Surrender value rule offers little incentive for insurance buyers

In December 2023, IRDAI had released a consultation paper proposing to increase the surrender value paid by life insurance companies to policy holders. But contrary to expectations, it decided to retain the regulations after suggesting a hike in the initial proposals in draft regulations vis-à-vis the surrender value.

The new proposal is pro-insurance companies at the cost of policy holders. As the insurance companies are paying a hefty commission to agents for soliciting new business, they seem to have used their lobbying powers with the regulator to continue with the existing norms for surrender value. 

What is 'surrender value'?

A surrender value in life insurance is the sum disbursed by the insurer to the policyholder when terminating the policy prematurely. To put it differently, it is the amount payable on a discontinued life insurance policy on surrendering the policy before its maturity date.

The surrender value may differ across policies; it is printed as part of the terms and conditions of the policy itself.

The following rates will be effective from April 1, 2024:

New slabs

The proposed slabs for the surrender value are:

30 per cent of total premiums paid if surrendered during the second year

35 per cent of total premiums paid if surrendered during the third year

50 per cent of total premiums paid if surrendered between the fourth and seventh years

90 per cent of total premiums paid if surrendered during the last two years

Different policies

This means that if the policy is surrendered during the first year, no amount will be paid. In such a scenario the entire premium paid by the policy buyer will be a loss for him/her. 

The above stabs are applicable for non-single premium life insurance policies.

For single premium products, the guaranteed surrender value will be 75 per cent of the total premium paid if surrendered within three years and 90 per cent within the last two years of the policy period.

Why the disappointment

The earlier proposal from IRDAI was to increase the surrender value substantially. It was proposed that a threshold premium amount be calculated based on a percentage of premium paid.

As an example, IRDAI presented a scenario involving a non-linked savings insurance policy on the following lines:

For an annual premium of Rs 1 lakh for a 20-year policy, the surrender value after three years may work out to Rs 2.51 lakh. But as per the present guidelines, it will work out to Rs 1.50 lakh only.

While the insurance industry is trying its best to increase the penetration of insurance products in India, the discontinued policies do not augur well for it. 

The year 2022-23 saw a surge in surrenders and withdrawals of life insurance policies. This increased 25.62 per cent to Rs 1.98 lakh-crore, compared to Rs 1.29 lakh-crore in 2021-22. The jump has been attributed to several factors ranging from inflation to issues related to mis-selling of insurance policies.

How to address the problem

First, one must understand that life insurance is a risk mitigation exercise, and life insurance products should be used to reduce or eliminate one’s risk. It is basically for risk management. This need not be treated as a saving or investment instrument.

So, consider only term insurance policies for life insurance. Under term insurance, one can get more coverage with lesser premium. There may not be any maturity value in a term policy and the legal heirs will get an insurance payout only on the death of the policy holder.

Second, before signing for any insurance policies, understand all the terms and conditions including the surrender value and avoid subscribing to unsuitable policies. If any policy has been taken wrongly, one can revoke the same within a 15- or 30-day window provided by insurance companies.

Third, insurance policies provide another way to keep the amount invested without surrendering the policy and without paying further premium till maturity date and to get what is called Paid Up Value. One can consider this option. But here one may not get the insurance coverage as envisaged earlier.

Fourth, insurance companies and banks extend loans based on the surrender value of the policies. One can make use of it to pay the premium and keep the policy alive. This can be used when there is a temporary fund crunch to service the policy.

(The views expressed here are the author's, and do not constitute investment advice.)