In September 2010, unit-linked insurance plans (Ulips) underwent customer-friendly reforms. The Insurance Regulatory and Development Authority (Irda) not only capped the overall costs in the product but also reduced the surrender penalty or exit load to a bare minimum.
Until 2010, the insurer could charge the full 100% of the premium that you paid as penalty, but that changed after September 2010. The surrender charge was capped to Rs.6,000 in the first year coming down to Rs.2,000 in the fourth year and nil thereafter.
Considering that older Ulips had a three-year lock-in, by September 2013, the last batch of the older generation of Ulips would have completed three years. The industry fears that as Ulips finish the mandatory lock-in period, a lot of customers would rush to surrender. If you are one of them, you need to look at the cost of surrendering your policy before you take that decision.
Cost of surrender
Your pre-2010 Ulip comes with a heavy exit penalty in the initial years. This on an already front-loaded product means you get very little back. In other words, surrendering your policy in the early days means you pay upfront in the policy before the policy is able to efficiently invest your money and you pay a surrender charge on top of it.
“Older Ulips were heavily front-loaded. So to pay all the costs upfront and then pay a surrender penalty on top doesn’t make sense. Even in the older Ulips, the recurring costs tend to come down after the third year. So it makes sense to stay on,” says Suresh Agarwal, executive vice-president and head (distribution and strategic initiatives), Kotak Mahindra Old Mutual Life Insurance Ltd.
Let’s understand how surrender penalty would eat into your returns. Suppose a 30-year-old buys a Ulip for a sum assured of Rs.10 lakh and pays an annual premium of Rs.1 lakh. Considering a policy allocation charge of 25% of the premium in the first two years coming down to 2% from the fourth year, the fund value after paying for other charges, such as the fund management charge, mortality cost and policy administration cost, will only amount to Rs.2.55 lakh at the end of the third year. This is assuming a growth of 10% per annum. Here, if the policyholder decides to surrender the policy at a surrender penalty of 8% of the fund value, he would get back only Rs.2.35 lakh.
Will unbundling the Ulip work?
If you decide to surrender, the most preferred option would be to unbundle your Ulip—buy a term plan and invest the balance in a mutual fund.
To start with, buying a term plan in India is difficult for non-resident Indians (NRIs). “Insurers don’t offer online term policies to NRIs. Also some insurers may refuse to offer a term plan to NRIs altogether and for those who do will insist on a medical test in India. Most insurers would also put a cap on the amount of sum assured,” says Kapil Mehta, founder, Securenow.in, an insurance broker.
Suppose you do get a term plan and invest the balance every year in an MF growing at 10% at an expense ratio of 2%, you would get only Rs.43.26 lakh at the end of 20 years. If, on the other hand, you continue with the Ulip, you would get around Rs.3 lakh more (see table).
When should you surrender?
Even as surrendering a Ulip in the initial years may not make sense if you look at the costs, you need to go beyond numbers and look at the performance of your fund. It is better to cut your losses in case your fund is underperforming consistently.
“In a lot of cases that come to us we see that the fund value has been consistently underperforming. If that’s the case then it makes sense to surrender the policy,” says Mehta. Take the help of a financial planner if you are not able to understand the charges or the performance of the funds before taking any decision.