Using your Insurance Policy as a bank!

10/20/2008 8:08:16 AM

Over the last few months we saw the debt crises world wide reducing many people to tears and with this a much stricter credit policy from banks. Just yesterday we heard that ABSA has decided to effectively freeze the Flexi reserve of clients on their home loans. For many people this was a last haven of obtaining capital in a crises situation.

As stated earlier, very often, investors who are short of money cash in their life assurance policies as an alternative. What they however may not know is that they may be able to borrow against the value of their policies keeping the policy in tact. Very often, especially with the older generation endowment policies, a savings element is included which means that a capital value is built up over time. Now it is important to note that not all policies have this element and many may only be a life cover policy. If the policy has a cash or savings element then you have other options than to summarily cancel the policy and withdraw the money. To merely cancel the policy may have many negative effects which may include the flowing:

• A reduced investment value due to penalties for early withdrawals. These are known as early surrender penalties.

• When in future you want to take out a new policy you will again have to pay fee’s

• If the policy included life cover you will lose that as well and it may be that when you want to take out life cover in future it may be more expensive or worse, due to your health that may have deteriorated you may not be able to obtain insurance.

So what other options do you have if you need to obtain money urgently?

Let us start with the premiums. If you no longer can afford the premiums you can make the policy fully paid up. This means that you don’t make any more contributions but leave the cash value built up over time in tact. This can be done if the policy is purely an endowment policy with no life cover. If the policy has life cover which you do not want to lose you may negotiate with the life insurance company to do one of the following:

Reduce the premiums by changing the type of policy i.e take away the savings component which leaves pure life cover or if the policy has a cash portion you may negotiate with the insurance company to pay your premiums from the cash saved. Alternatively you may reduce the life cover which may result in a reduction in the premium.

If however the premiums are not the problem but you need cash you may be able to borrow from your policy. Keep in mind that you cannot borrow from a retirement annuity or preservation fund but only from an endowment type of policy.

Life insurance companies have two ways in which they will lend you money. The first is as unitized no-interest loans. This kind of loan is effectively obtained by selling some of your units in the investment portion of your policy. The insurance company will not charge you any interest because you are effectively borrowing from yourself. The advantage however is that you can keep the life insurance in tact while getting your hands on the needed cash. You may repay the loan by investing the borrowed funds in future. The market may however have moved up which in effect means that you lost money. Conversely if the market lost value during the loan period you would gain by buying in at a lower cost per unit. You may also opt not to repay the loan which in effect means that the amount paid out at maturity of the policy will be reduced.

The second kind of loan from the insurance company is an interest-bearing loan. This type of loan is taken mainly against the older type of assurance policies. This type of loan means that you are borrowing from the insurance company. The insurance company uses the policy as insurance and charges you interest. It must be said that this should be your last option since the interest rates charged by the insurance companies are usually quite high.

Another alternative may be to use the value of the endowment policy as collateral to obtain a loan from a bank.

When borrowing against your policy there are two important things to look out for. Firstly the administration charges can be high which in effect erodes your value and secondly you may want to ensure that you have a repayment period. In most cases policies are used as savings vehicles for retirement or to finance some dream in future. By not having a repayment plan it could mean that the new car or the kids’ education never happens.

It is critical in times like these that you investigate and evaluate all options and not make hasty decisions that you may regret at a later stage.

Till next time, keep your head up better times may be closer than we think. Who knows?