Next time you apply for a home loan or a personal or education loan, the bank may try to sell you credit insurance along with it. Whether you want it or not, the insurance might already be included in your loan proposal. But do you really need credit insurance?

The United Bank of India offers a 0.25 per cent discount on its home loan interest rate if you take a credit insurance policy from SBI Life Insurance or Tata-AIG Life Insurance Company. IDBI Bank sells its personal loans with an insurance cover.

Other banks are making it mandatory for education loan applicants to have a life insurance cover. “We will implement this as it’s beneficial in the long term. Right now, we can’t say much about it, but it’s necessary,” said Prakash Mallya, Vijaya Bank chairman and managing director.

“We are in talks with Kotak Life Insurance and a deal will be worked out soon,” said K.C. Chakrabarti, Punjab National Bank chairman and managing director.

Insurance cover on retail loans is an attempt by banks to protect their lending. Banks also get a commission by selling insurance products of companies with which they have bancassurance tie-ups.

For insurers, credit insurance means big money as they are paying less than 25 paise towards claims against every Re 1 received as premium. The claim to premium ratio in other life insurance products is as high as 70 per cent.

On the face of it, a credit insurance policy that promises to repay a loan in the event of a policyholder’s death or disability sounds logical. But a closer look at the exclusion clauses, terms and conditions, and the premium rate of such a policy vis-à-vis other comparable insurance plans reveals a different picture.

Insurers worldwide sell different varieties of credit insurance: credit life insurance, which pays off a loan if the borrower dies during the loan tenure; credit disability insurance, which promises to repay the outstanding loan if the borrower becomes too ill or injured to work; involuntary unemployment insurance, which makes loan payments if the borrower loses his/her job because of a layoff or strike.

However, involuntary unemployment insurance is not available here. Credit insurance is sold both as an individual product and as a group product. SBI Life has reported a first-year premium income of Rs 225 crore from its credit insurance policies for housing loans and is expecting to earn Rs 500 crore in 2007-08. Other insurers have also reported fast growth in their credit insurance business.

Let us take a look at two different plans — credit life and pure term assurance. Both of these are pure risk covers and hence the policyholder will not get back the premium paid if he or she survives the policy term. A 30-year-old man will have to pay an annual premium of Rs 2,454 for taking a term assurance cover of Rs 10 lakh for 20 years. Now, if the person takes a home loan of Rs 10 lakh for 20 years at an interest rate of 10 per cent and opts to buy a credit insurance, he will have to take a cover of Rs 22,81,440 — the principal plus interest on it.

SBI Life offers a single premium rate (for a 30-year-old person) of Rs 2,256.19 per Rs 1 lakh credit insurance. In other words, the home loan borrower will have to pay about Rs 51,475 upfront for taking a credit insurance covering the entire loan outstanding. The lender bank, however, gives a loan to the borrower to pay for his single premium, while the borrower pays the money (with an interest) to the bank along with his home loan EMIs. The borrower pays interest twice — first on home loan and then on insurance premium.

Clearly, the higher the interest rate, the higher will be the premium simply because the borrower will need a higher insurance cover for his loan. Now, given a long-term loan, such as a home loan, the interest rate can go up and down over the tenure of the loan. So, if you buy a credit insurance when the interest rate is high, you will end up spending more on an insurance cover that is more than what you actually need.

Further, in credit insurance, the risk on the part of the insurer reduces with every payment of EMI by the borrower because the quantum of outstanding loan comes down. So, logically, the premium in credit insurance should be less than that in a term assurance plan. But look at the premium rates of these two types of plans for Reliance Life. While a 30-year-old man who takes a Rs 10-lakh Reliance Term Plan for 20 years pays an annual premium of Rs 2,600, the person will have to pay Rs 3,650 annually towards premium for a Rs 10-lakh Reliance Credit Guardian Plan.

Credit insurance has been the eye of a storm in the US and the UK. Rules have been put in place in those countries to restrict insurance firms from charging high premiums. India does not have any such rules at present.