Got an insurance policy? Know the cost of surrendering it

Financial security and tax relief are two critical reasons why most people buy life insurance policies. Yet, while it is very easy to buy insurance—it can even be purchased online these days and the premium payments are fairly simple—surrendering your policy is no easy task. The process is lengthy, time-consuming and even involves multiple visits to the insurance branch office.

Take the case of Sandeep Jagtap, a 38-year-old former banker and a businessman in Mumbai. When Jagtap tried to surrender his insurance policy, which had a term of 15 years, last year—five years after purchasing the policy— he found himself confronting several obstacles. For one, the insurer did not clearly communicate the surrender value of the policy. Jagtap was also required to visit the insurance office several times. It was frustrating, says Jagtap.

During Jagtap’s visits to the insurance office, an employee there tried to divert his attention towards different insurance products instead of assisting him. It took Jagtap 20 days to finally surrender the policy.

Financial experts say that insurance companies make it extremely difficult for customers to surrender their policies, and thus, every year, a large number of Indians get saddled with life insurance policies that they do not want. People want to surrender policies for various reasons, including a change in their financial goals or because they were mis-sold the policy in the first place. For instance, Mohit Rohan Shrivastava (36), an employee at JLL Business Services at Gurugram, decided to surrender his policy because he had come across better investment options. Jagtap did it because he needed funds to buy a house.

Alpeshkumar, 37, an IT professional based in Kolkata, wanted to surrender the policy because he was mis-sold one. Yet, he quit after multiple attempts, blaming it on the insurer’s offline process and a huge surrender penalty.

Taxation and returns

Among the many categories of insurance, endowment policies which combine insurance and investing are generally the subject of mis-selling. Buyers typically want to surrender these types of policies, say experts.

Vishal Dhawan, founder, Plan Ahead Investment Advisors says that, as a rule of thumb, the fewer premiums you have already paid, the better off you would be if you surrender the policy. This is because you will be able to direct your future savings into higher yielding investments for a long period of time and this will outweigh the loss resulting from surrender charges. Also insurance charges tend to be front-loaded and hence if you have been paying premiums for many years, many of the steep costs and charges will be behind you, not ahead.

Typically, many insurance buyers end up surrendering or discontinuing their policies within the first few years of buying it, say financial experts. For instance, almost half the customers of India’s largest insurer LIC surrender this type of policies within approximately five years, as per available data. The persistence ratio of LIC, post 61 months of a policy being sold, is 55.17, as on 30 September 2023. Persistency ratio tells you the percentage of policyholders maintaining premium payments over a specific period. A higher ratio implies stability and satisfaction, while a lower one suggests an increased likelihood of policy surrenders. LIC’s persistency ratio of 55.17 implies that almost half its customers choose not to continue their policies for the long term. An email sent to LIC about this did not elicit any response.

 

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(Graphic: Mint)
(Graphic: Mint)

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(Graphic: Mint)
(Graphic: Mint)

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(Graphic: Mint)

 

Another factor to consider is tax. The tax deductions claimed while paying the premiums of an insurance policy are reversed if it is surrendered in two years.

“The surrender value of a life insurance policy is generally not taxable. However, it becomes taxable under specific conditions. If the premium payment exceeds 10% of the sum assured for policies issued after 31 March 2012, or 20% of the sum assured for policies issued between 1 April and 31 March 2012, the surrender value becomes taxable. Additionally, for policies issued on or after 1 April 2023, the surrender value becomes taxable if the annual premium exceeds 5 lakh. It’s important to note that any deduction claimed under Section 80C of the income tax Act will be reversed if the policy is surrendered within two years.” said Prakash Hedge, a Bengaluru-based chartered accountant.

Once you have made the decision to surrender, you also have to navigate the complex set of procedures that insurers have created to discourage surrender of policies. Often insurers insist that you must visit the insurer’s office in person. This can become an issue if you have moved to a different city or are outside India.

Conclusion

The decision on surrendering an insurance policy or not does not require complex calculations. You have to make an estimate of the returns you will get in a competing product (say, a hybrid mutual fund) if you were to divert future premiums to the mutual fund instead of using them for the insurance policy.

What about the insurance cover? You should account for this in your calculation by assuming that you will couple the hybrid fund with a term insurance policy. Term insurance premiums are a small fraction of endowment policy premiums because term insurance has no maturity value—it only pays out to your family if you die during the policy term. In case you are not able to do this calculation on your own, it is better to consult a Sebi-registered investment adviser.

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