Why Surrendering Your Policy In The Final Phases May Be A Bad Idea

Oct 01, 2018 | 4 months ago | Read Time: 4 minutes | By iKnowledge Team

Surrendering Your Policy In The Final Phases May Be A Bad Idea - Aegon LifeSurrendering an insurance policy means terminating the relationship with the insurer. While this is tempting if the policy is not giving adequate benefits, if the policy is close to maturity, surrendering it may cause you to lose benefits.

Surrendering an insurance policy means cancellation of the policy. It means terminating your relationship with the insurance company. There may be many reasons for surrendering a policy. The policyholder may go through financial difficulties and may not be able to afford the premium. Or there may be more attractive insurance products providing similar or better benefits. Surrendering a policy means the insurance company could pay out certain benefits under the policy. This is called as surrender value.

Surrender value is different for different policies. General insurance policies such as health, mediclaim, critical illness, motor, travel insurance generally do not have a surrender value. In case of life insurance plans, it depends on the type of policy. Term insurance is a pure life insurance plan. A term insurance policy generally does not have surrender value. But traditional life insurance plans such as an endowment life insurance policy or ULIPs have a defined sum assured with benefits. These policies attract surrender value.

If endowment life insurance plans or ULIPs are surrendered, the policyholder can get a surrender value depending on certain factors. But when should you surrender a policy? Is there a best time to surrender the policy?

What is surrender value?

Surrender value is the amount that is payable by the insurance company if you surrender your life insurance policy. Whenever you surrender your policy, you get some amount of premiums paid back from the insurance company. That is called as Surrender Value.

When does a policy acquire a surrender value?

  • If the premium paying term is 10 years or above: In this case, surrender value is acquired if premium is paid for at least 3 consecutive years.
  • If premium paying term is less than 10 years: In this case, the life insurance policy acquires a surrender value if the premium is paid for at least 2 consecutive years.

How can guaranteed surrender value be calculated?

The IRDA has come out with regulations for calculating surrender value. The surrender value for a policy depends on 3 things:

  1. Premium Paying Term (PPT):
  2. Life of the Policy/ Policy Term:
  3. Year of surrender:

The guaranteed surrender value will be at least:

  • 30% of premiums paid if the policy is surrendered between 2nd and 3rd year of the policy both inclusive i.e including premiums paid for all years.
  • 50% of premiums paid if the policy is surrendered between 4th and 7th year of the policy including premiums paid for all years.
  • 90% of the premiums paid if the policy is surrendered during the last 2 years of the policy and policy term is less than 7 years.

If any survival benefits have been paid out before the life insurance policy is surrendered, it will be reduced from the guaranteed surrender value.

The guidelines do not mention any specific rules about the payment of bonus and other accrued benefits.

If the policy accumulates benefits, then a special surrender value calculation is used. The special surrender value is calculated using a number called as the surrender value factor.

Special Surrender Value = (Sum assured * (No of premiums paid/Total Premiums Payable) + Bonus) * Surrender Value Factor.

The surrender value factor is decided by the insurance company based on the life insurance policy. This information can be received from the insurance company at the time of purchasing the product.

For example, Aegon Life’s iReturn plan has published information about the Surrender Value Factor depending on the premium paying term and policy term. The surrender value details are a part of the product brochure.  The iReturn plan provides life and terminal illness cover and also returns the premiums paid under the policy on maturity. It is a term plan that provides premium returns which makes it an excellent plan to invest in.

Why surrendering your policy in the final phases is a bad idea:

It may seem very tempting to surrender an insurance policy, but if it has almost reached maturity, the calculation of special surrender value, or guaranteed surrender value will leave out benefits that you would have received on maturity.

The guaranteed surrender value calculation only considers the premiums paid and not all the premiums paid are refunded. Thus, you won’t get a complete refund of the premiums paid under the policy.

Secondly, the special surrender value considers the bonus amount accrued under the policy but depends on the surrender value factor. This factor depends on the insurance company and different life insurance plans. In either case, the calculation will not give you the entire amount of benefits accrued. This will make it lossmaking to surrender the policy.

Each insurance company may have surrender charges. For ULIP plans, if the policy is surrendered after the lock-in period, the insurance company does not deduct any charges, otherwise, they deduct administration charges. If a traditional life insurance policy is surrendered, it may have a surrender charge or some amount charged as penalty. The surrender value received will be reduced by the charges.

If the policy is close to maturity, and there are significant bonuses accumulated on it, it makes sense to wait for the policy to mature. The calculation of surrender value ensures that the policyholder gets some return, but it is not comparable to the return received if the policy matures.

For example, if the sum assured is Rs. 10 lakhs, the premium paying term is 10 years and the yearly premium is 30,000. The policy accrues a bonus of Rs. 5,000 per year of the policy. As per the insurance company’s guidelines, the surrender value factor is 60% for the particular life insurance policy.  If the policy is surrendered in the 8th year, the surrender value is calculated as follows:

Special Surrender Value: [ (10,00,000 * 8/10) + 40,000 ] * Surrender Value Factor of 60%

                                                  = 8,40,000 * 60%            = 5,04,000

In this case, there is a significant loss of benefits. If the premium had been paid for 2 more years, the benefits received would be Rs. 10 lakhs plus the bonus of Rs. 50,000. The extra premium payable would have been Rs. 60,000. But, by surrendering in the 8th year, in the final phases of the policy, the amount received is quite less.

It makes financial sense to let the policy mature, collect the benefits under the policy and reinvest it in higher earning instruments.

While deciding about surrendering a life insurance plan, evaluate the surrender value factor and the benefits that will be received on maturity and then take a decision. If the surrender value is equal to the proportionate benefits that would be received, only in that case should you consider making such a decision.  Otherwise, it is better to wait till the policy matures.

II/Sep 2018/4421


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