IRDAI norms on life insurance: Surrendering before maturity can be costly

For highly conservative investors who prefer to park the bulk of their savings in insurance policies and, more specifically, life insurance products, there is a disappointing development in store if they choose to or are forced to give up their policies before their term ends.

The Insurance Regulatory and Development Authority of India (IRDAI) came out with a formula late in March for calculating the surrender value in the case of non-linked life insurance products.

Going by the new surrender values that are mandated, policyholders will get only a small portion of their premiums if they forfeit their insurance before the maturity period and ask for their money to be returned.

Earlier, in December 2023, the IRDAI had come out with a proposal on surrender values in life insurance products and at that time, the regulator had suggested much larger amounts.

But the final regulations that kicked in from April 1 this year mandate much lower sums. There are also new norms for single-premium policies mandated by the IRDAI.

Read on for more on what policyholders can expect when they give up their insurance covers.

Eroded surrender values

Many traditional life insurance policies such as endowment or whole life products have a regular period premium paying timeframe that runs into several years.

Not all policyholders pay the premiums regularly and withdraw their money only upon maturity. Some are forced to surrender their policy and take whatever is on offer, usually because they need the money urgently. A few others may feel they have bought a product not suited to their needs and may choose to give it up.

So, when a policyholder surrenders a life insurance product, the IRDAI has specified the values to be paid back as a proportion of the premiums paid. The later the period when you surrender the policy, the higher is the amount you get back.

The latest norms suggest that only 30 per cent of the premium is to be returned upon surrendering a life insurance policy if the premium is paid for only one year and it is surrendered in the second year.

When a policy is surrendered in the third year, you can get back 35 per cent of the premiums. Between the fourth and seventh years, giving up your life insurance policy will get you 50 per cent of the total premiums paid.

The highest amount you can get back is 90 per cent of the premiums paid if you surrender your policy in the last two years of life insurance product’s maturity.

A few examples will make it clearer as to what you would get for surrendering your policy at various times.

Let’s assume a life insurance policy with an annual premium of ₹1 lakh that runs for a period of 15 years.

If you surrender your policy in the second year, you will get 30 per cent of the premium paid (₹1 lakh), which would be ₹30,000.

In case you forfeit your life insurance product in the third year, you will get back 35 per cent of ₹2 lakh (premium paid for two completed years), which would be ₹70,000.

When you give up your policy in the fifth year, you will get back 50 per cent of the premiums paid (₹4 lakh), which would be ₹2 lakh.

Finally, in case you surrender your policy in the fourteenth year, you will get 90 per cent of the premiums you paid (₹13 lakh), which totals to ₹11.7 lakh.

Thus, even if you hold your policy for over a decade and pay premiums regularly, but surrender a year ahead of maturity, you will still get an amount that is less than what you paid.

Reneging on earlier proposal

For a perspective on what these surrender values mean, it would be interesting to look at what policyholders would have got in return had IRDAI’s December 2023 draft proposal been mandated.

The regulator had then suggested a threshold limit up to which surrender charges would have to be paid. Beyond this limit, any premium paid would be returned to the policyholder.

When we take the same example as cited earlier with ₹1 lakh annual premium and 15 years policy, but with a threshold limit of ₹25,000, the surrender values would have shot up sharply.

The IRDAI had suggested 30 per cent for policies surrendered after payment of two premiums and 35 per cent for premiums paid beyond three years for calculating the surrender value of the threshold limit.

So, a policy surrendered in third year would have two premiums (₹2 lakh) paid. Here, the threshold limit for two years would be ₹50,000 (₹25000 for two years). When 30 per cent of ₹50,000 is calculated, we get ₹15,000. From the balance (above threshold limit) ₹75,000 paid for two years, we would get ₹1,50,000. Therefore, the surrender value would be the total of the two, which is ₹1.65 lakh.

A policy surrendered in the fifth year would give a surrender value of ₹3.35 lakh. In the fourteenth year, you would get a surrender value of ₹10.89 lakh.

For single-premium products, the surrender value would be 75 per cent of the premiums paid if given up within three years. The value would be 90 per cent from the fourth year onwards.

What’s in it for policyholders

As seen in the illustrations, the surrender value is significantly lower with the new regulatory norms, compared to the earlier proposal. For the initial few years, the difference is in the range of 40-60 per cent. It is only closer to the maturity period that the new norms seem to offer a slightly better deal for policyholders who choose to surrender.

For investors, the clear lesson is ideally not to buy traditional products, given their low life coverage and returns.

If they do end up giving in to the marketing pitch of an insurance agent and take a policy, ideally, staying the course till maturity is the best option. Even if you don’t pay premiums beyond a point, at least not surrendering would save you from certain losses, though returns would still be low.

And building a separate emergency fund is advisable so that you don’t have to surrender a life insurance policy at sub-optimal values to cover your contingency money requirements.