New IRDAI rules: Life insurance policyholders to get higher early-exit payouts from today

You will no longer lose your entire life insurance premium if you surrender your policy in the first year. Under a new rule by the Insurance Regulator and Development Authority of India (IRDAI) effective today, the surrender value will be available to life insurance policyholders after the first year of premium payment. Previously, policyholders could only surrender their policy after paying at least two full years of premiums, with no surrender value offered in the first year under the old guidelines.

However, the increase in surrender value may result in higher costs for life insurers, which is expected to lower returns on both participating (par) and non-participating (non-par) policies. Non-par policies are likely to feel the immediate impact, while par policies may see lower bonuses announced later. Additionally, there could be a shift in commission structures from upfront payments to a trail model to offset the cost increases.

In a participating policy, the policyholder shares in the profits of the insurance company in the form of bonuses or dividends. These bonuses are usually declared annually and are based on the insurer's performance. On the other hand, non-participating policies do not offer such bonuses. Instead, they provide guaranteed benefits like a fixed sum assured, with no link to the company's profits.

Surrendering a policy refers to ending it before its full term and withdrawing from coverage. When this occurs, the policyholder receives a payout called the surrender value or early exit payouts, which is the higher of two amounts: the Guaranteed Surrender Value (GSV) or the Special Surrender Value (SSV).

According to the new guidelines, insurers must ensure that the SSV equals at least the present value of the paid-up sum assured, future benefits, and any accrued or vested bonuses, while also accounting for any survival benefits already paid. The interest rate used for these calculations cannot exceed the current yield on 10-year government securities (G-Secs) plus an additional 50 basis points.

For example, consider a policyholder with a 10-year policy, a sum assured of Rs 1 lakh, an annual premium of Rs 10,000, and a bonus of Rs 50,000. Under the new rules, the present value of the paid-up sum assured plus the future bonus would amount to Rs 7,823 or 78%. This is calculated as follows:

{No. of Premiums Paid} / {Total Premiums to be Paid} * {Policy Returns Upon Maturity}

For instance:

1 / 10  * Rs 1,00,000 = Rs 10,000

Adding the paid-up bonus:

Rs 10,000 + Rs 5,000 = Rs 15,000

Discounting this over the remaining term using the 10-year G-Sec rate plus 50 basis points:

{Rs 15,000/(1.075)^9} = Rs 7,823

These new regulations will lead to an increase in the surrender value that policyholders receive but would also impact the return from these policies due to increase in costs.