As a first step to crack down on the mis-selling of insurance products, the banking and insurance regulators are questioning the need to forcefully bundle life insurance products with loans offered by small finance banks (SFBs).

It was recently brought to the attention of the Reserve Bank of India that SFBs were mandatorily forcing individual borrowers to avail of life insurance products and the loan amount disbursed to borrowers was net of premium. While MFIs are permitted to sell insurance products in JLG or joint liability group loans, it is not permitted in the case of loans sold to individuals. “It has come to a stage where banks threaten to cancel the sanctioned loan if a borrower declines to buy insurance products. Since MFI loans have an impact on the livelihood, borrowers end up taking insurance whether they need it or not because they won’t be able to avail the loan otherwise,” said a senior executive of an SFB aware of the development.

Problem of mis-selling

Microfinance (MFI) loans are largely small-ticket unsecured loans. Both the regulators, Reserve Bank of India and Insurance Regulatory and Development Authority of India (IRDAI) are probing SFBs and insurance companies the rationale for making life insurance products mandatory along with such loans.

“On a ₹40,000 loan if 10 per cent must be reduced because it should go towards the premium for a life insurance product, how would it benefit the borrower. The banking regulator has been warning SFBs for the last two years to review such products because they may not be beneficial to anybody – whether the borrower, bank or insurance company. But with malpractices continuing, the regulator is heavily coming down on a few banks,” said a highly placed source aware of the matter.

Lack of persistency

What is also becoming a contentious issue for IRDAI is whether life insurance companies can maintain persistence on such products. “Invariably after the first year’s premium is deducted when the loan is extended by the bank, the customer doesn’t pay premium on these policies. The persistency ratios of such products are observed to be very weak,” said a senior executive of an SFB who didn’t want to be named. Such bundled life insurance products merely add to the volume of policies sold and add little or negligible value to insurance companies.

Another aspect of these loans which is under scrutiny is whether the income assessment of the borrower has been done adequately. In most cases where loans and life insurance products were bundled, it was uncovered that the assessed income for life insurance and for availing the loan were different. “Annual household income for MFI loans has been capped at ₹3 lakh, whereas there are instances of the sum insured working out to ₹5 – 8 lakhs or more. These are glaring discrepancies,” said a highly-placed source with knowledge of the issue.

Although bundling of life insurance products with loans is becoming a huge problem across the banking industry, the regulator presently is said to be keenly focused on MFI loans, because of the economic implications of such practices. It is expected that there could be some directive or circular from the RBI on such mis-selling of insurance products.