After several revisions, the Insurance Regulatory and Development Authority of India (Irdai) has finally released new regulations on the surrender value of life insurance policies. Initially, the draft shared in December 2023 proposed high surrender values for policyholders. However, the final master circular, issued on Wednesday, has little bit moderated these values, though they are still higher than the existing rates.
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For those unfamiliar, surrendering a policy means fully withdrawing or terminating the policy before the term ends. The surrender value, paid upon surrender, is the higher of the Guaranteed Surrender Value (GSV) or the Special Surrender Value (SSV).
Currently, policyholders can surrender their policies at any time during the term, provided that two full years’ premiums have been paid. Surrendering before this period incurs heavy costs with no refund.
The new IRDAI Master Circular issued on Wednesday states that “SSV calculated shall become payable after completion of the first policy year provided one full year premium has been received.” This is good news for policyholders, as under existing rules, no surrender value was paid in the first year.
According to the new rules, insurers must ensure that the SSV is at least equal to the expected present value of the paid-up sum assured on all contingencies, paid-up future benefits, and accrued/vested benefits, accounting for any survival benefits already paid.
The interest rate used for these calculations cannot exceed the prevailing yield on 10-Year G-Secs plus a 50 basis points spread.
For example, if someone has a 10-year policy with a sum assured of Rs 1 lakh, an annual premium of Rs 10,000, and a policy bonus of Rs50,000, the present value of the paid-up sum assured plus the future bonus, according to the new regulations, would be Rs7,823 or 78%.
The paid-up value of an insurance policy depends on the proportion of premium payments made. It is calculated using the following formula:
Paid-up value = (Number of years for which premium has been paid)/ (Total policy term)*(Total Sum Assured)
These new regulations are expected to increase the overall surrender value for customers and have to be implemented by September 30, 2024. Currently, after two years, policyholders are only entitled to the Guaranteed Surrender Value. For instance, surrendering after the second or third year typically results in a refund of only 30-35% of the total premium, excluding bonuses. This proportion increases with the policy term, reaching 50% if surrendered between the fourth and seventh year and 90% in the last two years.
"While we anticipate a gross impact of approximately 100 bps on the company's New Business Margin (NBM) due to higher surrender value on early exits, we are confident in our ability to largely mitigate this impact without compromising the value proposition for our customers. We expect these measures to positively impact the long-term growth prospects for the industry’ said HDFC Life spokesperson.
Surrender Value Revisions
After the initial draft shared in December 2023, the Irdai in April 2024, announced planned to back down on surrender value proposals in Dec, 2023. By May 2024, they introduced a framework to implement the increase and invited insurers to submit feedback and seek potential relaxations on the proposed SSV increase by May 31.
In the draft regulations of December 2023, Irdai had proposed the concept of a premium threshold for each product. Beyond this threshold, no surrender charges would be levied on the remaining premium, irrespective of when the policy is surrendered. To illustrate, consider an endowment policy with an annual premium of Rs 1 lakh and a policy term of 20 years. Assuming a threshold limit of Rs 25,000, the guaranteed surrender value after the payment of the third annual premium could be computed as follows:
1) The guaranteed surrender value for the threshold premium would be Rs. 25,000 x 3 x 35% equating to Rs 26,250.
2) The premium refund surpassing the threshold premium would be Rs 1,00,000–Rs 25,000 x 3, or Rs 2,25,000.
3) Therefore, the adjusted guaranteed surrender value would sum (1+2) up to Rs 2,51,250.
4) The surrender value would be the higher of the Adjusted Guaranteed Surrender Value or the Special Surrender Value.
It would have been a significant jump in surrender value because as per the existing regulations, one would qualify for 35% of the premium paid, equivalent to Rs 1,05,000.
The Master Circular issued on Wednesday on Life Insurance products also announced about a simplified Customer Information Sheet, training programs, mandatory policy loans to enhance liquidity, introduction of variable annuities, extended free look period, robust processes to address customer grievances and higher value to customers on early exits should further the Regulator’s vision of insurance for all by 2047.
