Stopping premiums can reduce life cover

Published in Mint on Dec 02 2015

 

The Insurance Regulatory and Development Authority of India (Irdai) reiterated recently that when a policy is surrendered or discontinued, the insurer will have to follow the rules stipulated by linked and non-linked product regulations that came out in 2013. The regulator said so in a notification that came out on 29 September titled, (Acquisition of Surrender and Paid Up Values) Regulations, 2015. A policy is surrendered when you voluntarily terminate it and don’t pay further premiums.

The regulations further standardised the formula to calculate the minimum sum assured payable if a policyholder stops paying premiums in a traditional policy after it becomes paid-up. A paid-up policy is one that has acquired a surrender value. Once a policy acquires a surrender value, the regulations state that such a policy will not lapse by reason of non-payment of further premiums. In fact, if the policyholder doesn’t surrender, then the policy will be kept in force to the extent of the paid-up sum assured or reduced sum assured.

But before we get into how the insurers will calculate this paid-up sum assured, let’s start by understanding the rules for surrendering your policy in the case of unit-linked insurance plans (Ulips) and traditional insurance-cum-investment plans.

For Ulips

Ulips now come with a lock-in of five years. This means even if you surrender your policy during the lock-in, the money is made available to you only at the end of this period. So if you skip paying a premium, the insurer will give you a grace period of up to 75 days to pay, failing which your policy will be considered discontinued and the money will move to a discontinued policy fund. The insurer will levy a discontinuance charge—the maximum is up to Rs.6,000 in the first year coming down to Rs.2,000 in the fourth year and nil thereafter. The basic function of the discontinuance fund is to hold your money till the lock-in is over and also pay some interest.

Currently, Irdai has mandated a minimum return of 4% on this fund and the insurer can also levy a fund management charge not exceeding 50 basis points on the fund value per annum until the lock-in period is over. (One basis point is one-hundredth of a percentage point.) Once the lock-in is over, the money is paid back. But if you don’t want to surrender, then a discontinued policy can be revived within a period of two years.

If you discontinue the policy after the lock-in is over, you have three options to choose from—surrender the policy, revive it within a revival period of two years, or convert it into a paid-up policy with a reduced paid-up sum assured. The product regulations of 2013 state that the reduced paid-up sum assured is equal to the total number of premiums paid divided by the original number of premiums payable multiplied by the sum assured.

“In case the customer converts the policy into paid-up, the insurer will deduct only the mortality, policy administration and fund management charges. In case the fund value falls below one year premium, then depending on the policy document terms, the policy should be terminated and remaining fund value paid to the policyholder,” said C.L. Baradhwaj, chief compliance officer and chief risk officer, Bharti AXA Life Insurance Co Ltd.

For traditional policies

The rules are slightly different when it comes to traditional plans, and the surrender costs are steep. Though these plans don’t have a lock-in period, they usually don’t pay anything back if you surrender your policy right in the beginning. For instance, if the premium payment term is 10 years or more, the policy will acquire a surrender value only after paying premiums for three years. So, if you surrender your policy before that, you will not get anything back. If you surrender after three years, the insurer will pay at least 30% of the total premiums as surrender value. This means the cost of surrender is 70% of your money, and for the first three years you will not get any no surrender value.

If the premium paying term is less than 10 years, the guaranteed surrender value of at least 30% of the total premium paid will accrue after the second year. Between the fourth and the seventh year, it will be 50% of the premium paid. After the seventh year, the insurer has to file a surrender charge and get it cleared by Irdai.

Calculation of paid-up sum assured

Once your policy has acquired a surrender value, it automatically becomes a paid-up policy if you don’t plan to surrender. “Once the policy acquires a surrender value, it means that upon non-payment of further premiums the policy will not lapse, but the sum assured will proportionately reduce. Also, any guaranteed addition or reversionary bonuses in case of a participating plan will no longer accrue after the policy becomes paidup,” said Baradhwaj. The regulations have now standardised the formula to calculate the minimum reduced sum assured payable and the same formula is available for Ulips as well.

According to the new rules, for policies where the premium is fixed and uniform, the reduced paid-up sum assured payable on death or on maturity will be at least equal to the total period for which premiums have already been paid divided by the maximum period for which premiums were originally payable multiplied by the sum assured on death or on maturity. So if premium payment term of a policy is 10 years and premiums have been paid for only three years, and sum assured is Rs.10 lakh, then reduced sum assured will be Rs.3 lakh (i.e., 3 / 10 * 10).

“The base sum assured at the time of death will be first calculated. So, if an insurance policy states a death benefit will be higher of 10 times the annual premium or 105% of the total premiums paid till date or the sum assured, that will be first calculated to arrive at the sum assured on death and then the formula for paid-up sum assured will apply on this base sum assured. To calculate the sum assured payable on maturity, the same principle will apply,” said Baradhwaj.

The paid-up sum assured along with accrued bonuses and guaranteed additions until the time you were paying all due premiums will be paid to you.

“Until now, there wasn’t an explicit formula to calculate the paid-up sum assured. The market practice was to calculate the paid-up sum assured in a similar manner to the formula proposed, but now Irdai has prescribed the minimum floor rate, which is good,” said Kapil Mehta, executive director, SecureNow Insurance Broking Pvt. Ltd.

However, if the reduced sum assured exclusive of bonuses or guaranteed additions is less than Rs.1,250, then the insurer need not keep the policy in force. She can terminate the policy and pay the surrender value after the expiry of the revival period.

Irdai has explained the rules for surrender but do keep in mind that surrenders in the case of traditional plans is still expensive. Also, it helps to know the rules and understand the options that you can choose from when surrendering an insurance policy.

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