Offered lower interest rates on home loans and car loans when you buy insurance? It may not always come cheap; here's how IRDAI proposes to change it

Taking a home loan or car loan often comes with an insurance offer from the bank or lender. Borrowers may also be told that buying insurance is necessary to get the loan or to secure a better interest rate.

So, when does an insurance offer linked to a loan become a genuine benefit for the borrower, and when could it become an additional cost that the borrower did not really need?

IRDAI's latest proposals seek to address this very issue, with specific safeguards around how banks and NBFCs can offer insurance along with loans.


Also read: Tighter mis-selling rules, easier insurance buying and more: 4 prominent changes proposed by IRDAI that could affect policyholders the most

Can a bank or NBFC make insurance compulsory with a loan?

Under the proposal, banks and NBFCs registered with IRDAI as Insurance Distribution Entities (IDEs) would not be allowed to compulsorily bundle insurance with their lending products and services.

However, lenders would still be allowed to take group insurance policies at their own expense to protect their loan portfolio against risks relating to borrowers. IRDAI has proposed allowing certain package offers where there is a specific and demonstrable benefit to the customer.

For example, a bank could offer a loan along with additional term life insurance or property insurance and provide a lower interest rate if the borrower opts for the additional security. But such an offer would have to meet specific safeguards.

What if the bank offers a lower interest rate if you buy insurance?

This is particularly relevant for home loan and other borrowers. Under the proposed framework, a lender could offer a lower interest rate if the borrower provides additional security in the form of term life insurance equal to the loan amount or property insurance equal to the loan amount for the property. However, the borrower would have to be given enough information to make an informed decision.

The proposed safeguards include:

• The borrower must be told the interest rate with and without the additional insurance/security.
• The borrower should not be required to buy the insurance only from that particular bank or NBFC.
• The insurance premium should be paid separately and directly by the customer from their bank account, debit card or credit card.
• The insurance premium should not be deducted from the loan amount.

This means a borrower should be able to compare the cost of taking the lower interest rate along with insurance against the cost of taking the loan without that insurance.

What insurance package offers could still be allowed?

IRDAI has not proposed a blanket ban on selling insurance alongside banking and lending products. Some package offers would continue to be allowed where they provide a specific and demonstrable benefit to customers.

The consultation paper gives examples such as:

• Complimentary group term insurance for bank depositors maintaining deposits above a specified threshold;
• Complimentary group term insurance for certain borrowers;
• Credit cards bundled with term, travel or accident insurance without an additional charge apart from the normal card fee;
• Offer to include a bank’s customer in a group health insurance scheme negotiated by the bank with an insurer at a specified premium. Such offer should be accompanied with disclosure of the commission that the bank will get out of the premium and
• Loans where the interest rate is reduced if the borrower provides additional term life or property insurance, subject to the proposed safeguards.

The proposal also says packaging health benefit cover with home or motor loans against critical illness risk should be discouraged, as it may be cost-inefficient for borrowers.

What does this mean for borrowers?

The proposed rules could make loan-linked insurance more transparent and less dependent on the lender's preferred insurance product.

The important change for borrowers is that insurance should not simply become an unavoidable additional cost attached to a home loan, car loan or other lending product. Where a lender offers a benefit such as a lower interest rate in exchange for additional insurance security, the borrower should be able to understand the financial trade-off and, under the proposed framework, should not be forced to buy that insurance from the same lender or its insurance partner.

These are proposed reforms and not final rules yet. The eventual framework may change after stakeholder feedback and IRDAI's final decision.