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What is the Surrender Value of Life Insurance?

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What is the Surrender Value of Life Insurance?
February 29, 2024

Table of Content

 

In this policy, the investment risks in the investment portfolio is borne by the policyholder

The benefits of life insurance are long-term, and there can be instances when your policy must be terminated due to unfortunate circumstances. When you surrender your plan, you are essentially ending it before it reaches its maturity date. You will be able to receive a surrender value if you surrender your policy midway through its term. Please note that the surrender charge, which is deducted from this value, can change based on the plan's terms.

What is Surrender Value in Insurance? 

A surrender value in insurance refers to the amount paid by the insurance company to the policyholder upon terminating the policy before its maturity date. If the policyholder surrenders during the policy tenure, the earnings and savings portion will be paid to him or her. Surrender charges are deducted based on the terms of the plan. Surrender values typically are paid only after a policy has been active for a specified period of time, usually three to five years.

Imagine purchasing a Rs 2 crore term insurance policy five years ago, but being unable to pay the insurance premiums due to financial difficulties. In such circumstances, you can surrender the policy to the insurer. Surrendering a policy results in the surrender value being reduced by the surrender charge imposed by the insurer, and all associated policy benefits are terminated. Depending on the policy, surrender charges may vary; however, under IRDAI regulations, life insurance companies in India are prohibited from levying surrender charges on policies surrendered after five years.

Types of Surrender Values in Insurance 

There are two types of surrender value in insurance: 

  • Guaranteed Surrender Value

    • Amounts payable after completion of 3 years are usually stated in the brochure. A sum is calculated by adding all premiums paid throughout the policy period, excluding first-year premiums. It also excludes any additional premiums paid for riders and any bonuses you may have been eligible to receive at maturity. The Guaranteed Surrender Value is the product of the total premiums paid and the surrender value factor (% of total premiums paid). 

  • Special Surrender Value 

    • Depending on the total sum assured, premiums paid, policy term, and bonuses, the special surrender value can vary. We need to understand the paid-up policy in life insurance in order to understand the special surrender value. Suppose a person bought life insurance and could not pay the premiums, the policy itself would convert into a paid-up policy with the sum assured being reduced by the total premiums paid. Policyholders who surrender paid-up life insurance receive the special surrender value, which is calculated by adding the paid-up value to the surrender value factor.

    A special surrender value is determined by (Initial base sum assured times (Premiums paid minus Premiums payable+ Bonus) + surrender value factor). If premiums are stopped after a certain period, the policy continues with a lower sum assured. We refer to this sum assured as the paid-up value. Insurer's paid-up value = sum assured + (premiums paid/premiums to be paid).

    As an example, let's say you pay Rs 30,000 in premiums each year for a 20-year policy with a sum assured of Rs 6 lakh. Assuming you stop paying premiums after 4 years, the bonus accumulated so far will be Rs 60,000, and because the surrender value factor in the fourth year is 30%: the special surrender value = (30/100) *(6,00,000*(4/20) + 60,000) = Rs 54,000. 

    As more premiums are paid, the more will be the surrender value. Surrender value is calculated by taking the paid-up value and the bonus into account. In the first three years, this factor is zero, but it increases from the third year onward. Normally, it varies from company to company and is influenced by factors such as the type of insurance policy, the maturity date, the number of years the policy has been in operation, industry practices, and the fund performance for a particular policy. Surrender value factors are not mentioned in every company's brochure.

How is Surrender Value Calculated? 

In insurance, surrender values come in two forms: 

  • Guaranteed Surrender Value 

    • Typically outlined in the brochure, this sum becomes due after the completion of a 3-year period. The premiums paid, excluding the initial year's premium, are included in this figure. In addition, it excludes any extra premiums or bonuses that may be applicable at maturity. In order to calculate the Guaranteed Surrender Value, the total premiums paid are multiplied by the surrender value factor. This factor is expressed as a percentage of the total premiums paid.

  • Special Surrender Value

    • A special surrender value is determined by factors such as the total sum assured, the total premiums paid, the policy term, and any bonuses applied. In order to comprehend the special surrender value in insurance, it is crucial to understand paid-up policies. 

    In the event that an individual obtains life insurance but can't pay premiums, the policy becomes paid-up, with the sum assured reduced in accordance with the amount of premiums paid.

    In the event a policyholder surrenders a paid-up policy, he/she is eligible for a special surrender value. As a general rule, the special surrender value can be approximated by adding the paid-up value to the surrender value factor following the formula: Special surrender value = (Initial base sum assured (Number of premiums paid/Number of premiums payable) + total bonus received.

    When premium payments cease, the policy continues with a reduced sum assured known as the paid-up value. Paid-up value = original sum assured x (premiums paid / premiums due).

  • Example

    • Here's how we calculate the special surrender value: Imagine that you pay Rs 40,000 per year for life insurance coverage with a sum assured of Rs 8 lakh, and the policy term is 25 years. After 6 years of paying premiums, if the accumulated bonus equals Rs 80,000 and the surrender value factor is 25% in the 6th year, the special surrender value equals: (25/100) (8,00,000 (6/25) + 80,000 = Rs 84,000.

    The surrender value increases as the number of premiums paid increases. Using a surrender value factor, one can calculate how much of paid-up value is left over after the bonus has been taken out. This factor remains zero during the first three years, gradually increasing from the third year onwards. There are a variety of factors that affect cost, such as the type of policy, the time to maturity, the completion year of the policy, industry norms, and the performance of the fund. Some companies do not include surrender value factors in their brochures.

Factors to Consider While Calculating Surrender Value 

  1. Types and features of policies: Surrender value is heavily influenced by the choice of insurance policy. There are several factors that influence surrender value calculations depending on the type of policy, such as term life, whole life, or endowment plans. Depending on the policy, some may have cash value components, while others may not. How surrender values are determined requires an understanding of the specific features of the policy type selected.

  2. Duration of the policy: A longer policy term increases insurance holders' chances of receiving a more substantial surrender value. The accrued value is directly influenced by the duration of the policy.

  3. Accumulated policy value: The accumulated value of a life insurance policy includes premiums paid, interest earned, and any additional benefits. Using this cumulative value as a foundation for the calculation of surrender value is very important.

  4. Accumulated bonuses: Based on the company's performance, bonuses may be declared over the course of the policy. Whether accumulated bonuses are in cash or added benefits, they are crucial to enhancing surrender value. In most cases, policies with a consistent bonus accrual are likely to yield a higher surrender value.

  5. Higher premium payments: The amount of premium paid has a significant impact on surrender value. A higher premium will result in an increased surrender value for insurance holders. A correlation like this illustrates how premium levels affect surrender value calculations.

  6. Age of the insured: When a life insurance policy is initiated at a younger age, the surrender value is likely to be higher. During the course of a policy's life, the age at which it is initiated plays a pivotal role in shaping the surrender value. Due to extended policy duration, early adoption of policies often results in a higher surrender value.

  7. Current market conditions: Surrender value calculations are influenced by the current market conditions, including economic factors, interest rates, and investment performance within the insurance portfolio. Attention should be paid to market dynamics since they can affect the overall value of a policy in the long run.

  8. Fees for surrender: A surrender fee may be imposed on some insurance policies. Surrender fees are crucial to understanding, as they directly impact the amount a policyholder receives upon surrendering the policy. Those considering premature surrender may find it more advantageous to select a policy with a lower surrender charge.

  9. Optimal surrender timing: It is crucial to time the surrender correctly. Surrendering at the right time, considering factors such as market conditions, policy accumulation, and bonus declaration, will maximise the surrender value. A premature surrender will result in a reduced value, whereas a well-timed surrender will ensure that the policyholder receives the maximum amount possible. To make informed decisions, it is crucial to understand when is the best time to surrender.

Reasons Why Policyholders Choose to Surrender Their Policies

  • The discovery of a better alternative: Indian consumers may still be able to find a life insurance policy that best suits their financial goals and needs after conducting comprehensive market research. Insurers tend to raise their premiums as they age. One common reason for surrendering an insurance policy is the discovery of an alternative that offers a better sum assured, enhanced benefits, or an attractive bonus structure.

  • Emergencies in finances: In the face of financial emergencies or tight financial situations, policyholders in India might find themselves compelled to surrender their existing life insurance policy. Increased monthly expenditures can lead to difficulties in meeting life insurance premium payments, ultimately resulting in the decision to surrender the policy.

  • Additional funds are needed: Indian insurance holders may consider surrendering their life insurance policies due to the need for immediate funds. To meet the need for additional funding in circumstances where liquid cash is urgently needed, surrendering the policy is a viable option.

  • A change in financial goals: Policyholders in India may need to reassess their life insurance needs as their financial priorities change. By surrendering a policy, you can ensure that the chosen life insurance coverage remains in sync with evolving financial goals.

  • Transitions in career or lifestyle: In India, job changes and lifestyle changes can cause individuals to re-evaluate their life insurance needs. Occasionally, surrendering a life insurance policy can be a strategic decision to adapt to a new career path or lifestyle.

  • Evolving needs of policyholders: It is possible that policyholders' needs may evolve over time, necessitating a re-evaluation of their insurance coverage. A policy surrender can be a reflection of a policyholder's evolving needs and a proactive step towards aligning insurance choices with changing circumstances.

Do All Life Insurance Policies offer a Surrender Value?

To fully understand the surrender value of a life insurance policy, it is crucial to carefully review the policy's terms and conditions (T&Cs). To surrender a policy, you must consistently pay premiums for a minimum period of time. In most life insurance plans, surrender value only exists after consecutively paying premiums for a specified period, usually three years. After three years, if you surrender your insurance, you're eligible to receive the surrender value.

Additionally, you should be aware that not all policies have surrender values. Only endowment or Unit Linked Insurance Plans (ULIP) with a savings component provides a partial return to investors on their investments. However, regular term insurance plans lack a savings element and are therefore terminated upon surrender, with no surrender value.

What is Surrender Value Fees?

A life insurance policy loan can be obtained for an amount between 80% and 90% of the surrender value. Consequently, your policy's surrender value determines the amount of the loan you are eligible for. It is also possible to secure a loan against your policy by pledging it to a bank. Even so, borrowing in the early years of a policy may result in a lower surrender value.

When is the Right Time to Surrender Your Policy? 

You should consider factors such as your financial needs, the surrender value, and alternative options before surrendering your policy. As well, policy surrender is typically allowed after 3 years of premium payments under the guaranteed surrender value. Surrendering after this period may result in a surrender value of approximately 30% of the premiums paid so far. For personalised advice, it is a good idea to consult a financial advisor.

Is Surrendering My Policy a Good Idea?

The policyholder forfeits all scheme benefits upon surrendering the policy, receiving a much lower sum than the premiums already paid. In Unit Linked Insurance Plans (ULIPs), a significant portion of the premium is lost to agent commissions and various charges, leaving only a small portion for investment. Therefore, surrendering an endowment policy is recommended when the funds can be invested in an alternative product, which yields higher returns than the original policy.

Conclusion 

Surrender value in insurance allows policyholders to terminate their plans if they no longer need the coverage. Once life insurance is surrendered, the policyholder loses coverage and, in the unfortunate event of their passing, the nominee will not receive any benefits. Therefore, you should thoroughly review your policy documents and carefully consider your options before surrendering a life insurance policy.

FAQs on Surrender Value in Life Insurance

Q: What is the meaning of surrender value in life insurance?

If a policyholder decides to terminate the policy before its maturity, the insurance company will reimburse the surrender value to the policyholder. Many people believe that surrendering term insurance is not an option.

Q: How the surrender value is calculated?

Surrender values are determined by subtracting surrender charges from premiums paid by the insurer.

Q: What is an example of a surrender value?

As an example of surrender value, consider a scenario when you purchase a life insurance policy with a coverage of Rs 1 crore, and after consistently paying premiums for 3 years, you decide to surrender the policy. Assuming the premiums paid over the last three years totalled Rs 30,000, the insurer will offer a payout equal to the premiums paid, minus any surrender charges.

Q: To Surrender Or Not To Surrender: Which is a good option?

A person's decision to surrender depends on their circumstances and financial situation. Several factors should be considered, such as long-term goals, financial needs, surrender value, and alternative options. Based on your specific needs, a financial advisor can assist you in making an informed decision.

Q: What is the formula for calculating the surrender value amount?

Surrender value is calculated by subtracting the insurer's surrender charges from the total premiums paid.

Q: What is the benefit of surrender value?

Surrender value allows policyholders to cancel their insurance policies before maturity and receive a partial refund of their premiums.

Q: What is the difference between surrender value and cash value?

Cash value is a portion of your insurance policy that accumulates interest. It can be withdrawn in the event of additional financial need. The surrender value, on the other hand, is applicable only if you terminate your life insurance policy before its maturity date.

Q: Who pays the surrender amount to the insurance holder?

A surrender value of the policy will be directly paid by the insurance company if the policy is terminated before maturity.

Q: Is surrender value tax-free?

No, surrender values are not tax-free. Generally, life insurance funds are considered to be 'income from other sources,' and do not qualify for tax benefits.

Q: How do I maximise my surrender value and avoid surrender charges imposed by the insurance providers?

The IRDAI does not charge surrender value charges on life insurance policies whose premiums have been consistently paid for five consecutive years. Therefore, surrendering a policy after five years can avoid surrender charges.

Q: What will be the surrender value after 5 years?

According to IRDAI regulations, insurers may not charge surrender value charges if a policy is surrendered after five years.

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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The Unit Linked Insurance products do not offer any liquidity during the first five years of the contract. The policyholders will not be able to surrender or withdraw the monies invested in Unit Linked Insurance Products completely or partially till the end of fifth year. 

Unit Linked Life Insurance products are different from the traditional insurance products and are subject to the risk factors. The premium paid in Unit Linked Life Insurance policies are subject to investment risks associated with capital markets and the NAVs of the units may go up or down based on the performance of fund and factors influencing the capital market and the insured is responsible for his/her decisions. HDFC Life Insurance Company Limited is only the name of the Insurance Company, The name of the company, name of the contract does not in any way indicate the quality of the contract, its future prospects or returns. Please know the associated risks and the applicable charges, from your Insurance agent or the Intermediary or policy document of the insurer. The various funds offered under this contract are the names of the funds and do not in any way indicate the quality of these plans, their future prospects and returns. 

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