When does loan insurance help?

Three years ago, Mr Elisha Okurut got a loan from a local bank to complete his dream house. At that time, the house had reached the ring beam level but he had run out of funds because his business was not doing well.

Armed with a land title, Mr Okurut contacted a local bank and within days, he had the money and completed his house.
“They gave me the papers. I had two days to read through and later, I signed for the money. I was more interested in the money than anything else,” he said.

Mr Okurut added; “Soon, the grace period was over. I had paid part of the loan but with children who were supposed to go back to school, I somehow defaulted.”

The 48-year-old father of five added that he panicked because the bank started calling for explanations of why he was defaulting but he did not have an answer because funds were diverted.

“My elder son asked to check on the loan agreement. He discovered something talking about loan insurance and there I got some relief,” he said.

Mr Okurut said when he visited the bank the following day, he was told that loan insurance could not meet his loan obligations and he had to quickly renegotiate his loan payments or lose his collateral.
Financial advisors from the banking and insurance sector say it is catastrophic to get false relief believing that loan insurance can settle loan obligations when one defaults.

Loan insurance
Mr Christopher Sengendo, head of bancassasurance at Orient Bank, explains that loan insurance covers the bank and customer in case the customer defaulted or through many reasons fails to pay.

“In the event that the customer defaults, loan insurance becomes “plan B” in the process of risk management by financial institutions,” he says.

Mr Sengendo further explains that for the customer, it offers security for their property. For instance when the customer dies, the financial institution won’t go for the customers’ property or any other security.

“Some insurance companies pay accrued interest on the loans if customer lost his job or is temporarily out of the job for 12 months. But in case of death, they pay the remaining part of the loan,” he said.

Mr Protazio Sande, the director planning market research and development at Insurance Regulatory Authority (IRA), explains that loan protection insurance will pay the lender money in the event that the borrower falls seriously ill, is incapacitated or dies.

Some insurance companies with time have added extensions to cover events like loss of job, redundancies, retrenchment or catastrophic losses caused by floods, fires. This guarantees a business or that property.

“The loan insurance is done in favour of the bank regardless of the fact that it’s borrower who is paying it, becomes a valuable investment to a bank as soon as you borrow, hence the protection,” he said.

Mr Sande illustrates; “Loan insurance can cover unemployment, for example, Members of Parliament (MPs) because one is not sure if they will come back yet they could be having loans.”

Another classic example, according to Mr Sande, is where insurance companies compensated banks when traders whose goods were destroyed in the Kampala fires were unable to pay.

“When we witnessed fire outbreaks at St Balikuddembe market (Owino) many people had got loans from Pride Microfinance and other institutions were compensated,” he says.
But why can’t it cover defaults?

The rule of thumb about loan insurance is it is a small portion of the whole loan, meaning it can not bail you out completely.

Information from the industry says that insurance loan takes a percentage minimum of 1.77 per cent of the sum acquired.
According to Mr Sande, insurance cannot cover a loan because there would be no motivation for the insurer; loan insurance is for ‘just in case’ not to offset the loans.

“If loan insurance would cater for everything, people would get a loan decide to resign or just default because their insurance will pay,” he says.

Mr Sengendo adds, “When banks are giving out loans, they do screening of the customer and the insurance companies aren’t there. So at the time of issuing loans, it is the bank’s role to ensure that the customer meets their loan obligations.”

He adds; “By law, defaults that are covered by insurance are things to do with loss of jobs, or redundancies arising from restructuring and liquidation of the company. But if you are terminated, banks go for terminal benefits.”
In understanding Mr Okurut’s problem, Mr Sande says financial illiteracy is the biggest challenge. However, he was quick to blame the banks.