Surrendering an endowment policy? Here's how to calculate its value

If you stop paying premium before the end of the policy term, you are entitled to receive an amount, called surrender value, depending on the number of years completed, the premium and the bonus received.

Endowment policies, by their very nature, are difficult to understand. For instance, if you have bought a wrong policy and want to weed it out from your portfolio, it's not easy to calculate how much money you will get. Let's understand how to do that.

If you stop paying premium before the end of the policy term, you are entitled to receive an amount, called surrender value, depending on the number of years completed, the premium and the bonus received.

There are two types of surrender value-guaranteed surrender value and special/cash surrender value. While the guaranteed value is easy to calculate and is mentioned in the product brochure and the policy bond, the special surrender value is calculated only after the policyholder puts in the surrender request.

You are eligible to receive this if you have paid premium for at least three years. It is 30 per cent of the basic premiums paid, excluding the firstyear premium. Additional premium for riders such as accidental death benefit is excluded.

If you have paid Rs 75,000 (Rs 25,000 annually for sum assured of Rs 5,00,000) in the first three years, the minimum you will get is 30 per cent of Rs 50,000 (total premium paid minus first-year premium), that is, Rs 15,000.

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This does not include the bonus that you may have received from the insurer. If your policy pays bonus, which you accrue during its term, the amount you will receive on premature closure (surrender) of the policy will be the special surrender value.

Before special surrender value, we must understand paid-up value. If you stop paying premium after a specified period, your policy will continue but with lower sum assured. This reduced sum assured is called paid-up value or paid-up sum assured.

Paid-up value is calculated by multiplying the original sum assured and the ratio of the number of premiums paid to the number of premiums payable.

Let us consider that you pay the Rs 25,000 annual premium on a quarterly basis, and the sum assured is Rs 5 lakh for a policy term of 20 years. If you stop paying after three years, that is, have paid 12 premiums, the paid-up value will be Rs 5,00,000X(12/80).

Special surrender value =
{Basic Sum Assured X (Number of Premiums Paid/Total Number of Premiums Payable) plus total bonus received}X Surrender Value Factor.

Earlier, we calculated the paid-up value as Rs 75,000. Assuming that the bonus is Rs 60,000 and the surrender value factor in the 3rd year is 27.76 per cent, then the special surrender value = 27.76 per cent (Rs 75,000+Rs 60,000) = Rs 34,476.
In this case, 80 (20X4) is the number of premiums you were supposed to pay and 12 (3X4) is the number of premiums you have actually paid.

The paid-up value is Rs 75,000. This is the sum you will get at maturity or your nominee will get after you die. Paid-up value plus bonus is the total paid-up value.

If you discontinue the policy, the amount you will get is called the special surrender value. This is arrived at by multiplying the total paid-up value (paid-up value + bonus) with a multiplier called the surrender value factor.

The surrender value factor is a percentage of paid-up value plus bonus. It is zero for the first three years and keeps rising from thirdyear onwards. It differs from company to company and depends on various factors.

"Different companies use different approaches to arrive at the surrender value factor. Usually, the calculation takes into consideration factors such as completed policy years, policy type and time to maturity, with-profit fund performance in case of participating policies, besides the company's customer philosophy and industry practice," says Suresh Agarwal, executive vice-president, head, distribution and strategic initiatives, Kotak Mahindra Old Mutual Life Insurance.

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Not all companies declare the surrender value factor in the product brochure or on their website.

"This information can be obtained from the agent or the insurance company directly," says Rajeev Kumar, chief and appointed actuary, Bharti AXA Life Insurance. The special surrender value calculated in the box above is what you get against Rs 75,000 premium paid if you surrender the policy after three years.

Surrendering an endowment policy makes sense only if the amount (surrender value) received on doing so and invested in another product can generate a better return than the policy would have on completion of tenure.

"We usually do not recommend surrendering a policy as the customer not only loses out all the benefits of the insurance scheme but also receives a much lower amount than the total premium he must have paid," says Rajeev Kumar of Bharti AXA Life Insurance.

If you plan to dump your endowment policy, bear in mind all the money you have paid that you may never get back.