Insure to Ensure Your Loan? 

Manisha Ghosh, Executive | finserv@vinodkothari.com

Introduction 

It is quite common that whenever a borrower wishes to apply for a loan, lenders require the borrower to purchase an insurance policy, as a pre-condition for sanction. One may wonder if availing insurance can be a mandatory requirement for availing any loan? Insurance is not a regulatory requirement that is needed in loans, however, lenders prefer the same to safeguard their interest in the event of default. 

Lending institutions such as banks and NBFCs may also enter into insurance business in line with the Master Circular – allied activities- entry into insurance business, issue of credit card and marketing and distribution of certain products for Banks and the “Guidelines for Entry of NBFCs into Insurance” (Annex XVI of SBR Directions) for NBFCs. Generally, lenders try to solicit customers by marketing insurance to the borrowers who have applied for a loan by acting as commissioned corporate agents of the insurance companies under the supervision of IRDAI. 

In this article, the author examines the prevalent practice of lenders requiring borrowers to obtain insurance as a prerequisite for loan sanction and evaluates its permissibility within the regulatory framework.

Types of Insurance

Insurance policies are of various types, they may be life, health, general, however most common insurances in case of loan products are:

1. Credit Life Insurance: This policy insures the life of the borrower for the period of the loan tenure. In case of death of the borrower, the claim amount is used to repay the loan and balance, if any, is shared with the beneficiary. As the payout goes directly to the lender, the borrower’s family and co-signers are not burdened with the outstanding debt.
2. Asset Insurance: In case of secured loans, such as vehicle financing or housing loans, the vehicle or property on which security has been created is insured having coverage against accidents, fire, theft, natural calamities, etc. covering the loan tenure. 

Can lenders mandate insurance policy? 

As per para 1 of Annex XVI of the SBR Directions,

(ii) NBFCs shall not adopt any restrictive practice of forcing its customers to go in only for a particular insurance company in respect of assets financed by the NBFC. The customers shall be allowed to exercise their own choice”

(iii) As the participation by an NBFC’s customer in insurance products is purely on a voluntary basis, it shall be stated in all publicity material distributed by the NBFC in a prominent way. There shall be no `linkage’ either direct or indirect between the provision of financial services offered by the NBFC to its customers and use of the insurance products.

Similar provisions have been provided in the case of Banks under Annex 4 of Master Circular – Para-banking Activities. Accordingly, it is quite apparent that lenders are prohibited from the restrictive practice of forcing their borrowers to avail the policy from only a particular insurance company. 

However, it has nowhere been mentioned that lenders are not permitted to reject a loan if the borrower has not availed an insurance policy. In other words, while the borrower must have the freedom to choose the insurer, the lender may, as a matter of prudent risk management, stipulate that adequate insurance protection be in place before the loan is sanctioned.

To better understand the permissibility of various prevalent practices on availing insurance, the following scenarios may be considered: 

Let’s say there is an NBFC (A Ltd), that extends vehicle loansloans against residential property. The NBFC is also registered as a corporate agent for multiple insurance companies, enabling it to distribute both life and general insurance products. 

Scenario 1: Insurance of the secured asset

At the time of the loan application, A Ltd requires the borrower to insure the vehicleproperty against perils like such accidentas fire, theft, etc. This requirement is linked to the protection of the collateral securing the loan. 

Permissibility: The same should be permissible as the insurance directly safeguards the financial interest of the lender in the asset.

Scenario 2: Offering insurance through the NBFC’s tie-up insurer

A Ltd, also being a corporate agent, offers the borrower, insurance policy from its partner insurer. The borrower voluntarily opts for the same and the premium is deducted from the disbursal amount.

Permissibility: Should be permissible as the borrower’s consent is voluntary, and there is no coercion.

Scenario 3: Borrower chooses a different insurer

The borrower obtains insurance from a different insurer and submits proof to A Ltd. 

Permissibility: The same should be permissible as the lender cannot mandate insurer choice; coverage must merely satisfy the risk protection requirement.

Scenario 4: Mandating unrelated insurance 

A Ltd requires the borrower to also purchase a health or personal accident policy from its partner insurer as a precondition for sanctioning the vehicleproperty loan.

Permissibility: Not permissible. Such insurance does not have a direct nexus with the loan or collateral, and mandating it would amount to force-selling.

Scenario 5: Mandating credit life insurance

In another case, A Ltd stipulates that the borrower must obtain a credit life insurance policy covering the outstanding loan amount. The intent is to mitigate the lender’s exposure in the event of the borrower’s death during the loan tenure.

Permissibility: Should be permissible, since the policy has a direct link with the repayment obligation and serves a legitimate credit risk purpose. However, the borrower must retain the right to choose the insurer.

Why Force-selling/ mis-selling? 

Corporate agents receive commissions on the basis of the quantum of policies solicited by them. For earning more commissions, it was observed that lenders were forcing borrowers to avail insurance products not linked to the loan. One of the highlighted cases for this was settled by the High Court of Delhi in the All India Punjab and Sind Bank Officers Union v. Union of India. 

In 2004, All India Punjab and Sind Bank (‘Bank’) entered into a corporate agency arrangement with a life insurance company (‘Insurer’) to solicit customers in return for commission/fees. To promote business, the Insurer introduced a scheme offering incentives to Bank officers in cash and rewards in form of foreign tours under the guise of training programmes. Despite repeated complaints by some officers, no action was taken. By the time the employees’ union filed a writ petition in 2013, the arrangement had already been terminated, but incentives of about ₹25 crore had already been paid to executives. As a remedial action, the Bank’s Board passed a resolution for recovery of such incentives. However, the Court did not record whether the funds were ever reclaimed, raising serious concerns of accountability and misappropriation of public funds.

Protection of the policyholder: Regulatory provisions

While the IRDAI (Registration of Corporate Agents) Regulations, 2015 already provides that specified persons i.e persons selling the insurance shall not accept incentives from the insurer directly,  to further curb such mis-selling practices, regulatory changes were brought in by IRDAI in 2024. 

Under the Master Circular on Protection of Policyholders’ interests 2024, 

5.2. Every life insurer shall have a Board approved policy on assessing the suitability of a product to the prospect /policyholder and recommending suitable products to them. The policy shall also dwell on the measures to curb mis-selling, force-selling and mis-leading sales. It shall also deal with record keeping and retention thereof

Additionally, the Master Circular also requires the insurance distributors/ intermediaries, to put in place, the mechanisms which shall inter-alia include the following:

1. Ensure that fair treatment to customers is an integral part of corporate culture.
2. Personnel authorized to solicit insurance business must use only the approved prospectus issued by the insurer.
3. Sales persons involved in the solicitation are duly qualified and appropriately trained periodically.
4. Lay down a mechanism of obtaining customer feedback. 
5. Punitive action for breach of market conduct including blacklisting the sales person who indulge in unhealthy solicitation practices or market misconduct. 

In May 2025, IRDAI also proposed a transaction-fee model where fees would directly be charged to the borrower. The pricing of the transaction fee will be flexible, determined by market dynamics. The objective is to reduce conflicts of interest and make insurance sales more aligned with customer needs rather than the earning potential of the bank. The same has not been notified yet. 

Conclusion

While lenders have a valid reason to insist on insurance that directly protects the loan like credit life or asset insurance, the practice of force-selling unrelated insurance under the garb of lending has raised concerns of fairness, transparency, and accountability in the financial sector. While regulatory frameworks under the IRDAI, RBI and SBR Directions make it clear that borrowers cannot be compelled to opt for a specific insurer, ground-level practices have often reflected otherwise.  

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