Unhappy with your non-linked policy? Consider
early surrender
But if you have held it for long, run
the numbers; continuing may be prudent
In December 2023, the Insurance Regulatory and
Development Authority of India (Irdai) issued an exposure draft on the
surrender value of non-linked insurance policies. Had those proposals been
implemented, they would have made surrendering of life insurance policies less
painful for policyholders.
The guaranteed surrender value (GSV) rates that apply
to non-linked policies from April, 2024 have not changed. The regulator has
maintained the status quo on rates.
The revised surrender value guidelines issued by Irdai
are a reiteration of the regulator’s intent to ensure that customers stay invested
in life insurance policies for the long term.
These GSV rates are lined to holding period. If a
policyholder surrenders his policy before it completes three years, the GSV
will be lower than if he surrenders it between the fourth and the seventh policy
year.
An insurance company creates long-term liabilities for
itself upon selling non-linked, traditional plans (money-back and endowment). To
meet them, it creates long-term assets by investing in long-tenure instruments,
usually government securities and equities. When a customer surrenders the
policy, the insurer has to unwind these investments and could have to take
losses if interest rates are up or equity markets are not doing well. Insurers
argue that making surrendering of policies painless and easy would lead to an
asset-liability mismatch for insurers.
With a significant portion of insurance plans invested
in long-term assets such as long-term bonds and equities, immediate surrender
would necessitate insurers to maintain more liquidity, requiring investment in
short-term assets instead. This would ultimately impact the maturity returns of
customers.
Higher surrender costs in the initial years deter the
temptation to withdraw while ensuring that insurance providers are able to
service these policies effectively without affecting their bottom line.
Insurers plan to modify their product mix. A separate
set of products is expected to be launched with higher surrender values than
the minimum required, which will cater to customers seeking higher liquidity,
albeit with slightly lower maturity returns.
Customers get a bad deal
The policyholder always takes a loss under this GSV
regime. For however long a policy is held, the policyholder never gets the
entire premium back, forget about a return on the total premium amount. They
get 90 per cent of total premiums back even in the last couple of years of the
policy term.
Insurers pay a special surrender value, but that is
not guaranteed and depends on a host of factors.
Financial advisors disagree with insurers’ argument
about having to unwind long-term investments. The asset-liability mismatch
argument does not hold since insurers create long-term assets based on their
past experience of surrenders. Hence, there is no excess long-term investment
that needs to be unwound.
Insurers also argue that it takes a lot of effort to
sell a policy, due to which they have to pay high upfront commissions to
agents. These costs need to be deducted when a policy is surrendered.
Investment products from all other regulators have moved to trail commissions
which in turn prevents mis-selling.
Issue of low persistency
Persistency ratio is the percentage of the total
number of policies or premium amount that remains in force from inception to various
periods. On average, after five years, the numbers of life insurance policies
in force drops to around half.
A major reason for low persistency is mis-selling.
When customers realize they have been sold an unsuitable policy, they exit.
When an exit happens, whether early or late in the tenure, at no point does the
insurer, agent, distributor or banc assurance partner suffer a loss. The only
party that ends up paying a heavy price owing to the high surrender charges is
the customer.
Enter with caution
Avoid mixing insurance and investment. Any product
that pays a commission as high as 35 per cent in the first year to the agent or
the distributor cannot be good for the customer.
Most traditional plans have an internal rate of return
(IRR) between 4 and 6 per cent. These are low returns for a 20 to 30-year
product.
The only class of customers who may perhaps invest in
these plans is the financially non-savvy ones who have so far invested only in
real estate and gold. Such customers are often afraid of losing money in the
financial markets. For them the safety of insurance products is a big pull.
The rest, who are either financially savvy or have
access to good advice, may avoid them.
When should you surrender?
Policyholders in the early part of the policy tenure,
who feel they have made the wrong choice, should exit despite the considerable
loss.
Policyholders must overcome the sunk cost fallacy and
surrender these policies sooner rather than later.
If you have been in the policy for three to five
years, take the loss and exit. Once you have crossed the seven-or 10-year mark,
get and informed person to calculate the pros and cons. In many cases, it may
make sense to continue servicing the policy.
SURRENDER VALUE: WHAT’S THE
FUARANTEED PAYOUT?
Non-single premium policy
2nd 30
3rd 35
4th to 7th 50
Within 2 years of Maturity 90
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