A few days ago, a friend of mine called frantically. “My investments in insurance are falling short of my retirement goal” he complained. He asked, “Should I give it back and reinvest into equities”.
What’s the answer?
First of all, let’s understand the concept of Surrender Value (SV). It’s the money you get from the insurer on giving back the life insurance policy before the due date. Usually a SV factor is calculated to discount your investment portfolio. The earlier you surrender, lesser is the SV factor and vice versa.
What’s your policy?
The policy acquires a surrender value, only for those with a built-in savings component. This is the case for traditional life insurance policies – endowment, money-back or pension plans - or a unit-linked insurance plan (ULIPs). Pure term covers, health or car insurance don’t fall in the list.
My friend owned a 20-yr endowment plan.
How long have you been paying premiums?
As per IRDA rules, you can return your policy within 15 days of buying it without a penalty.
For traditional policies with a maturity of 10 years or more, surrendering is possible only from the fourth year (after paying initial three premiums).
In case of ULIPs, there is a lock-in period of five years after which policyholders can surrender and get its investment at current market value. However, if one wants to withdraw earlier, there are flat discontinuance charges. And on the day of discontinuing, the fund (at NAV value) is transferred to a discontinuance fund, where it earns a flat 3.5% p.a. till five years.
My friend had been paying premiums regularly on his traditional policy for the last seven years, which made him eligible for surrendering the policy.
My friend essentially had to choose from the following two options:
1. Continue with insurance premium payments till maturity (another 13 years)
2. Surrender the policy and reinvest it into equities
Nitty-Gritties – the SV factor
Surrender value varies with policies as well as across insurers. For my friend’s policy, this was the case.
In case of premiums, surrender value was 0% in the first two years, 30% for the third year, 50% for 4-7 years. Thereafter, it kept increasing smoothly to 90% for the 19th year.
In case of bonus and others (returns that is), SV factor gradually increased from 8% in the second year to 87% in the 19th year.
Since he was planning to surrender after seven years, SV applicable was 50% for premiums paid and 16% for bonus and accrued additions.
I calculated the pay-off table to get a clear picture.
However, if he surrenders it now, he will not even recover his capital. Surrender value for him works out to Rs 1.9 lakh. If he redeploys the surrender value, though, into equities and continues to invest Rs 50,000 into equity funds every year, he will be better off.