What is Surrender Value in Life Insurance?

Surrender value in insurance is the amount that a policyholder will receive when they voluntarily surrender their policy to the insurer before the contracted policy term. In the case of many types of life insurance plans, this facility becomes available only after you’ve paid the policy premiums for at least three years. Some insurers may also add bonuses in addition to refund of all previous premiums paid to calculate the final payout.

While not every policyholder may want to surrender their policy before the end of the policy term, here are some of the reasons why knowing the key features of surrender value in life insurance matters: 

• Liquidity during emergencies: Life is unpredictable, and while life insurance plans can act as a safety net in case of the death of the life insured, it does not provide protection from other financial emergencies. This is where the surrender value benefit may help the policyholder. The payout by surrendering your policy can help you access cash from your insurance plan and provide relief during financial stress.
• Transparency in planning: The life insurance surrender value calculator shows you how much money you would receive if you exit your policy early. This can help you make better financial choices.
• Impacts long-term goals: Surrendering reduces insurance protection, therefore, it is very important to understand the effect of the surrender value beforehand. While it might seem like a good idea to use the surrender value payout to resolve an immediate financial crisis, no longer having life insurance in place might impact your protection needs and future financial goals.

Surrender value can be broadly classified into two kinds, guaranteed surrender value (GSV) and special surrender value (SSV). Let’s see what they mean and the difference between these:

• Guaranteed Surrender Value (GSV): This is the minimum cash value the insurer must pay if the policy is surrendered subject to applicable terms and conditions. GSV is usually calculated as a percentage of total premiums paid plus any applicable additions and/or bonuses. This amount is usually payable in the case of life insurance policies that after completion of at least 3 years. For example, if Priya has paid ₹1,50,000 in premiums since inception, and the surrender factor is 30%, her GSV would be ₹45,000. The exact terms and conditions of guaranteed surrender value calculation tend to vary depending on the plan as well as the insurance provider.
• Special Surrender Value (SSV): This is also known as non-guaranteed surrender value. The payout under SSV is usually higher than under GSV as these depend on the policy’s bonuses, accrued value, and insurer’s discretion. For instance, if Priya’s policy has earned reversionary bonuses worth ₹20,000 and the GSV for the policy is ₹45,000, her SSV could be ₹65,000 (GSV + bonuses). The SSV amount is liable to rise as more premiums are paid with the progress of the policy term. The paid-up value and the bonus are taken into consideration when calculating the surrender value. Moreover, this factor is zero throughout the first three years, but it begins to increase from the third year onward.

It is important to note that not all life insurance policies feature both GSV and SSV. What’s more, these surrender benefits might not be available to policyholders over the entire policy term.

The surrender value formula can differ by policy, but generally follows a pattern. It is different for GSV and SSV. In the case of most plans the surrender value in insurance calculation is based on two broad methods. Insurers typically pay the higher of the two amounts at the time you exit.

Like a lot of decisions in personal finance and insurance, timing is important, and this is no different when it comes to calculating surrender value. Surrendering a policy is not possible immediately after commencement and typically the policyholder has to wait at least 3 years prior to receiving the benefit. Surrendering a policy before completion of this period usually does not lead to a payout. After year three, the surrender value increases as you keep paying your premiums.

The exact terms and conditions of when an insurance policy can be surrendered are specified in the policy documents and contract. However, typically, surrender is allowed only after a specified policy term has been completed. However, often surrendering the policy is not allowed during the last 5 years of the policy term.

Even though surrendering an existing life insurance policy means losing the benefit of life cover, some policyholders may decide to surrender their plan. The common reasons for surrendering life insurance policies before end of their contracted tenure can include the following:

• Urgent financial needs: Medical emergencies or sudden job loss push people to seek liquidity. In such a situation the policyholder may decide to surrender their policy and fulfill the immediate requirement.
• Better investment opportunities: Investors may find higher returns elsewhere, for example, in mutual funds or equities, and decide to move their investment elsewhere. But it is important to truly weigh the pros and cons of switching with the potential loss of a life cover when making this decision.
• Inability to pay premiums: Rising expenses can make it difficult to maintain the policy, and it is one of the simplest, most common reasons why policyholders may decide to surrender their policy.
• Change in financial goals: A person who initially bought a 25-year plan may later prioritise short-term goals, like children’s education, and this is a big reason why a lot of people do surrender. But it is best to factor in such things well in advance so that you don't have to lose out on the current plan.
• Consolidation: If you hold multiple policies, you want to surrender one or more of your policies. This can help your ensure that adequate cover is maintained without having to spend extra on premiums.
• Superior Alternative: You may find a plan that offers superior benefits compared to your current insurance policy. In such a situation, you may not want to pay the premiums for two separate plans and instead surrender the old policy while retaining the new policy.

If you ask, “how is surrender value calculated in life insurance?”, you will have to take into account multiple factors. Below are some of the key factors that can impact the calculation of surrender value in an insurance policy:

• Policy term: The benefit of surrender value is often not available during the entire policy term. Moreover the surrender value also tends to increase as the policy tenure progresses. During the first few years of the policy term, the guaranteed surrender value (GSV) calculated is quite low. As the policy term progresses, the surrender factor usually rises. This means a policyholder surrendering later in the policy term will receive a higher surrender value payout.
• Type of insurance plan: Traditional savings plans, like endowment plans and ULIPs, don’t work the same way as a term plan when calculating surrender value. In a traditional plan, surrender value usually depends on paid-up value and bonuses. In ULIPs, it is about your fund value minus charges, with a mandatory five-year lock-in. Exiting a unit linked insurance plan (ULIP) in year two, for example, does not result in an immediate payout. In such a case the fund is shifted to a discontinued policy fund and released only after lock-in ends.
• Bonus accruals: If your policy is a participating plan, you may have accrued reversionary bonuses or terminal bonuses. These can help add to the special surrender value paid out by the policy.
• Loss of protection: The cash payout is only one side of the equation. By surrendering your existing term, you also give up the life cover your family would have received from the policy. While this impact may be minimal if you have multiple term policies in place, do think twice before surrendering, if you have only a single term policy.
• Charges: Life insurance plans typically feature various charges such as mortality charges, administration fees, and fund management costs. These are typically deducted when processing your surrender application and can reduce the final surrender value payout of your insurance policy.

Understanding surrender value meaning, calculation formula, etc., helps you make an informed decision about your life insurance policy. It is about making choices between short-term cash needs and long-term security. However, surrender value calculations can be complex and they vary depending on the type of insurance policy, the policyholder's age and health, and various other factors. Thus, it is essential for policyholder to understand their life insurance policy surrender value and how it is calculated, as it can impact their future financial as well as insurance needs.