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Should you surrender your life insurance endowment policy

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Life Insurance article in Advisorkhoj - Should you surrender your life insurance endowment policy
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There are times when you think whether you should surrender your endowment or money back life insurance policies. You may want to surrender your policy for a number of reasons. You may have bought the wrong insurance. You may have realized that there are better tax-saving options. Maybe, you are unable to pay premiums due to some financial distress. Whatever the reason for discontinuing your endowment policy, there are several options available to you.

You can let the policy lapse

If you discontinue paying premiums, your policy will either lapse or become paid up. We will explain what paid up policy means later, but please note that if your policy will not acquire paid up value, unless it has continuously be in force for a period of at least three years. What this means is, if you fail to pay the premium even within the grace period your policy will lapse. You will lose your life insurance cover and you will not be entitled to any benefits. If your policy lapsed due to financial distress, you can revive it again, if you want, by paying premiums in arrears along with interest.

You can surrender the policy

You can exit the policy before the maturity by surrendering the policy. When you surrender your policy the insurance company gives you some money in return. This is known as the surrender value. Surrender value is applicable only after you have three full years premium. Three factors determine surrender value.

  • Number of premiums paid as a percentage of total number of premiums payable over the term of the policy

  • Sum assured (or cover) of the policy

  • A multiplier factor known as surrender value factor

Surrender value calculation may differ from insurer to insurer. Life Insurance Corporation of India (LIC) calculates 2 surrender values.

  • Guaranteed Surrender value: 30% of all premiums paid excluding first year premium. This is the minimum surrender value, provided your policy has been in force for three years.

  • Special Surrender value: Paid up value discounted by surrender value factor. Special surrender value is calculated using the following formula:-

Surrender Value = [{(Number of premiums paid / Number of premiums payable) X Sum Assured} + Accumulated Bonus] X Surrender Value Factor.

The surrender value of your policy will be the greater of the Guaranteed Surrender Value and the Special Surrender Value. Please note that, not all life insurance companies disclose the surrender value factor in the policy bond, product brochure or even in the company website. You have to obtain the information from your insurance advisor or directly from the company.

Example of Surrender Value calculation

Let us assume you bought LIC Jeevan Anand policy. The sum assured of the policy is 5 lacs. The annual premium is 28,700. You have paid premium for 5 years and now want to surrender the policy. LIC declared annual bonus rate of 48 per 1,000 of sum assured since the policy has been in force. Applicable surrender value factor is around 30% as per LIC tables.

Guaranteed Surrender value = 28,700 X 4 X 30% = 34,440

Special Surrender Value = [{(5/20) X 500000} + {48 X (500000/1000) X 4}] X 30% = 66,432

Since the special surrender value is larger in amount than the guaranteed surrender value, you will receive this amount ( 66,432), if you surrender the policy after paying premium for 5 years.

Please note that you have paid total premium of 1.44 lacs for this policy over five years. If you surrender your endowment policy, you may not get back all the money you have paid as premium.

You can make the policy paid up

You also have the option of not paying premiums but not terminating the policy. In this option, after you have made a specified minimum number of premium payments (e.g. 3 full years of premium payments), you can continue the policy till maturity without making any further premium payment. You will continue to receive life cover through the maturity of the policy but the sum assured will be reduced to the paid up value. The formula for calculating paid up value of sum assured is as follows:-

Paid up Value of Sum Assured = (Number of premiums paid / Number of premiums payable) X Sum Assured

This paid up value will remain the same through the term of the policy. Once a policy is made paid up, it will not qualify for any further bonuses.

Maturity value of a paid up policy = Paid up value of sum assured + Accumulated bonuses (before the policy was made paid up)

Example of maturity amount calculation for paid up policy

Continuing with our earlier example, if you choose to make your endowment policy paid up instead of surrendering it, the reduced sum assured or paid up value will be calculated as follows.

Paid up value of sum assured = (5/20) X 500000 = 1,25,000

Through the balance term of the policy, after you make it paid up, you will get a sum assured of 1.25 lacs.

Maturity amount = {(5/20) X 500000} + {48 X (500000/1000) X 4} = 2, 21,000

What option should you choose: Surrendering the policy or making it paid up

At first glance, it seems that making your endowment policy paid up is a better option than surrendering your policy. The maturity amount of your paid up policy is much higher than the surrender value. But we should not ignore the opportunity cost. If you are able to re-invest the proceeds received as surrender value in better investment opportunities, then you may be able to earn higher returns compared to making your policy paid up. For example, let us assume that, you surrender your policy after 5 years and re-invest the proceeds in mutual funds. Even if your mutual fund scheme gives 12% compounded annual rate of return, the value of your investment after 15 years will be 3.63 lacs. Compared to the maturity amount of your paid up policy, surrendering your policy and reinvesting the proceeds in higher yield investment options may give you higher returns. However, when you surrender your endowment policy you lose life insurance cover. Therefore, if you decide to surrender your endowment policy, you should ensure that you have enough life insurance cover.

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Dwaipayan Bose

An alumnus of IIM Ahmedabad, Dwaipayan is a Finance and Consulting professional, with 13 years of management experience, mostly in MNCs like American Express and Ameriprise Financial, both in India and the US. In his last role, he was the Chief Financial Officer of American Express Global Business Services in India. His key interests are building best in class organizations, corporate governance and talent development

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