More often than not, insurance policies do not make efficient investment products. There is a host of other options available which can do a better job. Hence the question: should I surrender my old policies or not?
If insurance was a good investment product, I am sure this question would not have come up. But the answer, I am afraid, will not be a plain 'yes' or 'no.'
Insurance is a cost
Firstly, we need to be a clear about one point -- insurance is a cost. Whether one would want to incur this cost or not, and to what amount, is a matter of personal choice. As the insurance companies themselves say -- 'insurance is a subject matter of solicitation,' which essentially means that insurance has to be requested or asked for, not sold.
However, given the uncertainties of life, it may be prudent to get an insurance cover to protect the family from any unforeseen eventualities. And since it is a cost, one should try to minimise this cost, without sacrificing the need for life cover. This is very well achieved by what is called Term Policy, which are pure-protection policies.
Low popularity of Term Policy
But the problem with term policies is that, one doesn't get anything back if one survives the policy term. So psychologically, it is difficult for people to pay-up hard cash for an intangible product, i.e. security.
Therefore, they tend to go for products, which give some returns at the end of the term. Hence, Moneyback and Endowment (and of late ULIP) type of policies are more popular.
But people tend to forget that the same amount that they would otherwise pay in a term policy also gets deducted from these so-called protection and investment policies. And only the net amount gets invested.
Further, since (a) the administrative costs are high and (b) the corpus is invested in very safe instruments, the returns from such policies are usually very low -- usually in the range of 5-7% pa.
Therefore, a person would be better off taking a term policy to get the life cover and investing the balance premium amount say in PPF where he can earn 8% pa returns (assuming he wants no risk of investing in equity).
Desire to surrender
As more people realise their mistake, they want to exit from such insurance policies. Unfortunately, however, early exit from insurance policies results in a huge loss. So does it make sense to surrender one's policies despite this loss?
There could be three broad scenarios possible, depending on how many premiums you have already paid, out of the total premiums payable.
The three scenarios
Early stage: A policy can be surrendered only if it has been in force for three years and premiums have been paid for these years. If you have paid just one or two annual premiums, then you will get back nothing when you exit from the policy.
Even thereafter, you will get back say only 25-35% of the premiums paid + bonus accrued, if any. This is for a typical 20-year term policy. The % varies depending on the term and premiums paid.
So, broadly speaking, you will get back say 0-35% if you surrender the policy in early stages. If you invest this amount + the future premiums in other investment options, you will need to generate around 9-11% p.a. returns to recover the lost premiums and break-even with the insurance policy if you had continued with it.
So, if you are confident of making better returns than that, you could consider surrendering your policy, taking a hit and moving on to better investment options.
Middle stage: If you are somewhere around the middle of the policy, you have two options.
(a) Surrender the policy
Here you can take whatever money you get -- maybe around 50% of the premiums paid + bonus; and invest this and the future premiums somewhere else. The absolute loss is higher here as more premiums have been paid and time for recovery is less. So, you need to generate maybe around 14-17% pa returns to break-even.
(b) Make the policy paid-up
Herein, you can make the policy fully-paid. Your sum assured will be suitably lowered. And you will back the premiums paid + bonus earned -- but only at the end of the original term. Also no fresh bonus will accrue during this period.
The net return for this amount works out about 4%. Invest the future premiums in the other options. Here you may have to generate somewhat lower returns of around 12-15% p.a. to break-even on overall basis.
Of the two, option (b) could be a better alternative in middle stages.
Late stage: If your policy is just about to mature in three to five years, then it may well be prudent to let it run its' course. You can't do much by saving 3-5 years' of premium payments.
Note that these are very broad numbers and the actual numbers could vary significantly. Given the plethora of insurance policies, the policy term, no. of premiums paid, et ceterea, it is important that you do a detailed working for each of your policies, before taking any further
Since there is risk element involved in earning higher returns, you have to decide whether you are a game for it. My view would be that if you have the capacity to take risk, it may well be worth it.
Moreover, we are NOT talking of some 'unreasonably high return expectations.' With a GDP growth expectation of 7-10% over the next decade or so, it is quite reasonable to expect 12-15% returns from equity over this long period. And one can just choose the index funds for this.
The author, Sanjay Matai, is an investment advisor.
