Early in the tenure of non-linked policy you don't like? Surrender it

But if you have held it for long, run the numbers; continuing may be prudent

In December 2023, the Insurance Regulatory and Development Authority of India (Irdai) issued 

an exposure draft on the surrender value of non-linked insurance policies. Had those proposals been implemented, they would have made surrendering of life insurance policies less painful for policyholders.
 

The guaranteed surrender value (GSV) rates that apply to non-linked policies from April 1, 2024 (see box) have not changed. “The regulator has maintained the status quo on rates,” says Abhishek Kumar, a Sebi-registered investment advisor (RIA) and founder, SahajMoney.
 

According to Alok Rungta, managing director (MD) and chief executive officer (CEO), Future Generali India Life Insurance Company, “The revised surrender value guidelines issued by Irdai are a reiteration of the regulator’s intent to ensure that customers stay invested in life insurance policies for the long term.”
 

These GSV rates are linked to holding period. “If a policyholder surrenders his policy before it completes three years, the GSV will be lower than if he surrenders it between the fourth and the seventh policy year,” says Naval Goel, CEO, PolicyX.

Insurers’ perspective
 

An insurance company creates long-term liabilities for itself upon selling non-linked, traditional plans (moneyback and endowment). To meet them, it creates long-term assets by investing in long-tenure instruments, usually government securities and equities. When a customer surrenders  the policy, the insurer has to unwind these investments and could have to take losses if interest rates are up or equity markets are not doing well. Insurers argue that making surrendering of policies painless and easy would lead to an asset-liability mismatch for insurers.
 

“With a significant portion of insurance plans invested in long-term assets such as long-term bonds and equities, immediate surrender would necessitate insurers to maintain more liquidity, requiring investment in short-term assets instead. This would ultimately impact the maturity returns of customers,” says Tarun Chugh, MD & CEO, Bajaj Allianz Life.
 

Adds Rungta: “Higher surrender costs in the initial years deter the temptation to withdraw while ensuring that insurance providers are able to service these policies effectively without affecting their bottom line.”
 

Insurers plan to modify their product mix. “A separate set of products is expected to be launched with higher surrender values than the minimum required, which will cater to customers seeking higher liquidity, albeit with slightly lower maturity returns,” says Chugh.

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Customers get a bad deal
 

The policyholder always takes a loss under this GSV regime. “For however long a policy is held, the policyholder never gets the entire premium back, forget about a return on the total premium amount,” says Harsh Roongta, Sebi-registered investment advisor (RIA) and principal officer, Fee Only Investment Advisors. They only get 90 per cent of total premiums back even in the last couple of years of the policy term.
 

Insurers pay a special surrender value, but that is not guaranteed and depends on a host of factors.
 

Financial advisors disagree with insurers’ argument about having to unwind long-term investments. “The asset-liability mismatch argument does not hold since insurers create long-term assets based on their past experience of surrenders. Hence, there is no excess long-term investment that needs to be unwound,” says Roongta.

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Insurers also argue that it takes a lot of effort to sell a policy, due to which they have to pay high upfront commissions to agents. These costs need to be deducted when a policy is surrendered. “Investment products from all other regulators have moved to trail commissions, which in turn prevents mis-selling,” says Roongta.
 

Issue of low persistency
 

Persistency ratio is the percentage of the total number of policies or premium amount that remains in force from inception to various periods. On average, after five years, the number of life insurance policies in force drops to around half.
 

A major reason for low persistency is mis-selling. When customers realise they have been sold an unsuitable policy, they exit. “When an exit happens, whether early or late in the tenure, at no point does the insurer, agent, distributor or bancassurance partner suffer a loss. The only party that ends up paying a heavy price owing to the high surrender charges is the customer,” says Roongta.
 

Enter with caution
 

Avoid mixing insurance and investment. “Any product that pays a commission as high as 35 per cent in the first year to the agent or the distributor cannot be good for the customer,” says Roongta.

Most traditional plans have an internal rate of return (IRR) between 4 and 6 per cent. These are low returns for a 20 to 30-year product.
 

“The only class of customers who may perhaps invest in these plans is the financially non-savvy ones who have so far invested only in real estate and gold. Such customers are often afraid of losing money in the financial markets. For them the safety of insurance products is a big pull,” says Ravi Saraogi, co-founder, Samasthiti Advisors.
 

The rest, who are either financially savvy or have access to good advice, may avoid them.
 

When should you surrender?
 

Policyholders in the early part of the policy tenure, who feel they have made the wrong choice, should exit despite the considerable loss. 
 

“Policyholders must overcome the sunk cost fallacy and surrender these policies sooner rather than later,” says Kumar.
 

Adds Saraogi: “If you have been in the policy for three to five years, take the loss and exit. Once you have crossed the seven- or 10-year mark, get an informed person to calculate the pros and cons. In many cases, it may make sense to continue servicing the policy.”

Guaranteed surrender values under the April 1, 2024 norms

Non-single premiums

Surrendered in 2nd year = 30% of total premiums paid

Surrendered in 3rd year = 35% of total premiums paid

Surrendered in 4th to 7th year = 50% of the total premiums paid

Surrendered before 2 years of maturity = 90% of the total premiums paid

Single premiums (Single pay policies)

Surrendered in the 3rd year = 75% of total premiums paid

Surrendered in the 4th year = 90% of total premiums paid

Surrendered before 2 years of maturity = 90% of the total premiums paid