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IRDA (Insurance Regulatory and Development Authority), the insurance sector regulator in India has indicated that general insurance companies, also called non-life insurance companies, cannot offer credit guarantee.
So what is Credit Insurance?
Credit insurance is a simple guarantee that the insurance company provides to the financial company which is offering credit to its customers – in case the customer is unable to pay the back the loan, the insurance company will make good the amount of loss to the financial company. In return, the financial company needs to pay a premium for every such loan which is being granted. Credit insurance can be of various types in which the conditions under which the insurance company will pay the financial institution is very strictly laid down. Usually the insurance company studies the history of the lender and the way the existing loan portfolio if performing and then arrives at a premium amount.
Let us take a simple example of Mr Kumar who wants to take a personal loan from Bank ABC for Rs. 5 Lakhs. Based on the banks risk assessment, the loan would be provided to Mr Kumar. Now Mr Kumar can be advised to take credit insurance, in which case in certain circumstances due to which he is unable to pay off the loan, insurance company would pay on behalf of the customer. Say, Mr Kumar met with an accident and loses his job or he passes away – his family would not have to bother about repaying this loan – the insurance company would take care of it. The conditions under which the insurance company makes good the loan payment are usually well defined. In some way, certain amount of the risk of the bank is taken care of as the insurance company takes care of that component.
The recent action by IRDA seems to be precipitated by a loan of Rs. 400 crores given to Paramount Airways which have been given credit insurance by Oriental Insurance Company. Now when Paramount Airways are unable to make the payment, the financial institutions want Oriental Insurance Company to pay up, as a large part of the decision to grant the loan to Paramount Airways was influenced by the fact that it was backed by this insurance policy.
In the case of individuals taking loans, the credit insurance is usually provided by life insurance companies. When companies take a loan, the credit insurance is usually provided by general insurance companies. Now with this option gone, at least temporarily, banks would further tighten the norms of lending to companies.
Export Credit Guarantee Corporation has been excluded from this ban.