Repaying insurance loan may be a good policy

Attention, people who took out loans on life insurance policies at 5 to 7 percent interest when everyone else was charging 10 to 15 points more: Your insurance companies would like some of that money back. To get it, several insurers are offering higher returns on existing policies as well as on any borrowed money that is repaid.

At the end of 1978, before interest rates began blasting off, United States life insurance companies had just over $30 billion in policy loans outstanding, according to the American Council of Life Insurance. These loans were 7.8 percent of the industry's assets. But by the end of this June, there were $53.9 billion in loans outstanding, or 8.6 percent of assets. The only consolation for the insurance companies in these figures is that the rate of increase is slowing and the percentage of assets is down; at the end of 1981, it was 9.3 percent.

At times, policy loans have represented a serious drain on the finances of several insurance companies. In some cases, insurers had to borrow money from banks and other big lenders at 13 to 15 percent to fulfill their contractual obligations to lend it to customers at 5 percent.

In earlier days, when the interest charged on policy loans was not much less than bank loans, they were not a problem for the insurance industry. From 1950 to 1965 these loans never accounted for more than 5 percent of assets. As late as 1968, they were only 6 percent of assets.

For borrowers, these loans have always been an attractive alternative to the banks. Traditionally, they were used for things the insurance industry intended them for: college tuition, down payments on homes, major home repairs, and large emergency expenses. But in the 1979-81 period, many people took out 5 percent policy loans and simply put the money into 15 percent money market funds or certificates of deposit.

In addition to low interest rates, the principal on the loans never had to be repaid if the policyholder chose not to do so. Only payments on interest and the regular premiums were needed to keep the policy in force.

There is one negative aspect to these loans, however. Should the customer pass on before the loan is repaid, the payment to his beneficiaries is reduced by the amount of the outstanding loan. Another possible negative is the fact that these loans are only available on whole-life policies, and if a person followed the ''buy term, invest the difference'' practice, the money that might have been borrowed would be readily available in savings or investments.

The competition from term insurance has helped provide part of the answer to insurance companies looking for ways to get some loan money back into their portfolios. Lately, the industry has started offering more competitive products that look much like the old whole-life policies but have more flexibility and higher interest rates.

Since last November, for example, Northwestern Mutual Life has been offering policyholders the opportunity to update their existing policies to pay 93/4 percent. In addition, any borrowed money that is repaid will earn the same 93/4 percent rate. This rate, notes Thomas Dyer, in-force marketing officer at Northwestern Mutual, is tax-deferred, making it equivalent to a 13 to 16 percent taxable rate, depending on an individual's tax bracket.

''This applies to any policy, no matter if it was written yesterday or 20 years ago,'' Mr. Dyer said. The higher rate also applies to any new policies as the standard return, not just to old policies that have loans out against them, he added.

Several other life insurance companies, including Massachusetts Mutual, New England Mutual, Phoenix Mutual, and Lutheran Brotherhood, are also offering incentives to bring back some of their loans.

There is, of course, another option to paying back the loan, even when the company is offering a higher return. Many people, after borrowing the money and seeing their new bills for premium and interest payments, have decided they could do better by canceling the policy altogether. Because you cannot borrow more than the cash value of the policy, you were actually ''borrowing'' your own money, so there is nothing wrong with not paying it back. And money that would have been used for interest and premium payments may buy more term coverage.

While this may work for some people, others should take the insurance companies up on their offer and start repaying, contends Eugene Naegele, a financial planner with the New England Financial Planning Group in Burlington, Mass.

''It all depends on the individual,'' he says. ''Some people have problems saving money. For them, sometimes a forced savings program may be the best way to ensure they have the coverage they need. Also, people who don't have the money to invest in other places may want to keep their insurance.

''This kind of return (93/4 percent) is better than the money market - which is taxable - is paying,'' he adds. Finally, Mr. Naegele points out, people who do not repay policy loans but keep the insurance in effect should remember they are leaving their heirs with less insurance coverage, something they may not want to do.

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