Kumar had recently suffered losses in business and had some emergencies at home, too. Parekh has known Kumar for a very long time, but he isn't sure if he should lend such a big amount without any guarantee. He cannot ask for a collateral due to old relations.

"Parekh could get life insurance in Kumar's name and insure his capital, provided Kumar agrees to it. Because both parties need to sign the insurance documents," says GN Agarwal, chief actuary, Future Generali Life Insurance. Also, the life insured or the debtor has to pay the premium. Earlier, the debtor and his family would never know about the creditor buying a life insurance. Only when the premium payment period would lapse and the insurer would contact them, would they find out.

Here, Parekh (creditor) will be the policy proposer and Kumar (debtor) will be the life insured. A proposer proposes to enter into a contract of insurance with a life insurance company to insure himself or another life on whom he has insurable interest. In this case, Parekh has an insurable interest in Kumar and, hence, will be the nominee of the policy till the loan is repaid.

If the debtor, Kumar in this case, agrees to insuring the deal, can the creditor or Parekh approach a life insurance company? Then the deal has to be on paper. Usually, when individuals lend money to family members and/or friends, they do not prepare a deed. In the absence of a loan deed, insuring is not possible. Along with the life insurance papers, Parekh and Kumar will need to provide the life insurer with the loan documents and a declaration that says the former has lent Rs 15 lakh to the latter for five years.

Kumar will have to undergo a health check and sign a declaration of good health before the life cover will come into force.

"But, such cases may not always be accepted for insurance. The underwriter will need to figure whether or not to accept such proposals on a case-to-case basis," says Manik Nangia, senior vice president and head, products, Max New York Life Insurance.

In such cases, applications are mostly rejected or claims not honoured if the creditor has insured a debtor who is not in good health.

Recalls a life insurer, a creditor had insured a 28-year-old debtor, who was in the last stage of cancer.

As the debtor was very young, the insurer did not press on a health check-up. At the end, they had to honour the claim.

If the debtor repays the loan within the stipulated period, it is for him to decide if he wants to continue with the cover.

If he wants to keep the cover, the policy proposer or the creditor will have to assign the policy to the debtor, i.e. make him the proposer. After this, the debtor can change the nominee of the policy.

If the debtor wants, he can assign an existing policy to the creditor and name him the nominee, provided the sum assured is more than the amount borrowed by the debtor.