LIFE AND HEALTH INSURANCE

Policy Loan Provisions
      One of the most important secondary benefits of a life insurance contract is the policy loan provision. The insured may, at any time, obtain a loan from the insurancecompany, usually equal to the full amount of the cash surrender value, using the policy as collateral for the loan. The loan provision is subject to a delay clause similar to that previously discussed in connection with the cash surrender value and under which the companymay delay making the loan for up to six months. As in the case of surrender, the option of delay is rarely exercised.

      The loan will bear interest at some percentage stipulated in the policy (5 or 6 percent in older policies but up to 8 percent in newer contracts), or the loan may be subject to a variable rate. During the 1970s, insurers experienced significant disintermediation as policyholders took cash value out of their life insurance policies to invest it elsewhere at higher rates.3 Because life insurance rates explicitly consider the investment income that will be earned on prepaid premiums, the lower earnings realized on policy loans create da subsidy from 1nonborrowers to borrowers. In an effort to address this problem, the NAIC adopted a new Model Policy Loan Interest Rate Law in December 1980, which permits variable-interest-rate
policy loans. Some variation of the model law has been enacted by every state. As explained later, the existence of a loan under a  ticipating policy may affect the policy dividends.

       Although some insurers charge interest in advance, the more common practice is to charge interest
at the end of the year. If the interest is not paid when due, it is added to the policy loan. If the insured
dies while the indebtedness exists, the loan plus interest will be deducted from the proceeds of the policy.
     An insured who becomes financially embarrassed and needs temporary funds may borrow on his or her life insurance policy. For example, according to Table 15.1, the insured could borrow asmuch  as $19,733 on the $200,000 policy purchased at age 35 if the policy had been in effect for 10 years and could do so merely by assigning the contract to the insurance company as security for the loan. The advantage of this right should be obvious. First, it would be practically impossible for the insured to borrow elsewhere and pay only a true annual rate of 6 to 8 percent interest. Compare this with the rate that one would have to pay the XYZ Finance Company—perhaps 18 percent or more. Second, the insurance company cannot refuse the loan, regardless of its purpose. Finally, there is no legal obligation to repay the loan, and the insured will not be
hounded for repayment, as might be the case with an overdue loan from a finance company.

     The policy loan right also carries some substantial  disadvantages. The most important is, of course, the ease with which the loan can be acquired and the lack of legal pressure for repayment. If the insured does not repay the loan, the indebtedness will constitute a lien against the contract to be subtracted from the proceeds when the insured dies. This, of  course, could defeat the purpose of the life insurance.