Life insurance is a long-term contract in which you pay premiums over several years. Of course, some plans give you the option of paying all the premiums upfront, through the single premium mode, but most plans need you to pay regularly: either every year throughout the policy term or for a limited number of years. But what happens if you stop paying the premiums?
In the case of a term plan, which only charges you for the insurance cover, the policy lapses after the grace period. And if you don’t revive the policy, then you simply forfeit all the premiums you had paid.
In the case of policies that also invest a part of your money, when you stop paying the due premiums, these premiums acquire a residual value after some years, called the surrender value. A paid-up policy is one that has acquired a surrender value. But the sum assured in a paid-up policy gets proportionately reduced.
When does a policy become paid-up?
In traditional plans, the policy acquires a surrender value after 2-3 annual premiums have been paid.
For instance, if the premium payment term is at least 10 years, then the policy acquires a surrender value after three annual premiums are paid. So, if you surrender your policy before that, you don’t get anything.
After 3 years, the policy becomes paid-up and the sum assured will reduce proportionately. Keep in mind that when a policy becomes paid-up, the guaranteed additions or even the bonuses in the case of participating plans, may no longer accrue.
In the case of unit-linked insurance plans (Ulips), there is a lock-in period of 5 years. During this time, even as the policy acquires a surrender value, it doesn’t convert into a paid-up policy and after the lock-in is over, the surrender value is paid to you. But if you stop paying premiums after 5 years, you have the option to convert it into a paid-up policy with a reduced paid-up sum assured.
Calculation of paid-up sum assured
For policies where the premium is fixed, the reduced paid-up sum assured payable on death or on maturity is a minimum of the total period for which premiums have already been paid divided by the maximum period for which premiums were originally payable multiplied by the sum assured on death or on maturity. So if premium payment term of a policy is 10 years and premiums have been paid for 5 years, and sum assured is Rs10 lakh, then reduced sum assured will be Rs5 lakh. However, if the reduced sum assured or the fund value in case of a Ulip is not sufficient, then the insurer can terminate the policy and pay the surrender value.