Surrender Or Paid Up: Which One Makes More Sense?

Per IRDAI data, roughly 67 per cent of all Life Insurance policies in India do not go on to receive their fifth-year premiums. The reasons behind this phenomenon of abysmally low persistency compared to global standards are complex and multi-layered. Some attribute it to the sharp selling tactics employed by many insurance agents, who essentially view the relationship with a client as 'over' as soon as a policy is sold. Some say this is due to growing awareness about market linked instruments such as Mutual Fund SIP's. Others, still, believe that this is due to the rising popularity of the concept of 'pure risk' coverage as a distinct financial need that must be decoupled from savings.

Whatever the reason may be; if you've chosen to stop paying the premiums for your traditional (non-linked) Life Insurance policy after paying your premiums for at least three years (or two years for a policy with a term of less than ten years), you've essentially got two choices: make the policy paid up, or surrender it. Which one makes more sense?

First up - what's the difference between the two? From the third year onwards, your policy begins to acquire what is called a "surrender value". You may choose to stop paying further premiums at this stage and surrender your policy. If you do so, you receive a fraction of the premiums you've paid, and the death benefit associated with the policy ceases, of course.

When you make a policy paid up, you don't need to pay any future premiums either. However, you receive no encashment value. Future 'annual bonuses' stop accruing within the policy, and your policy's sum assured gets adjusted on a pro rata basis depending upon the percentage of total premiums due, that have been paid by you. For instance, if you've got a 10-year traditional plan with a sum assured value of Rs. 10 lakh, and paid 4 premiums before making it paid up, the sum assured figure gets adjusted to Rs 4 lakh.
 
Making your traditional plan paid up makes sense for two reasons. First, the costs of surrendering your policy, especially early on, can be prohibitive. For a 10-year policy that has completed 4 premium paying years, the surrender value for most traditional plans will likely be 30 per cent or so; implying that you'll receive just about Rs. 1.33 lakh in lieu of the Rs 4 lakh you've shelled out. Even if you were to grow this money at a reasonable 12 per cent rate of return for the remaining six years, you'd end up with a corpus of just Rs 2.62 lakh. Clearly, you're better off keeping the policy in force as 'paid up' and receiving Rs 4 lakh, plus accumulated bonuses over the 4 premium paying years, plus a possible guaranteed loyalty bonus.

Secondly, surrendering the policy means letting go of the associated death benefit - this may not be sensible for those who are in their late thirties or forties, as it becomes increasingly difficult to get new policies issued without underwriting related hassles. The body does go through it's inevitable wear and tear, after all!

Surrendering a policy is also associated with the unmistakable anguish of writing off money, as doing so would most likely involve booking a whopping loss of 30 per cent to 70 per cent of premiums paid, depending upon the type and stage of your policy (refer your policy's benefit illustration for the precise surrender value associated with it). By making your policy paid up, you circumvent this pain as well.

There may be scenarios when surrendering makes financial sense - that would be when your policy has acquired a surrender value of at least 60 per cent of your premiums paid, and you've got a fair amount of time (say ten years) left until the plan's maturity. In such a scenario, you could potentially end up creating more wealth by surrendering the policy and investing it smartly for the pending decade-plus time horizon. Your age also needs to be taken into consideration from the perspective of how easy or difficult it would be to replenish the lost cover through a term plan. A qualified Financial Planner could help you with your decision.

End Note: In most scenarios, it's sensible to make your traditional policy 'paid up' instead of surrendering it altogether. If any (or all) of these apply to you, you may need to consider surrendering, though: One, you're in your twenties right now. Two, your policy has acquired a surrender value exceeding 60 per cent of your premiums paid. Three, you've got nearly ten years remaining until your policy's maturity date.