Your life insurance policies often serve as more than just financial protection, they are also an asset during times of need. Policyholders can leverage their policies by getting a loan secured by the value of the policy, assigning the policy for consideration, or surrendering the policy to gain liquidity at the cost of insurance coverage. One key aspect of evaluating how best to utilize a policy to access liquidity is the surrender value, the amount payable by the insurer if you decide to terminate your policy before its maturity.
Understanding how to calculate surrender value of Life Insurance Policy is crucial, as it directly determines your loan eligibility or the value you could get from surrender or assignment. This article will explain what surrender value is, how it is calculated, and how it impacts your ability to secure loans, helping you make informed financial decisions.
What is Loan Surrender Value in an Insurance Policy?
The loan surrender value of an insurance policy is the amount that the insurer pays if you choose to discontinue your policy before its maturity. This value represents the financial worth of your policy at a given time.
There are two types of surrender values, and what the insurer pays out is the higher of the two calculations:
- Guaranteed Surrender Value (GSV): A fixed percentage of the total premiums paid (excluding taxes and additional charges), guaranteed by the insurer as per regulatory guidelines.
- Special Surrender Value (SSV): A more dynamic value based on the paid-up sum assured, accrued bonuses (if any), and other policy-specific factors. SSV usually becomes payable after the first policy year for single-premium policies or after a year of premium payments for regular plans.
How to Calculate the Surrender Value of a Life Insurance Policy
The general formula for GSV and SSV is as illustrated below (Pic reference from an article by Mera Kal in collaboration with D91 Inner Circle) - https://d91labs.substack.com/p/transforming-credit-access-with-digitized :
Let’s consider the case of LIC’s Bima Jyoti (Plan 860):
● Sum Assured (SA): ₹5,00,000
● Yearly Premium: ₹10,000
● Policy Term: 20 years
● Premium Paying Term: 15 years
● Accrued Bonus:
○ ₹75,000 (for Year 3)
○ ₹2,50,000 (for Year 10, with a ₹25,000 bonus/year)
● Bonus Factor:
○ 16.22 (for Year 3)
○ 18.16 (for Year 10)
● Surrender Value Factor (SV Factor):
○ Year 1: 0%
○ Year 3: 35%
○ Year 10: 57.50%
Guaranteed Surrender Value (GSV):
- Year 3 GSV Calculation: GSV = (₹10,000 × 3 × 35%) + (₹75,000 × 16.22%) = ₹22,665/-
- Year 10 GSV Calculation: GSV=(₹10,000 × 10 x 57.50%) + (₹2,50,000×18.16%) = ₹1,02,900/-
Special Surrender Value (SSV):
- Year 3 SSV Calculation: SSV = (₹5,00,000 × (3/15)) + (₹75,000 × 16.22%) = ₹1,12,165/-
- Year 10 SSV Calculation: SSV = (₹5,00,000 × (10/15)) + (₹2,50,000 × 18.16%) = ₹3,78,733/-
Comparison Table of GSV vs. SSV
While surrendering the policy, the insurer shall pay the LIC Loan Surrender Value equivalent to the higher of GSV i.e., Guaranteed Surrender Value, or SSV i.e., Special Surrender Value. As illustrated in the above example, SSV is higher than the GSV and its payment is typically made subject to specific terms and conditions of the policy.
Factors that Affect the Calculation of Surrender Value
Several factors influence the surrender value of your insurance policy:
- Policy Duration: The longer your policy has been active, the higher the surrender value. For instance, in the initial years, the calculation of surrender value might be 30%-40% of premiums paid, while in later years, it can exceed 50%-60%. The surrender value factor increases as the policy tenure progresses, making the policy more valuable over time.
- Premium Payment Term and Frequency: Policies with regular premium payments typically accumulate higher surrender values over time compared to single-premium policies.
- Type of Policy: Traditional plans like endowment or whole-life policies often have more predictable surrender values compared to ULIPs (Unit Linked Insurance Plans), which are market-linked and depend on fund performance. The surrender value of money-back schemes on the other hand could vary over time based on when payouts are made.
How Surrender Value Impacts Business Loan Eligibility
The surrender value of a policy is critical in determining loan against insurance eligibility. Using this value as collateral, lenders can issue secured loans to policyholders. In addition to the surrender value itself, lenders also consider other policy-related factors to determine loan eligibility and value.
- Loan-to-Value Ratio (LTV): Traditional policies usually offer higher LTV ratios due to the underlying asset being government securities, which are considered practically risk-free for lenders. ULIPs may have lower LTV ratios due to the variability in fund value that comes with market-linked performance. Insurers typically offer loans at 85%-90% of the surrender value for traditional policies. For example, if your surrender value is ₹40,000, you may be eligible for a loan of ₹34,000 to ₹36,000. For ULIPs, depending on whether the funds are invested in debt or equity, the LTV could vary from 50%-70% of the current net asset value of the policyholder’s funds.
- Policy Restrictions: Some policies, like pension plans, may have a surrender value but restrict loans to specific circumstances like medical emergencies. Others, such as moneyback plans could have restrictions basis the upcoming payouts.
Things to Keep in Mind Before Loan Surrender
Surrendering your policy might seem like a quick solution for liquidity, but it comes with long-term implications. Life insurance schemes are fundamentally long-term risk management tools and therefore are not efficient tools for short-term liquidity. Given the cost structure of insurers who acquire customers and offer life coverage over the long term, there are penalties associated with the early exit of these contracts to cover these costs. Here’s what to consider:
- Loss of Benefits: By surrendering, you forfeit future bonuses, maturity payouts, and other benefits. For example, a policy with a maturity benefit of ₹10,00,000 might only pay ₹3,00,000 as a surrender value in Year 5.
- Surrender Loss: Surrendering often results in a financial loss. Instead, consider taking a loan against your policy or assigning your policy to retain its long-term benefits while addressing immediate needs.
You can always use the Mera Kal Loan Surrender Calculator to estimate your policy’s worth and assess whether surrendering or borrowing is the better choice for you.
Understanding the Importance of Calculation of Surrender Value
Surrender value plays a vital role in managing your insurance policy effectively, especially when it comes to understanding your liquidity options and securing loans. Understanding the calculation of surrender value, the factors that influence it, and its implications for loan eligibility can help you make informed financial decisions. While surrendering your policy may provide immediate liquidity, it often comes at the cost of long-term financial benefits.
Before deciding to surrender, consider what you may lose and explore alternatives such as loans against your policy. By approaching your insurance portfolio strategically, you can ensure that your policy remains a valuable financial asset that supports your long-term goals.