When does it make sense to surrender life insurance policy?3 min read . Updated: 05 Aug 2020, 10:22 AM IST
- While liquidating investments to bridge the gap in cash flows work better than taking up new loans, surrendering your life insurance policies may not always make sense.
Given the layoffs and pay cuts across industries due to the covid-19 pandemic, life insurance companies are witnessing some surrender pressure (Read here). Surrendering means to stop your life insurance policy before its time of maturity, and insurers said Ulips, in particular, are seeing significant surrenders.
According to a report by Motilal Oswal Institutional Equities, due to the lockdown during April and May and choppy markets, persistency trends were weak across cohorts as policyholders used the grace period to renew policies. “Among the segments, the decline was seen in persistency in Ulips, while improving trends were observed in protection," stated the report.
While liquidating investments to bridge the gap in cash flows work better than taking up new loans, surrendering your life insurance policies may not always make sense. We tell you when you should consider this option.
Understand that surrendering your policy after the free-look period—usually 15 days after you’ve received the policy documents—could mean bearing some costs. In the case of Ulips, you can stop paying the premium and collect the surrender value after five years from the start of the policy. In the case of traditional products such as endowment and money-back policy, you can exit after three years of paying the premium. There is no lock-in, so you can exit at any given point but surrender charges could be huge in the initial years," said Melvin Joseph, founder, Finvin Financial Planners.
Note that if you stop paying the premium before the end of the policy term, you are eligible for the surrender value, which further depends on total premium paid, number of years completed and any accrued bonus amount.
“There are typically two options. One is guaranteed surrender value and the other is non-guaranteed. Guaranteed surrender value is fixed percentage of your premium, which is about 30% of all premiums paid minus the first year premium," said Indraneel Chatterjee, principal officer and co-founder, RenewBuy, an online insurance aggregator.
If the premium paying term (PPT) of a policy is 10 years or more, it will acquire a guaranteed surrender value if all premiums have been paid for at least three consecutive years. However, in case the PPT is less than 10 years, the policy shall acquire a guaranteed surrender value if the premium is paid for at least two consecutive years.
"The guaranteed surrender value of a traditional policy would be 30% of the total premiums paid if surrendered between the second year and the third year of the policy," said Chatterjee. Similarly, the guaranteed surrender value would be 50% of the total premiums paid, if surrendered between the fourth year and the seventh year of the policy. This will go up to 90% of the total premiums paid if surrendered during the last two years of the policy if the term of the policy is less than seven years.
The non-guaranteed surrender value is the current market value of the assets held against the policy. “This value depends on various factors such as the sum assured, bonus, policy term and the number of premiums paid. Most insurers pay the minimum guaranteed surrender value, especially if the surrender happens early during the policy term. However, as you move towards maturity, you get the non-guaranteed surrender value," added Chatterjee.
Traditional plans are front-loaded because a good percentage of the first few premiums are used as administrative costs and other expenses. Therefore, most of the traditional plans don’t carry much surrender value, which means you could book losses in case you stop paying the premiums.
However, this may not always be a bad deal.
Joseph said it is better to cut losses in some cases to avoid further damage due to the time value of money. “You cannot expect more than a 4% return on your investment in such policies in the long term. If you have such a policy and if it is maturing in the next 10 years, continue to pay the premium. Otherwise, surrender the policy and invest the future premiums in products such as public provident fund and mutual funds for better returns," he added.
But if you are facing a liquidity crunch and want to liquidate assets from your basket of investments, picking bundled plans first for redemption should be the strategy you follow. However, remember that the drawback is you will have to let go of the insurance cover, however, little it may be. In the case of term plans where you are not paying a huge sum as the premium is only for insurance and the product doesn't invest your money, you shouldn't consider surrendering it at all, especially if you have financial dependents.