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Life Policies
Saturday, November 1, 2008
Don’t bank on it

Policies with an investment component generally allow for loans against the security of the contract. At a time when interest rates are increasing it is important for policyholders to be aware of the implications of making use of this facility. The Ombudsman’s office has been receiving an increasing number of complaints about loans in the past few months.
The following cases will demonstrate the effect that such a loan can have on the value of the policy.

Case 1 – Interest bearing loan prior to 1st January 1999
On 15th January 1985 the client applied for a policy. It was issued with date of commencement 1st April 1985 and a premium of R41,07 payable by monthly stop order. Life cover of R10 000 was provided and there were supplementary benefits included to cover accidental death of R10 000 and a co-insured benefit of R7 000 with accidental death cover of R7 000. The policy also had an investment component. The term of the policy was 25 years.
On 25th July 1988 the policyholder applied for a loan, and R415 was paid to him. Interest in terms of the loan application was to be determined by the insurer (which is common to all interest bearing policy loans). The loan was not repaid and no demand was made by the insurer but on 5th February 2000 the policy lapsed as the loan value plus interest exceeded the surrender value. The loan debt was R5 891,79 and the fund value was R5 347,99.
Despite letters advising the client that the policy had lapsed, premium deductions continued until three months prior to the policyholder’s death on 8th January 2002. A claim was submitted but the insurer declined the it on the basis that the policy had lapsed. Premiums that were deducted after the lapse were refunded.
This was a case where the policyholder really had no value from the policy apart from a R415 loan, despite the fact that he had paid premiums amounting to some R7 288 over 14 years and 8 months prior to the lapse, and some thereafter.
We pointed out to the insurer that apart from anything else it had created an expectation by continuing to deduct premiums after the “lapse” date and we therefore suggested that it reconsiders its position. We suggested that it may be more equitable to treat the loan as a part surrender rather than a loan.
The insurer agreed to make an ex gratia payment but the details of such payment still have to be finalised.
This case demonstrates the effect that a loan can have on the value of a policy but in addition the effect it has on the risk component if the policy lapses due to the loan debt.

The in duplum rule
There is a common law rule that the interest on a debt cannot exceed the outstanding capital component of the debt. A provision in the Insurance Act 27 of 1943 exempted policy loans from the operation of this rule. It was only when the new Long-term Insurance Act became effective on 1st January 1999 that policy loans were no longer exempted from the in duplum rule. Insurers argue, however, that loans granted prior to 1st January 1999 are still exempt from this rule. This means that interest continues to accrue on these loans even when it exceeds the capital part of the loan. In the case above the interest therefore far outstripped the original loan.

Although policyholders sometimes incorrectly assume they are borrowing their “own” money when they take a policy loan this is not correct. In the case of an interest bearing loan the insurer lends the policyholder money against the security of the policy.
Where, however, the insurer grants an “interest free” loan or unit linked loan the value of this is deducted from the policy investment account when it is paid to the policyholder; it is then reflected in the loan debt account. This type of loan affects the investment value of the policy but interest does not continue to grow on the loan.

Case 2 – An interest free unit linked loan
The following case demonstrates the effect of an “interest free” loan on the operation of the policy.
The client took out a pure endowment policy on 1st March 1995 for a term of 12 years maturing on 1st March 2007. Premiums were R150,00 per month increasing at 15% per annum. A smoothed bonus portfolio was chosen as the investment medium. The policyholder took three loans to the value of R40 899,20 over the term of the policy. When the policy matured the policyholder received R7 365,20. In total he, therefore, received R48 264,40. Had the loans not been taken the maturity value would have been R66 995,67.
What happened was that the loan value was taken out of the investment value when the loan was granted. That means there was obviously no growth on that amount.
These types of loans are similar to part surrenders except that the policyholder obviously has the option of repaying the loan if he wants to ensure that growth takes place on the loan value.

Repayment of loans
Policyholders with existing loans on their policies should reassess their situations with the assistance of their financial advisers to ascertain whether it would not be in their best interests to repay their loans (even if they have to take a part surrender to do so). We emphasise that steps should only be taken after seeking financial advice.
It is important to ensure that the amount of repayment, if not done as a lump sum, is sufficient to cover at least the interest component.

Case 3 – Repayment of loans
This case demonstrates the effect of paying an insufficient amount in respect of a policy loan.
The client took out an endowment policy on 1st October 1974 for a 33 year term. The premium was R674,84 per annum and included life cover and occupational disability cover of R40 000.
On 19th December 2000 the policyholder received a loan of R35 000. The interest was 18% at the time and reduced over the term of the loan as interest rates reduced. The policyholder was under the incorrect impression that a repayment of R500 per month would repay the loan by the maturity date.
When the policy matured in February 2008 the loan debt was still R31 021,56 even though the policyholder had already paid R44 500 as repayment of the loan.**
To overcome this type of problem the policyholder needs to repay the loan at an amount that is sufficient.

Notice to policyholders
Our office regards it as important that policyholders should be kept informed about details of their policy loans. We requested the Financial Services Board to include provisions to this effect in the Policyholder Protection Rules (PPR), which was done.
In terms of section 18 of these Rules an insurer must send quarterly statements to policyholders who have loans indicating the amount of the loan, the accrued interest in relation to the value of the policy and the applicable interest rate.
An insurer must also notify the policyholder when the loan is about to equal to the value of the policy and as a consequence at what point the benefits would terminate.
It is a legal obligation for insurers to send out these notifications. Our office would be obliged to notify the regulatory authorities if we become aware of non-compliance with provisions of section 18.

**Editor’s note: Averaging out the calculations would suggest this R35 000 loan taken at R500 per month would have been repaid over 20 years at 16,5% per annum. This clearly shows a lack of decent financial advice on the part of the advisor who should have known the policy was to mature in less than eight years’ time.

Copyright © Insurance Times and Investments® Vol:21.10 1st November, 2008
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