The Insurance Regulatory and Development Authority of India (Irdai) recently proposed changes to how surrender value is calculated for non-linked life insurance policies. These policies usually have two parts in their premiums: risk and savings. Currently, Irdai's rules don't separate the savings part from the risk component of the premium. The proposed changes might treat the excess premium over a certain threshold as the savings component. Breaking down the proposed changes through an example Irdai presented a scenario involving a non-linked savings insurance policy. In this case, with an annualized premium of Rs 1 lakh and a 20-year policy term, considering a threshold limit of Rs 25,000, the adjusted GSV after the payment of the third annualized premium is computed as follows:
i. GSV for threshold premium: Rs 25,000 x 3 x 35 per cent = Rs 26,250
ii. Premium refund beyond threshold premium: Rs (1 lakh – 25,000) x 3 = Rs 2.25 lakh
iii. Adjusted GSV: (i) +(ii), i.e. Rs 2,51,250.
iv. Surrender value will be the higher of Adjusted GSV or Special Surrender Value (SSV)
The GSV represents the minimum amount that an insurance company disburses to the policyholder when surrendering the policy, and it is established at the policy’s initiation.
On the other hand, the SSV is an amount provided at the discretion of the insurance company, exceeding the GSV. The SSV considers factors, such as the policy’s duration, the number of premiums paid, current market conditions, and other relevant elements.
For a non-linked savings insurance policy with an annualised premium of Rs 1 lakh and a 20-year policy term, and assuming a threshold limit of Rs 25,000, if the policy is surrendered in the first policy year, the adjusted GSV after payment of the first annualized premium is as follows:
i. GSV for threshold premium: Nil
ii. Premium refund beyond threshold premium: Rs (1 lakh – 25,000) x 1 = Rs 75,000
iii. Adjusted GSV: (i) +(ii), i.e. Rs 75,000
iv. Surrender value will be the higher of (Adjusted GSV or SSV)
It is mandated that all individual non-linked savings and protection-oriented products, including non-linked life insurance and pension products (excluding pure risk premium products like term insurance, health insurance, and immediate annuity products), must incorporate a guaranteed surrender value.
In financial instruments like fixed deposits or recurring deposits, customers might want to cancel and get their money back due to personal reasons. When this happens, they receive a terminal value, usually their initial deposit plus some interest (though it might be less if the deposit is ended early). Life insurance policies are different because they're long-term, with premiums paid over time. But in the first year, there are higher expenses like policy issuance fees and commission. Insurance companies recover these initial costs through renewal premiums in later years. Because of these higher initial expenses, the surrender value of a life insurance policy is typically only a certain percentage of the premiums paid.
For the insurance company, because of the higher initial expenses in the first year, this might lead to lower surrender charges (the difference between premiums received and surrender value paid). Life insurers will need to reassess their profit margins and how they link distributor compensation to keeping customers and long-term persistence.
However, this unintended result could also prompt customers to exit their life insurance contracts early, even though these contracts are meant to be long-term and offer guaranteed returns over a longer period. This inconsistency with the long-term nature of life insurance contracts could be a concern.
According to experts, this is a customer-friendly initiative as a change in surrender value means that an investor who may bought an insurance policy in a hurry without doing enough due diligence around its suitability for his financial situation, or has a change in financial goals, has more flexibility to exit the policy with a lower cost. “Whilst this does not mean investors are not careful whilst purchasing an appropriate insurance policy, which happens quite often for tax saving purposes, it could mean that the impact on the investor as a result of this error may be lower and there is a better possibility of reducing the cost of this mistake,” Vishal Dhawan, CEO and founder, Plan Ahead Wealth Advisor, and a Securities and Exchange Board of India (Sebi) – registered advisor said.
The draft suggests a certain threshold for applying the current surrender value factors beyond which the entire premium paid is sought to be returned on surrender. “Clients surrender when they have wrongly been sold a product or they have incorrectly assessed and bought the product. This will be a huge deterrent for misselling insurance and clients will be able to recover a substantially higher amount they have wrongly paid,” Suresh Sadagopan, founder and principal of Ladder7 Financial Advisories, a financial planning firm said.
Earlier, surrender charges would affect the entire yearly premium of Rs 1 lakh. So, if these proposals are adopted, it could be good news for the customer.
