Final answer:
A loan that uses a universal life insurance policy as collateral, where the interest charged on the loan is neutralized by the interest earned on the policy's cash value, is known as a policy loan.
Step-by-step explanation:
When a loan is taken out on a universal life insurance policy using the policy as collateral, and the interest charged on the loan cancels out the interest paid on the cash value, the type of loan in question is known as a policy loan.
Universal life insurance is a type of cash-value life insurance which has both a death benefit and an accumulated cash value. This cash value can serve as an account that the policyholder can use during their lifetime.
Collateral is something valuable, often property or equipment, that a lender has the right to seize and sell if the borrower does not repay the loan. In the case of a policy loan, the collateral is the cash value of the life insurance policy. If the policyholder does not repay the loan, the life insurance company can use the policy's cash value to recover the loan amount.
A life insurance company's primary purpose is to provide financial protection for survivors of the insured. However, once policies have been paid out, the company often has substantial cash on hand. This cash can be lent to others, including policyholders who wish to borrow against the value of their policies.
These loans must be repaid with interest, though in the scenario described, the interest paid on the cash value of the policy can offset the interest charged on the loan, resulting in a balance.