Abandoning life insurance policies midway through the term often results in a significant financial setback due to the high surrender costs associated with the early years of the policy. Recognising this, the Insurance Regulatory and Development Authority of India (Irdai) has proposed measures to increase the surrender value of non-linked policies in an exposure draft released on December 12. Non-linked policies or traditional insurance plans are not connected to the stock market. They offer low-risk returns, along with a defined maturity amount and bonuses.
In the draft regulations, Irdai has proposed the concept of a premium threshold for each product. Beyond this threshold, no surrender charges would be levied on the remaining premium, irrespective of when the policy is surrendered. Stakeholders are requested to submit any comments or suggestions on the proposed regulations by January 3.
To illustrate, consider an endowment policy with an annual premium of Rs 1 lakh and a policy term of 20 years. Assuming a threshold limit of Rs 25,000, the guaranteed surrender value after the payment of the third annual premium could be computed as follows:
1) The guaranteed surrender value for the threshold premium would be Rs. 25,000 x 3 x 35% equating to Rs 26,250.
2) The premium refund surpassing the threshold premium would be Rs 1,00,000–Rs 25,000 x 3, or Rs 2,25,000.
3) Therefore, the adjusted guaranteed surrender value would sum (1+2) up to Rs 2,51,250.
4) The surrender value would be the higher of the Adjusted Guaranteed Surrender Value or the Special Surrender Value.
It would be a significant jump in surrender value because as per the existing regulations, one would qualify for 35% of the premium paid, equivalent to Rs 1,05,000.
Currently, the policy can be surrendered by the policyholder at any time during the policy term provided two full years’ premiums have been paid. Before that surrendering a policy can incur heavy costs as no money is refunded. Post 2 years policyholders are only entitled to the Guaranteed Surrender Value, which carries significant costs. For instance, if you surrender after the second or third year, 30-35% of the total premium is refunded, excluding survival benefits such as bonuses. This proportion increases with the term of the policy. For example, 50% is paid if surrendered between the fourth and seventh year and 90% if surrendered in the last two years.
The good part is even for the policy surrendered in the first year the IRDAI proposes to offer Adjusted Surrender Value to the policyholder. Consider a non-linked savings insurance policy with an annualised premium of Rs 1 lakh and policy term of 20 years. Assuming a threshold limit of Rs 25000, if the policy is surrendered in the first policy year, the adjusted guaranteed surrender value after payment of first annualised premium may be as follows:
(1) Guaranteed surrender value for threshold premium: Zero
(2) Premium refund beyond threshold premium: Rs (1,00,000 – 25,000) x 1 = 75,000
(3) Adjusted guaranteed surrender value: (1) +(2), i.e. Rs. 75,000
(4) Surrender value shall be higher of (adjusted guaranteed surrender value, special surrender value)
If a policyholder discontinues premium payment, surrendering the policy is one option. Although it might seem like a simple solution, it carries considerable financial implications. The Irdai’s proposed regulations aim to alleviate this burden, providing policyholders with a more fair and equitable way to exit their policies.
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