Financial planners advise that one should carefully assess one’s need for insurance and the features of a policy before signing on the dotted line. A insurance plan bought in a hurry to save tax or sold by some insurance agent or a bank executive persuaded are common situations. What should you do if you have already bought an insurance policy? What are the exit options? Those who are wondering whether they should discontinue their traditional life insurance policies have the following options.
- Let the Policy Lapse
- Surrender the Policy
- Make the Policy Paid up
- Take loan against the policy
In this article we shall discuss these options in detail.
If you stop paying your insurance premium it discontinues the policy, which in insurance terminology is called the policy lapse.
- One loses protection cover.
- In case of endowment, money-back policies, if you have paid the premium for the policy for less than three years and decide to discontinue it, you will receive no benefit for the money you have paid as premiums. In case of term plan you will not get any premium back at any time. The insurance company will retain all the premiums paid. You don’t get anything back and all your premiums paid go waste.
If due to ignorance or money crunch if policy gets lapsed one can revive it, called as Policy Revivals: The lapsed policy may be revived from the date of the first unpaid premium by making payment of the premiums in arrears along with interest on such terms and conditions as fixed by the Company. Revival is a fresh contract wherein the insurer can impose fresh terms and conditions. It varies from policy to policy, insurer to insurer Details for revival of LIC policy from LIC’s webpage guidelines for policy holders.
Letting the policy lapse might be the preferred option if you had bought the traditional insurance policy(endowment, money-back) just 1-2 years ago. You will have to forego the premium paid in the first couple of years, but it is better than continuing with it and compounding the error.
2. Surrendering the policy
Surrendering the policy means exiting from the policy before the maturity. It is the voluntary termination of the insurance contract by the policyholder before the maturity or premature encashment of the life insurance policy. On surrendering a policy:
- The life cover or protection ends.
- The tax benefit, if availed of on the premium paid till then,may be reversed if surrendered before premium has been paid for two years and 5 years for ULIP products after the date of commencement of policy.
- On surrendering before the maturity date the cash value that you receive is called the surrender value of a policy.
- Policies usually acquire a surrender value after premiums have been paid for three years.
- If any extra premium is paid towards Accident benefit etc, it is usually excluded.
- The surrender value is calculated by the insurance company depending upon the time for which the policy was in effect (the age of the policy), the total duration of the policy, the premiums paid and any bonus accrued.
- If the policy is in its initial stages (3-4 years old) the surrender value is only about 30% of the premiums paid plus any bonuses that may have accrued till then. The closer you are to the maturity date of your policy, the higher is the amount you get when you exit. Towards the end of its term, this can be as high as 80% of the premium. Even after three years, during the early stages of policy the surrender value is just a fraction of the total premiums paid.
The top three reasons for traditional policy surrender are: low bonus or benefits, wanting to get proper insurance through term life and better investment options. Our article Surrendering Life Insurance Policy covers Surrendering a Policy, Tax implications , calculating surrender value, how to surrender.
3. Turn it into a paid-up plan
When you make a policy paid up,
- You don’t have to pay any more premiums,but the policy is not cancelled.
- Instead the policy continues till maturity with a reduced Sum Assured. This means that you would be halting future contributions to the policy, but still let it run to maturity. The reduced sum assured is called the Paid up value of the policy.
- Paid up value is calculated as a proportion of premiums paid versus the premiums actually needed to be paid.
- If you have bought insurance policy with additional benefits such as future bonuses and dividends, these would be lost in such a policy. However, you would retain any bonuses paid out before you made the policy “paid-up” and would be paid on maturity( end of the policy term) or on death, whichever is earlier
- Riders such as Accident benefit and critical illness riders do not acquire any paid-up value.
- Many traditional products offer final additional bonus (FAB) as an incentive to stay with the policy. The FAB,if associated with your policy, given at the end of the policy term will not be given for paid-up policies.
Paid Up Value
Paid-up value is calculated by multiplying the original sum assured and the ratio of the number of premiums paid to the number of premiums payable.
Paid Up Value = Original sum assured * (Number of premiums paid / Total number of premiums that were required to be paid)
Total Paid Value = Paid Up Value + bonus.
For example Mr Mehta pays Rs 25,000 annual premium on a quarterly basis, and the sum assured is Rs 5 lakh for a policy term of 20 years. If he stops paying after four years,then
- As he pays quarterly premium Premium paid = 4* 4 = 16
- Value of premium paid = 25,000 * 4 = 1,00,000
- Total number of premiums he had to pay = 20* 4 = 80
- The paid-up value will be = Rs 5,00,000 X (16/80) =1,00,000
For example, a policyholder of age 25 years holding LIC endowment policy with a policy term of 10 years pays a premium of Rs 1,03,032 for Sum Assured(SA) of Rs 10 lakh. If the policyholder converts the policy to paid-up after paying five premiums, (Ref: MoneyLife)
- He would have paid Rs 5,15,160. (1,03,032 * 5)
- The paid-up value will be half the Sum Assured (SA), which is Rs 5 lakh.
- The paid-up value along with bonus declared till converting the policy to paid-up will be paid on death or end of policy term. The total bonus based on current bonus rate (of Rs34 per thousand of SA) is Rs 1,70,000. Please Note The bonus amount will depend on the actual declared rate , this is just an example
- The total paid on death or after completing the policy term of 10 years is Rs 6,70,000.
- The return on premium at the end of 10 years is 3.33%. If you had continued premium payment till the end of policy term, the return on premium would have been 4.73%.
Loan against the policy
Most of the traditional life insurance policies , especially endowment plans, have a loan feature which can also be used. An individual can avail of loans on all traditional policies, except moneyback plans, if he has paid premiums for at least three years.Private insurers may charge a higher rate of interest on the loan than LIC. Kotak Life is charging between 12%-12.5%pa.
- Interest rates: The interest rates vary from company to company.Insurers have their own criteria to arrive at the rate. Banks link it to their base rates. Banks, unlike insurers, do not charge a fixed rate-it depends on criteria such as the premium paid by the insured, the number of premiums paid. Interest rates of some of the insurers are From Business Today Loans on Life ( Jan 2012)
Name of Insurer Interest rate LIC 9% Bharti Axa 11% Kotak Life 12.5% Birla SunLife 13.5% ICICI Prudential 14.5%
- Loan Amount : The amount of loan and way the loan amount is calculated is different for Ulips and traditional policies. It also varies from company to company.
- In traditional plans, you get the higher of the guaranteed surrender value or surrender value, also called the special surrender value. The guaranteed surrender value, which is the minimum amount available as loan, is 30% of the total premium paid minus the first premium amount.
- Thus, if you have paid Rs 25,000 as premium for four years and take the loan in the fifth year, the total you have paid is Rs 1 lakh. So, the minimum loan you can get is 30% of 1,00,000 that is, Rs 30,000.
- Unit-linked plans (Ulips): Not many insurance companies offer loans against Ulips. The loan amount depends on the current value of the corpus. If a Ulip has invested more than 60% assets into equity, you can get up to 40% of the corpus. If debt accounts for more than 60% assets, the maximum loan amount is 50% of the corpus.
- It also varies from company to company. For example:
- LIC : The maximum loan amount available under the policy is 90% of the Surrender Value of the policy (85% in case of paid up policies) including cash value of bonus. Details here.
- For Bharti Axa The maximum amount of loan will not exceed 70% of the acquired Surrender Value. The loans given under the Policy are as per the Policy provisions. Details here.
- Repayment : The tenure and repayment options differ from insurer to insurer. The loan can be for the remaining policy term. The insurer provides a repayment schedule. Most provide provision of pre-payment also.
- Life Insurance Corporation’s loans have tenures of at least six months. If you wish to repay before six months, you have to pay interest for the full six months. In case of death of the policyholder or maturity of the policy, the interest will be charged only up to the date of death or maturity.
- In case of some traditional policies, if the insured fails to pay the premium, the policy will lapse.
- How to proceed
- The first step is to ask the insurance company or the bank the amount you are eligible for.
- The next is applying for the loan and assigning the policy to the insurer/bank. This means all rights on the policy will be transferred to the lender.
- The loan is usually sanctioned in two-three days. But this may vary from company to company.
Difference between Surrendering and Making Policy Paid up
|Surrender a Policy||Make a Policy Paid Up|
|Stop paying premiums immediately?||Yes||Yes|
|Get money immediately?||Yes -Fraction of premiums paid||No|
|Insurance cover continues?||No||Yes – for reduced amount|
|Get money at the end of the tenure?||No||Yes – the paid value|
How to check the ‘Surrender Value’ and ‘Loan Eligibility’ , Paid Up Value of your policy?
Contact your insurer/agent to find the Surrender Value, Loan Eligibility of your value.
- Visit LIC and register as a new user or Click on Lic New User Registration (it’s free. Help on LIC’s Registration can be found on LIC webpage Registration)
- Login to your account and click “Enrol Policies” in the left menu.
- Click “Click to Enrol New policies” and click “Proceed”.
- Enter your policy number, premium and name of the insured and “Enrol your policy”.
- Once enrolled, click “View Enrolled policies”.
- From your policies list click “Click for details” under “Loan and Bonus” column.
- The surrender value and loan eligibility can be found there.
- I followed the steps, created the account and enrolled my policies but I was not able to get the Surrender Value/Loan Detail.
- From eHow How to Calculate the Surrender Value of LIC some references I found are: Sriraj Digital Magazine: LIC Policy Surrender Value Details, Blogsolute: Check LIC Policy Details Status and Pay Premium Online.
- InsureMagic gave me the details but I had to create a Free account on it.
- IIT(M) Prof,Pattabiraman M who runs Free Personal Finance Calculators, has written an excel Insurance Policy Surrender Value & Paid-up Value Calculator. Try it to get an idea of surrender value
- If you know the resource we would be obliged if you can share with our readers.
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- Surrendering Life Insurance Policy
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In this article we covered the exit options that one has after buying a life-insurance policy. More on Surrendering the policy, and choosing the exit option soon. If you have information on surrendering /paid up/loan eligibility please share with us. Have you considered or used any exit options? If yes why?