Not a good idea: Surrendering insurance policy early entails higher loss

To avoid losing protection cover, explore the option of taking a loan against it

Loss of income since the start of Covid-induced lockdowns has forced people to resort to a variety of desperate measures. Media reports suggest policyholders have been surrendering their life insurance policies, either to avoid paying premiums or to raise much-needed liquidity.

When you terminate a policy before maturity, the amount that the insurer pays you is the surrender value. Policyholders who need money should explore alternatives, so that they do not have to lose out on the protection provided by a life insurance policy. And if they must surrender, they should understand the rules carefully, so that they are able to minimise their losses.

Not all policies offer a surrender value. Says Naval Goel, chief executive officer, PolicyX.com: “Only traditional plans and unit-linked insurance plans (Ulips) offer it. Term plans, which are pure risk covers, do not.” Hence, you can only expect some money from traditional plans like endowment and moneyback, and from Ulips.

Insurers deduct a portion of the premiums paid before they return the balance. These charges vary from one product to another. Due to these deductions, the surrender value is generally lower than the sum total of premiums paid. The gap tends to be wider during the initial years and reduces closer to the policy’s maturity.

In Ulips, a policyholder gets the surrender value only after the completion of five years from the policy’s start. The surrender value is equal to the fund value on the date of surrender.

 

 

Traditional policies acquire a guaranteed surrender value (GSV) after the policyholder has paid the full premium for the first two years. Explaining GSV, Kayzad Hiramanek, chief-operations and customer experience, Bajaj Allianz Life Insurance, says: “It means that a certain amount of the capital invested is paid back to you.”

According to the new rules effective from February 1, a traditional policy will acquire a GSV after the second year. After two years, the policyholder gets 30 per cent of the total premium paid, less survival benefits paid. After three years, he gets 35 per cent, and between the fourth and seventh year, he gets 50 per cent (less survival benefits).

“Single-premium policies acquire a surrender value immediately after the payment of the single premium,” says Pankaj Mathpal, founder and managing director, Optima Money Managers.

Traditional policies also offer a special surrender value if the policy is surrendered closer to maturity date. This amount depends on the value of investments, sum assured, bonuses, policy term, and premiums paid. As for bonuses, Hiramanek says: “In most products, bonuses tend to be back-ended.” Hence, it is better to avoid surrendering.

Also explore taking a loan against your policy. Normally, liquidating an investment is better than taking a loan. But these are uncertain times. Says Hiramanek: “It is not a good idea to lose your protection cover. If you pledge your policy for a loan, your cover will stay intact.” Lenders are willing to offer 80-90 per cent of the policy’s surrender value as loan.