If you wish to discontinue your life insurance policy for any reason, you can do so, but at a cost.
In case of a term life insurance policy, if you stop paying the periodic premium, the policy automatically lapses, i.e., the risk cover ceases but there is no other additional downside or cost.
However, the situation is different in the case of an investment-cum-insurance policy, i.e., a traditional life insurance policy.
The returns in a traditional life insurance policy, such as an endowment or a money-back policy, are generally in the 4-6 per cent range, if continued till its maturity.
Since life insurance policy is a long-term contract, if you discontinue it earlier, then the original maturity sum gets reduced by the insurance company, thus bringing down the in-hand return even more.
Potential buyers should, therefore, understand the objective and working of a traditional life insurance policy well so that it runs its full course.
So if you have traditional life insurance policy and want to discontinue it, there are two broad options: First, convert it into a paid-up policy without exiting, and second, surrender and ask the insurer for the surrender amount by completely exiting the policy.
The first condition
There is, however, a condition in the above 2 options, i.e., the policy should have acquired a surrender value.
Typically, one should have paid at least three years’ premium to the insurer and thereafter can opt for either one of the 2 above mentioned options for policies with a term of 10 years or more. For policies with a lesser term, at least two years’ premium payment is mandatory.
Nowadays, there are several policies where the premium paying term (PPT) is lesser than the policy’s actual term.
If the PPT is less than 10 years (even if the actual policy term is 25, 30 years), the policy will acquire a surrender value if the premium has been paid for at least two years. For single premium policies, the surrender value gets acquired after the first year itself.
In case you haven’t paid even 2 or 3 years’ premium (as per the case above) and want to discontinue, the insurer will not pay you back anything and will not convert it into a paid-up policy either. The money is all but lost.
So if you have already paid 3 years’ premium, not paying any future premiums will convert the policy into a paid-up policy.
You won’t get any money back in the year you turn it into a paid-up policy but will have to wait till the policy’s original maturity.
Although the bonuses already attached to the policy will continue, the sum assured will reduce and will be called paid-up sum assured.
The life cover will be equal to the paid-up sum assured. Let’s say, one has paid for 5 years, while the original term of a Rs 3-lakh policy is 20 years.
Paid-up Sum Assured = Sum Assured X (Total number of premiums paid/Total number of premiums payable). So paid-up sum assured value after having paid 5 years premium becomes Rs 75,000. (3 lakh *(5 years/20 years)
The policy will not be eligible for any future bonuses as the insurer is not receiving any fresh premium.
On maturity, the amount, along with the bonus (or guaranteed additions) already added to the policy, will be paid to the policyholder or the nominee.
If the policyholder dies (before the policy matures), then the higher of the paid-up sum assured or 105 per cent of the premium is paid to the nominees.
Take, for example, an endowment plan for a sum assured of Rs 10 lakh for a term of 20 years, which has an annual premium of Rs 47,000.
Assuming an average bonus of Rs 42 per Rs 1,000 of sum assured over the term of the plan, the maturity value at the end of the term will be approximately Rs 18.5 lakh, which yields an internal rate of return (IRR) of 5.97 per cent.
Now, say the policyholder wishes to make it a paid-up policy after paying premiums for six years.
The sum available to the policyholder at the end of six years is Rs 5.52 lakh, including the paid-up sum assured (Rs 3 lakh) and the bonus (Rs 2.52 lakh) , assuming Rs 42 of bonus rate.
However, this amount can be had only after another 14 years as the original term is 20 years. The IRR comes to about 3.82 per cent, a return lower than even a savings bank interest rate.
The return could vary, depending on the number of years one has paid the premium for.
If one doesn’t want to make it a paid-up policy and exit altogether, then the policy can be surrendered.
Surrendering the policy
Once you intimate the insurer that you want to surrender the policy, the insurer will calculate the surrender value amount that will be paid to you.
You will not get an amount equal to what you paid as premiums plus some interest (bonus) on it.
The surrender value amount will be based on a surrender value factor and will always be less than what you have already paid as total premiums.
The surrender value for the initial seven years is fixed by the Insurance Regulatory and Development Authority of India (IRDAI).
From the seventh year, it is at the discretion of the insurer, but only after getting it cleared from the regulator.
In the third policy year, it is 30 per cent of the premium paid, between the fourth and the seventh year, it is 50 per cent of the premium paid.
Typically, the closer you are to the maturity date of your policy, the higher will be the amount you will get when you exit.
For the actual surrender amount, one needs to contact the insurer and get the values from them as calculations could vary.
In the example above, in case one surrenders after the sixth year, a surrender value of, say, Rs 65,000 is received immediately, which, along with future premiums of Rs 47,000, can be diverted towards debt products such as Public Provident Fund (PPF) or debt funds, the maturity value could be around Rs 12.5 lakh (assuming 8 per cent growth for next 14 years).
Before you stop or exit
But even before you consider making the policy paid-up or surrender it, ensure that you have adequate life cover. Get one through pure term insurance plan for at least 10 times of your annual income.
In your absence, it works as an income replacement tool for your financial dependents. Keep reviewing the life coverage and adjust for any long-term financial goals such as home loan, kid’s education or marriage.
A Rs 10-lakh life cover can be bought at around Rs 3,000 annually for 20 years, or Rs 2,500 for 14 years.
Having taken a life cover, one may either start investing in a debt product such as PPF, which too helps in accumulating tax-free corpus as life insurance, or even consider investing through balanced or debt mutual funds for the long-term.
Those who are more comfortable in handling their investments may invest through diversified equity mutual funds too.
It is important to have adequate life cover and a reasonably high inflation-adjusted return on your savings to create a sizeable corpus over the long-term.
Keeping them separate helps to not only keep the costs lower but also provide adequate coverage and flexibility.