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Surrender Value in Insurance

Life insurance is a long term financial benefit, and there are some unfortunate events when you might need to surrender your plan. This simply means terminating the plan before its maturity. So, in case you surrender a plan in mid of the policy term, you would receive a surrender value that has been allocated towards earnings and savings. The surrender charge that gets deducted from this amount varies from plan to plan.

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Let’s see what the surrender value in insurance is before learning about the different types of surrender values in life insurance.

What is Surrender Value in Insurance?

Surrender value in insurance is the amount the insurance company pays to the policyholder when he/she decides to terminate the plan before maturity. If the policyholder decides on a mid-tenure surrender, then the sum distributed towards earnings and savings would be given to the policyholder. A surrender price is deducted, depending on the plan. 

Usually, the insurer pays the surrender value only if the policy has completed a certain number of years, which can be 3 to 5 years, depending on the policy T&Cs.

So suppose you purchased a 1 Crore term insurance 5 years ago, but due to some financial reasons, you are unable to pay the premiums for the policy. In such cases, you can inform the insurer that you wish to surrender the policy. After surrendering the plan, you will receive the surrender value minus the surrender charge levied by the insurer, and all the policy benefits will cease.

This surrender charge amount differs from policy to policy, but as per the IRDAI mandate, the life insurance companies in India cannot levy surrender charges if the policyholder surrenders the insurance after five years.

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What are the Types of Surrender Values?

There are two types of surrender value in life insurance:

  1. Guaranteed Surrender Value 

    This amount is usually mentioned in the brochure and is payable after the completion of 3 years. It is the sum of the total premiums paid, excluding premiums for the first year. It also does not include any additional premium paid for riders and any bonuses you may have been eligible to receive at maturity. The Guaranteed Surrender Value is the product of the total premiums paid and the surrender value factor ( % of total premiums paid).

  2. Special Surrender Value:

    Special surrender value depends on the total sum assured, total premiums paid, policy term, and applicable bonuses. 

    To understand the special surrender value of life insurance, we need to understand the paid-up policy in life insurance. If suppose a person purchased life insurance and was unable to pay the premiums, the policy itself converts into a paid-up policy with the sum assured reduced according to the total premiums paid. On surrendering a paid-up life insurance, the policyholder will receive the special surrender value, which can be estimated by adding the paid-up value to the surrender value factor.

    Special surrender value = (Initial base sum assured * (Number of premiums paid/Number of premiums payable) + total bonus received) * surrender value factor

    When one stops paying premiums after a certain period, the policy continues but with a lower sum assured. This sum assured is called the paid up value.

    Paid up value = original sum assured * (No. of premiums paid/No. of premiums payable)

    Let us calculate special surrender value by taking an example:

    Suppose you pay Rs. 30,000 premium annually for life insurance of a sum assured of Rs 6 lakhs, and the policy term is 20 years. Now, if you stop paying premiums after 4 years, the bonus accumulated so far will be Rs. 60,000, and since the surrender value factor in the 4th year is 30%:

    The special surrender value = (30/100) *(6,00,000*(4/20) + 60,000) = Rs. 54,000 

    The more the number of premiums paid, the more will be the surrender value.

    The surrender value factor is a percentage of the paid-up value plus the bonus. For the first three years, this factor is zero and keeps increasing from the third year onwards. It varies from company to company and depends on factors such as the type of policy, time to maturity of the policy, completed years of the policy, industry practices, and fund performance in particular policies. Not all companies mention surrender value factors in their brochures.

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Do all Life Insurance Policies Offer Surrender Value?

Before surrendering a life insurance policy, you should always go through the list of the policy’s T&Cs to ensure you understand all the aspects of the surrender value. This way, you would know how much the minimum period for which the premiums need to be duly paid before you can surrender the policy. For example, in most life insurance plans, the policy acquires surrender value only when premiums for 3consecutive years have been paid to the insurance company. This means you would be eligible to receive the surrender value only if you surrender the insurance after three policy years. 

Also, it is important to note that not all policies acquire a surrender value. Only policies such as endowment or ULIP policies with a savings component within the plan will partially return the amount invested for life cover. Regular term insurance plans do not have a savings element and thus may terminate on surrender, with no surrender value payable to the assured.

Using Surrender Value Effectively

Loans against life insurance policies can be availed to the extent of 80%-90 % of the surrender value. Hence, surrender value of your policy is used to calculate the loan amount you would be eligible for. You also have the option to pledge the policy to bank and borrow against it. However, borrowing in the initial years of the policy is not suggested as a you would acquire low surrender value.

To Surrender Or Not To Surrender: Which is a good option?

By surrendering a policy, the customer loses out on all the benefits of the scheme and receives a much lower amount than the premiums he has already paid. In ULIPs particularly, the insurer loses a large amount of premium paid in the initial years, most of which goes towards agent’s commission and other charges, and only the remaining amount is directed to the fund. Hence, surrendering an endowment policy is advisable when the received money can be invested in another product, generating higher returns than the original policy till completion of its tenure.

Final Thoughts

The surrender value in insurance allows policyholders to exit or cancel the plan if they no longer feel the need to be covered under a life insurance policy. However, once you surrender life insurance, you will no longer be covered under the policy’s benefits, which means, if the policyholder, unfortunately, passes away after the insurance surrender, the nominee will receive no benefit amount. Thus, you should go through the policy documents and weigh your decisions carefully before surrendering a life insurance plan.

FAQ's

  • What is surrender value examples?

    Ans: The surrender value example is, suppose you purchased a life insurance policy for 1 crore life cover, and after 3 years of consistently paying the premiums, you decide to surrender the policy. If the total premiums paid during these 3 years were 25,000, the insurer will payout the entire total premiums paid of Rs. 25,000, excluding the surrender value charges levied by the insurer.
  • What is the formula for surrender value?

    Ans: The formula of surrender value is the total premiums paid minus the surrender charges levied by the insurer.
  • What is the surrender value after 5 years?

    Ans: As per the IRDAI directive, insurers cant levy surrender value charges if the life insurance policy is surrendered after 5 years.
  • Who pays surrender value?

    Ans: The insurer pays the surrender value to the life assured if the policyholder cancels the plans before the maturity date of the policy.
  • Is surrender value tax free?

    Ans: No, surrender value is not tax-free as the proceeds received from the life insurance come under the ‘income received from other sources,’ and thus are not applicable for tax benefits.
  • How do I avoid surrender charges?

    Ans: As per the IRDAI, the surrender value charges are not applicable on life insurance policies whose premiums have been duly paid for 5 consecutive years. Therefore, you can avoid surrender charges by surrendering a policy after 5 years of its issuance.

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