Should we Exit an Insurance Policy through Surrender or Paid-up?

In this article, we will be addressing a very common dilemma – a situation that a lot of buyers of traditional life insurance policies (not ULIP) have gotten themselves into and want help to address. We will do this in 2 parts. So you may find it longish, but to get a perspective do take the effort to read, understand and act.
 
1. What options do you have with your traditional insurance policy?
2. How to take the final decision using actual numbers, for your own policy?
 
In this article, we will cover Part 1.
 
A traditional life insurance policy is something that many of us would have bought. For some of us who are risk-averse, we are perhaps convinced that the policy indeed has good returns. This article is not meant for those customers.
 
But in most cases, a traditional life insurance policy would have been sold to you by an agent and it was something you never really needed. Also, it is likely that it was not the product benefits but the lure of Tax Benefit that you really fell for, without realizing that in the long term the policy can do you more harm than good. For this large majority which has realized that returns from a traditional life insurance policy (5-7%) are much below their expectations, this article should give you some direction.
 
There will be questions in your mind – How could I buy such a poor product? If only I had listened to my friend who was suggesting a term plan instead? I have another 12 years of premium to pay – should I continue paying premiums? Will it be worth? Can I get my money back or exit now? What will I get if I do? What if I stop paying premiums – will I get anything at the end of the policy term? 🙁 🙁 🙁
 
 

 
Well, we will now show you the options and the numbers so you can decide what exactly to do with your policy. We will make no specific recommendations as such – only show you the choices at hand.
 
A big influence on your options will be the question of how many premiums you have paid so far. Here’s how it works.
 

Policy Purchase Date	Premiums Paid	Options You Have
Before 1 Jan 2014	Less than 3 full years’ premiums	Continue with the policy, or write off the premiums paid as losses by lapsing the policy
Before 1 Jan 2014	3 full years or more premiums	Continue with the policy, or write off the premiums paid as losses by lapsing the policy, or surrender the policy, or convert into a paid-up policy
After 1 Jan 2014	Less than 2 full years’ premiums	Continue with the policy, or write off the premiums paid as losses by lapsing the policy
After 1 Jan 2014	2 full years or more premiums	Continue with the policy, or write off the premiums paid as losses by lapsing the policy, or surrender the policy, or convert into a paid-up policy

Please note that the above rules for policies sold before Jan 1, 2014 could differ for a rare few traditional plans of some insurance companies, but will hold for more than 95% of them.
 
1. Continuing with your Policy
 
While many or us may feel that a traditional life insurance policy does not give you much returns, one always needs to have at least a portion of her/his overall investments into safe, guaranteed instruments. This is a basis tenet of Asset Allocation. And to do that, such traditional insurance policies fit the bill perfectly. So even if these policies do give you low returns, continue with it as part of the low-risk, low-return part of your portfolio. Just ensure that if you are less than 35 years of age, keep this investment less than 35% of your overall portfolio. While we do not make recommendations per se, if at all we did, this would be the option we would urge you to strongly consider.
 
2. Lapsing a Traditional Life Insurance Policy and Writing It Off
 
This is an easy thing thing to do. Just stop paying any further premiums. Once the grace period for premium payment (usually 30 days) ends, the policy lapses and your life cover stops. You get no further returns from your policy – so when you lapse the policy, you treat this investment as a bad dream and try to forget it!
 
3. Surrendering a Traditional Life Insurance Policy
 
Use the table above and find out if you can surrender the policy at all. If you indeed can surrender your traditional life insurance policy, you do get some money back. Surrender Value (or Guaranteed Surrender Value) will be mentioned in your policy brochure and policy contract. It is generally equal to a certain percentage of all your premiums paid (minus premiums for rider attachments such as Accident Benefit), and depends on how many premiums were to be paid as per the policy, how many your really paid and what was the total duration of the policy. This illustrative table shows a calculation of surrender value for a certain policy. This could differ from company to company, and plan to plan.
 
What you also get is a proportion of the the bonuses accrued till then. This table shows how the portion of accrued bonus is calculated.
 

 
Surrender of your policy will also mean reversal of tax benefits (Sec 80C) if you had used the policy to avail of them in the earlier 3 years.
 
4. Converting a Traditional Life Insurance Policy into “Paid Up” Status
 
So if you don’t want to lapse (write off) your policy and if you feel surrender is a bad deal (which it is), the best option you have is to convert the policy into a “paid up” one. For a policy that is mis-sold this could be a possible exit plan, if it suits you, but you need to understand implications clearly. If you choose to go ahead with this option, all you need to do is inform the company that you need to convert it into a “paid up” policy (fill up a form for that) and then stop paying premiums. The policy continues based on the premium you have paid, and so does the Life Insurance cover but the extent of cover is the proportion of premiums already paid, to what you needed to pay originally. Any rider attachments such as Accident Benefit or Waiver of Premium on Critical Illness, are withdrawn. When the policy ends (when it was originally supposed to) or if death occurs, you get the Sum Assured + the Bonuses accrued till the year the policy gets converted to “paid up”. Other bonuses (loyalty bonus, terminal bonus, final additional bonus, etc.) will also not be payable.
 
“Paid up” Sum Assured = (No. of premiums paid / Total premiums as per contract) x Original Sum Assured.
The policy continues without paying further premiums.
 
“Paid up” Policy Maturity/Death Benefit = Paid up Sum Assured + Bonuses accrued till conversion to “paid-up” status.
 

 
For the record, a “paid up” policy can be surrendered later, but not vice versa.
 
Well, this understood, let us now see some numbers to help us take the decision. Let’s move on to Part 2 – Real examples to help you decide on your traditional life insurance policy.