Calculating Surrender Value of Insurance Policies

Introduction to Surrender Value in Insurance Policies

Life insurance policies are one of the best financial safeguards to secure an individual’s or their loved one’s future. However, sometimes, a person may need to terminate their plan before it reaches maturity.

This would result in the insurance provider paying a specific amount to the policyholder. This sum is known as the surrender value.

Learn how to calculate surrender value in insurance policies and other things to remember before surrendering a policy to make informed decisions.

What is Surrender Value?

Surrender value in insurance policies refers to the payable amount a policyholder receives from the insurance company if they terminate their policy before it reaches maturity.

For instance, a midterm exit would net a sum of the savings and earnings from thereon. Even so, the insurance company will levy a designated charge based on their terms and conditions.

Apart from this, the surrender value will apply to those with regular premium policies if they have maintained their payments consistently for 3 years. However, once terminated, policyholders will immediately lose access to all the benefits associated with the insurance policy.

Note that term insurance policies do not have surrender values.

Types of Surrender Value

There are primarily two types of life insurance surrender value.

The first is guaranteed surrender value. This is a fixed sum payable to the policyholder if they exit before the maturity period. Generally, the amount depends on the stipulations in the policy papers and is a percentage of the total premiums paid until that point.

Thus, the amount will be close to 100% of the total number of paid premiums if the policy is terminated near the maturity date.

The second type is the special surrender value. Usually higher than the former variant, this is calculated by adding accrued bonuses to the paid-up amount and multiplying it with the surrender value factor.

Regardless, the payable sum depends on specific terms and conditions set by the life insurance provider, the policy course and the amount insured.

Factors that Affect Surrender Value

Certain factors affect the surrender value in insurance policies. This applies to both the guaranteed and the special surrender sums. Listed below are the three primary elements that you have to consider:

1. Policy Term

In most cases, the proximity of the maturity period to the date of termination determines the guaranteed surrender value. Since this is a fixed sum calculated based on a percentage of the paid premiums, the amount is closer to 100% of the payments the longer a policy is maintained.

Consider the example below to understand this better:

An insurance company pays 30% of the premiums after a policy reaches three years. Past that period, that percentage increases by increments of 2% for every month.

So, if Person X terminates their policy at the three-year mark, they will only receive 30%. However, if they wait another year, they get 54% of their total paid premiums.

That said, it is best to pick a policy length based on your age. For example, the ideal duration for term policies for people in their 20s would be 35 to 40 years rather than 15 to 20 years.

2. Age and Health of the Policyholder

As a rule, the older an individual is, the higher the premium. Insurance providers determine life insurance policy terms and conditions based on actuarial life tables. As such, it is much more cost-effective to buy an insurance policy when a person is young.

Nonetheless, due to the variability in the premiums, life insurance surrender value will often be higher if the policyholder is older.

3. Premium Payment Term

The premium payment term is critical in determining surrender value in insurance policies. It also decides the type of surrender amount the policyholder receives.

For instance, the guaranteed surrender amount in regular premium plans is made available after three years of payments. In other cases, an individual may receive a special surrender sum after two years.

Regardless, this particular determinant varies across policy plans and depends on the stipulated terms and conditions.

Methods to Calculate Surrender Value

There are three primary ways to calculate surrender value. One is based on a traditional manual calculation, while the second leverages a basic formula that applies to most policy exits. Finally, the third option leverages online calculators.

Here are some additional details regarding all of them:

1. Traditional Method

The traditional method to calculate surrender value in insurance policies involves using distinct formulas for each type. For instance, the guaranteed surrender amount will rely on a separate calculation, while the special surrender sum uses another formula.

This is only relevant when individuals are unsure about which category they fall under. However, in most cases, the insurance provider will inform the policyholder about the compensation that applies to them.

2. Shortcut Method

The second, quicker method to calculate surrender value is to divide the number of total paid premiums by the assured sum and then add any existing bonuses. The resulting amount is then multiplied by the surrender value factor.

This also doubles as the calculation for the special surrender sum, which is applicable in most cases of policy terminations.

3. Online Policy Surrender Value Calculator

Aside from these manual calculations, most insurance companies host an online policy surrender value calculator on their official websites. This will require the policyholder to submit specific insurance plan details, after which the surrender sum will be automatically calculated.

This method is often the best option for the average person as it accounts for all potential outliers and policy stipulations.

Understanding Surrender Value Calculation

Due to there being two types of life insurance surrender value, each has a distinct formula for calculation. That said, let's look at how to calculate surrender value for each category:

1. Surrender Value Calculation Formula

In most cases, the guaranteed surrender amount constitutes 30% of the paid premiums. However, this may vary based on the insurance provider. The payments for the first year are also excluded from this amount in addition to any bonuses or costs paid to insurance riders.

In short, guaranteed surrender value in insurance policies is calculated by subtracting the premium for the 1st year from the surrender value percentage of the paid installments. Then, that amount is subtracted from levied surrender charges in addition to any optional covers.

2. Premiums

The special surrender sum is dependent on the paid-up amount. This refers to the reduced assured amount of a plan if the policyholder stops paying premiums after two years. From thereon, continuing the policy will mean adhering to the mitigated amount.

As such, the paid-up value is calculated by multiplying the assured sum by the total number of paid or payable premiums.

Based on that amount, the special surrender value is determined by adding the paid-up amount with any accrued bonuses and multiplying it by the surrender value factor.

3. Sample Calculations for Guaranteed and Special Surrender Values

Let's examine two practical examples of guaranteed and special surrender values to understand how both formulas work.

For instance, say Person X has an assured sum of INR 3,00,000. For three years, they pay an annual premium of INR 10,000. In addition, the insurance provider offers a surrender value of 30% with a surrender charge of INR 2,000.

Using the formula mentioned above, the guaranteed surrender amount payable to them would be as follows:

• 30% of (INR 30,000– INR 10,000) – INR 2000 = INR 4000

For the special surrender value, let's assume Person Y took up a policy for INR 3,00,000 for 20 years with an annual premium of INR 15,000. After four years, they stopped making payments, which would make the paid-up amount INR 60,000.

The hypothetical bonus here is INR 30,000. Sticking to the formula listed previously, the special surrender sum would be:

• (INR 60,000 + INR 30,000) x (30/100) = INR 27,000

Things to Consider Before Surrendering an Insurance Policy

In addition to losing the benefits associated with an insurance policy, surrendering a plan before maturity also results in a reduction of the payable sum. That is why it is critical to consider the following factors before choosing to do so:

1. Surrender Charges

As mentioned, all insurance providers charge a designated fee for terminating a policy before maturity. Thus, factoring in this amount will enable policyholders to determine the net value they receive.

Nonetheless, the Insurance Regulatory and Development Authority of India (IRDAI) has established specific directives to mitigate the impact of surrender charges. In short, those who terminate their policies within two to three years get 30% of their paid premiums. On the other hand, those exiting four to seven years later receive 50%.

Finally, prematurely ending a policy two years before the maturity date results in the policyholder getting 90% of their paid premiums.

2. Policy Loans

Policy loans are an excellent alternative to surrendering a plan. These loans are issued by the insurance company and leverage the policy's cash value as collateral. Typically, such financial tools have lower interest rates than other loan types and are more flexible regarding repayment.

Even so, there are a few factors that decide the viability of such an option, those primarily being:

• Policy Eligibility: Only specific insurance policies are eligible for loans
• Loan Amount: The borrowed value will be 85% to 90% of the life insurance surrender value
• Waiting Period: Policyholders can only avail of a loan after three years
• Interest Rates: The total amount of paid premiums determines the interest rate
• Repayment Terms: Policyholders should repay their loans during the policy tenure, with either the interest amount or principal amount + interest amount

As such, while the surrender value in insurance policies can be helpful in emergencies, it is always best to consider a policy loan before committing to a termination.

Wrapping Up

In almost all cases, there are significantly better alternatives to surrendering a policy. However, personal commitments or other unforeseen challenges can necessitate such a step.

That is why it is best to examine a specific policy in detail before opting for it. A simple tip here is to discuss the surrender value in insurance policies at the time of purchasing. Apart from that, always align your income or budget with the payable premiums. This will ensure that the insurance plan is suited to your means.