Recently, the Insurance Regulatory and Development Authority of India (IRDA) declared that they won’t be changing the rules about surrender value for life insurance policies in the country. This decision came after some uncertainty when IRDA was thinking about increasing surrender values back in March.

This announcement brought relief to many life insurance companies who were worried about potential changes. But what about the policy holders? The data indicates that over 50% of life insurance policies in India do not reach maturity. They are either surrendered or get lapsed because people can’t or don’t want to keep paying premiums. This trend is observed globally, regardless of variations in economic development and life insurance market dynamics.

This high volume of surrendered and lapsed policies raises questions about the reasons behind such untimely exits and underscores the significance of surrender value for policyholders. Why do so many people surrender or let their policies lapse? And what does this mean for policyholders who might be relying on their insurance? These are key issues that highlight the importance of surrender value for life insurance policy holders.

Surrender Value demystified:

In life insurance, ‘surrender value’ is a term every policy holder should know about. It’s like a safety net for policyholders when money is tight. If you can’t keep paying your premiums, surrender value ensures you still get some benefits. The Insurance Act, 1938, states that the policyholder must get some money back if they stop paying premiums and want to exit the policy. This money is often called ‘cash value’ and is a part of the premium amount already paid by the policyholder before discontinuing the policy.

If you’ve paid for at least three years, you can get about 30% of that back if you decide to quit. For instance, consider an endowment plan where the policyholder has paid Rs 1000 per month for 30 months, totaling Rs 30,000. If the policyholder chooses to discontinue the contract before the pre-specified term of that policy, no value is received initially. However, if they have paid premium payments for three years, then policy assumes a paid-up value, which is payable at the end of the term. This value, calculated based on specific surrender value factors, may amount to 30-40% of the accumulated sum, offering a partial safeguard to the policyholder’s investment.

However, if premiums are not paid for the stipulated period, the policy loses its value, unless revived within a grace period of six months. The intricacies of surrender value and its implications underscore the complex dynamics between policyholders and insurers, have sparked considerable debate within the industry.

The surrender value debate:

There are different opinions on what policyholders should get back if they surrender their life insurance policies. According to some experts, they shouldn’t get anything because life insurance is a contract between the life insurer and the policyholder for a predetermined period of time, where the life insurer is bound to provide the benefits in return for the specific premium payments by the policyholder. The surrender implies that the policyholder is terminating this contract before its prespecified maturity. Thus, a financial feasibility view argues that instead of giving higher surrender value to the quitting policyholders, insurance companies could use that money to offer increased dividends to the continuing policyholders. While this approach was historically practised, often resulting in insurers benefiting from increased surplus without reducing premiums, it eventually led to the enactment of non-forfeiture legislation. This legislation mandated insurers to repurchase life insurance policies at a predetermined cash surrender value.

On the contrary, another view on surrender value states that policyholders should get back all the money they’ve paid in premiums, minus any dividends and interest earned. Plus, they should also get a fair share of the money set aside for expected death claims. They argue that many policies are cancelled early because they were sold incorrectly and did not suitably match the financial needs of the policyholders, so policyholders deserve to get back everything they’re owed for such mis-selling. This is a benevolent view where the welfare of the policyholder is given priority over the financial feasibility of the life insurer.

Third view provides a middle ground between the previous two approaches. It advocates for surrender values that approximate the policyholder’s contributions to the insurer’s funds, adjusted for costs, handling expenses, and a contribution to insurer surplus. This approach aims to ensure equitable treatment for both withdrawing and persisting policyholders. This approach is adopted by most life insurance companies while paying the surrender value. This results into the surrender values being much lower than what is already paid by the quitting policyholder. Thus, they argue that they should get a full refund of what they have already paid by way of premiums. The question then arises: How can life insurance companies justify offering lower surrender values, and what potential solutions exist to address this issue? This dilemma calls for a deeper exploration of the dynamics between insurers, policyholders, and other stakeholders to arrive at solutions that safeguard the interests of all involved parties.