Surrendering your life insurance policies makes little financial sense. However, sometimes you may be forced to surrender your existing policy/policies, particularly in case of some financial emergency or for any other benefit. But before taking a look at the pros and cons of surrendering a policy, we should first try to learn about the surrender value itself, as also how it is calculated:
What is surrender value?
Surrender value is the cash value you will get when you cancel your policy before its due date of maturity. When you cancel a life insurance policy, for instance, you may not get the full money you have already paid as premium, but only a portion of it. The portion of money you get back is called surrender value.
What kind of policies have a surrender value?
Only life insurance policies with an element of savings built into them will have a surrender value. That means, auto, health insurance and term insurance policies do not have any surrender value as there are no savings built into the policy values.
In other words, “pure risk protection policies (such as term, health, property, casualty and liability covers) will have no surrender values. Whatever you may pay as premium is used up in providing you the risk cover. When such risk covers have an additional element of endowment, money back, retirement etc as maturity benefits, those benefits can be encashed partly before the due date of the policy,” says Dr P Nandagopal, Founder of Insurance Inbox.
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How is surrender value calculated?
Usually any life insurance policy, if surrendered before its lock-in period, doesn’t have any surrender value. The policies surrendered after the lock-in period do have a proportionate surrender value, which differs from policy to policy. Normally, it’s calculated as the current accumulated savings portion of the policy minus administrative and acquisition costs, if any.
However, IRDA has some time back come out with new surrender value norms. As per the new norms, the surrender value of a life insurance policy depends on the premium paying term, policy term and the year of surrender. For instance, “if the premium paying term (PPT) of a policy is 10 years or more, it will acquire a guaranteed surrender value if all premiums have been paid for at least 3 consecutive years. However, in case the PPT is less than 10 years, the policy shall acquire a guaranteed surrender value if premium is paid for at least 2 consecutive years,” says Dr Nandagopal.
Under the new rules, the guaranteed surrender value of a traditional policy would be 30% of the total premiums paid, if surrendered between the second year and the third year of the policy, and also the first year premium will not be deducted, which was the norm earlier.
Similarly, the guaranteed surrender value would be 50% of the total premiums paid, if surrendered between the fourth year and the seventh year of the policy. This will go up to 90% of the total premiums paid, if surrendered during the last two years of the policy, if the term of the policy is less than 7 years.
In case of a unit-linked product (other than linked pension products), if the policyholder wants to surrender the policy before the lock-in period, he can do so. But the proceeds of the discontinued policy shall be refunded only upon completion of the lock-in period. The income earned on such fund/ policy account value shall be apportioned to the discontinued policy fund/discontinued policy account value.
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However, if the policyholder wants to surrender a unit-linked plan after the lock-in period, then the insurer will refund the amount equivalent to fund value, without deducting any charges.
“No need to mention that the new IRDA norms are consumer-friendly. Now insurance companies are coming out with traditional plans keeping in mind these new guidelines. The surrender value has been made more attractive for policy buyers wherein it can go up to 90% in some cases. What’s more interesting is the fact that the exclusion of first year premiums have been removed and the surrender value has been linked with the policy continuation term. With this, the insurance company will have to ensure that the policyholder does not leave early, while the policyholder gets more value only at the later years of the policy continuation,” says Jitendra PS Solanki, CFP & Founder of JS Financial Advisors.
The pros and cons of surrendering a policy
In normal circumstances, insurance policies should not be surrendered. Simply because early surrender causes losses to all the three parties involved: the insurance company, the customer and the agent. All will lose money if a policy is surrendered. That is because life insurance contracts are long-term contracts and the longer you keep paying the premium, the better the benefits are.
However, “policies which are not efficiently managed in terms of bonuses, returns earned or claims settled may be surrendered if better and cheaper options are available in the market and the policyholder could get similar or better coverage at a cheaper premium,” says Dr Nandagopal.
The second circumstance in which a policy may be surrendered is when the policyholder’s financial condition has changed and he/she could no longer afford to pay premiums regularly. In such a case, either the policies may be surrendered or treated as ‘paid up’ (if permitted by the insurance company) where the policy would continue but with lesser benefits, for which no future premiums need to be paid.
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For instance, “as term insurance rates have dropped substantially during the last 10 years and also the overall costs of ULIPs have been brought down by IRDAI regulations, some policyholders might have surrendered their older, costlier policies and replaced them with newer, cheaper policies,” informs Dr Nandagopal.
However, as the life insurance policies’ premium depends on the health of the individual, and one’s health usually deteriorates with age, one has to be doubly careful before surrendering a policy as the new policy one likes to take may charge higher premiums if one’s health has deteriorated since the first policy was taken.
