IRDAI’s revised norms for those looking to surrender a life insurance policy: Explained

IRDAI introduces provisions for higher surrender value in life insurance policies to protect policyholders and improve persistency.

The story so far: The Insurance Regulatory and Development Authority of India (IRDAI) on June 12 introduced provisions that would guarantee a better exit payout for life insurance policy holders unwilling or unable to continue paying for their insurance. Providing higher ‘surrender value,’ or the exit payout, was also discussed in a consultation paper floated in December last year. At present, policyholders receive less or no payout if they discontinue paying premiums. The regulator has sought that, while determining the surrender value, insurers must also establish “reasonableness and value for money” for both exiting and continuing policyholders. 

In insurance, surrender value is the amount that a policyholder is liable to receive when s/he decides to terminate their policy before the maturity date. Insurers deduct a certain amount as ‘surrender charges’ based on the terms set out in the plan. 

Important to note, notwithstanding whether or not a policy is discontinued, the policyholder is still liable to receive the earnings, savings and other associated benefits accrued from the tenure of his association with the policy. However, the surrender charge levied by the insurer takes away a portion of the payout. These charges constitute a portion of the cash value, or the premiums paid. They are primarily used as potentially disincentivising tools to discourage policyholders from premature exits, as well as compensate (insurers) for the administrative expenses and potential losses because of no further premiums.  

Surrender value is of two kinds, that is, guaranteed surrender value (GSV) and special surrender value (SSV). As the name suggests, GSV is the minimum amount that the insurer would have to pay to the discontinuing policy holder. Its computation excludes bonuses that the holder would be eligible for at maturity. SSV, on the other hand, is the essential metric that takes into account the paid-up capital, eligible bonuses and other material benefits at the time of surrender to the terms set out in the policy document.  

Essential to note, if the holder stops paying premiums after a certain period, the policy continues to exist albeit with a lower sum assured. This is referred to as paid-up value.  

SSV is computed as the sum of the accrued bonuses and paid-up value multiplied by the surrender value factor. Let’s say a policyholder pays a premium of Rs 20,000 each year for a 25-year policy which assures a sum of Rs 5 lakh. It so happens that the holder stops paying premium after 5 years because of financial constraints. Currently, s/he has accumulated bonuses totalling Rs 75,000. Now, at the 5th year, the surrender value factor is 30%. Thus, the special surrender value would be calculated as (30/100) *(5,00,000*5/25 + 75,000). Thus, the SSV comes to Rs 52,500. For clarity about the computation, the product of the sum assured (Rs 5 lakhs) and the premiums paid to the total (5/25) is the paid-up capital.  

The most important of the provisions is that insurers will now be liable to pay the special surrender value if the exit takes place after completing one year. No exit payouts were given until now in the first year. This provision can be utilised if the policyholder has already paid the premium for the first year. The same applies for policies with a payment tenure of less than 5 years and single premium policies.