Understanding Surrender Value in Insurance

Understanding Surrender Value in Insurance

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Have you bought a life insurance policy which is not as per your requirement? Are you planning to terminate the policy as it does not have features promised to you? You can surrender the policy to the insurance company, but are you aware about the surrender value attached to this premature policy termination?

But before we answer these questions, let us understand what surrender value is all about.

Surrender Value

If a policyholder decides to terminate the policy before maturity, the amount which the insurance company will pay to the policyholder is known as surrender value.

If the policyholder does a mid-term surrender, he would get a sum of what has been allocated towards savings and earnings on them. A surrender charge would be deducted from this amount and this varies from policy to policy. If the policyholder terminates the cover after five years, then as per the recent IRDAI directive, life insurance companies can’t levy any surrender charges. The policy holder will then get the fund value of his investment only.

Types of Surrender Value

There are two types of surrender value: guaranteed surrender value and special surrender value.

Guaranteed surrender value is mentioned in the brochure and is payable after the completion of 3 years. It is 30% of the premiums paid, excluding premium for the first year. It also excludes any additional premium paid for riders and any bonus that you may have received from the insurer.

Special surrender value = (Original sum assured * (No. of premiums paid/No. of premiums payable) + total bonus received) * surrender value factor

When one stops paying premiums after a certain period, the policy continues but with 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 a sum assured of Rs 6 lakhs and policy term being 20 years. Now, you stop paying after 4 years, the bonus accumulated so far is Rs. 60,000 and surrender value factor in 4th year is 30%:

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

More the number of premiums paid, more is the surrender value.

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

Not All Policies Will Acquire Surrender Value

A policy acquires surrender value only when premiums for full three years have been paid to the insurance company. Also, not all policies will acquire surrender value. Only policies such as ULIPs or endowment policies that have a savings component embedded will partially return the amount invested for life cover. Pure term plans with no savings element will lapse and all the benefits associated with them will cease to exist.

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: That Is The Question

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.