New laws regarding the surrender value of life insurance contracts have finally been announced by the Insurance Regulatory and Development Authority of India (IRDAI) following many changes. The December 2023 draft first suggested large surrender values for policyholders.These figures have been somewhat tempered by the final master circular, which was released on Wednesday, but they are still higher than the current rates.

For those who are not familiar, surrendering an insurance entails canceling it before its term expires or withdrawing it completely.The surrender value is the greater of the Special Surrender Value (SSV) and the Guaranteed Surrender Value (GSV), which is paid at the time of surrender.

Presently, policyholders have the option to abandon their policies at any point throughout the term as long as they have paid for both full years of premiums. If you turn in before this time, there are steep fees and no reimbursement.

"SSV calculated shall become payable after completion of the first policy year provided one full year premium has been received," according to the updated IRDAI Master Circular, which was released on Wednesday. For policyholders, this is good news because, under the current regulations, there was no surrender value paid during the first year.

The new regulations require insurers to guarantee that the SSV, after deducting any already paid survival benefits, is at least equivalent to the projected present value of the paid-up sum insured on all contingencies, paid-up future benefits, and accrued/vested benefits.

The interest rate utilized in these computations cannot be higher than the current yield on 10-Year G-Secs plus a spread of fifty basis points. According to the new laws, the present value of the paid-up sum insured plus the future bonus, for a person with a 10-year policy that has a sum assured of Rs 1 lakh, an annual premium of Rs 10,000, and a policy bonus of Rs 50,000, would be Rs 7,823 or 78%.

The percentage of premium payments made determines the paid-up value of an insurance policy. This formula is used to compute it: Paid-up value is calculated as follows: (Total policy term / Number of years premium has been paid)*(Total Amount Guaranteed).

These new rules, which must go into effect by September 30, 2024, are anticipated to raise the total surrender value for clients. Policyholders are currently only eligible to the Guaranteed Surrender Value after two years. When someone surrenders after the second or third year, for example, they usually only receive a refund of 30–35% of the premium amount, not including incentives. The percentage rises during the course of the policy, hitting 50% in the event of a surrender between the fourth and seventh year and 90% in the final two years.

A representative for HDFC Life stated, "Although we expect higher surrender values on early exits to have a gross impact of about 100bps on the company's New Business Margin (NBM), we are confident in our ability to largely mitigate this impact without sacrificing the value proposition for our customers. We anticipate that these actions will have a positive effect on the industry's long-term growth prospects."

Updates on Surrender Values

Following the release of the first draft in December 2023, the Irdai declared in April 2024 that they intended to withdraw their plans for surrender values in December 2023. A framework for implementing the increase was established by May 2024, and insurers were requested to provide comments and explore possible relaxations of the proposed SSV rise by May 31.

Surrender Value Revisions

After the initial draft shared in December 2023, the Irdai in April 2024, announced planned to back down on surrender value proposals in Dec, 2023. By May 2024, they introduced a framework to implement the increase and invited insurers to submit feedback and seek potential relaxations on the proposed SSV increase by May 31.

IRDAI had suggested the idea of a premium threshold for every product in the December 2023 draft regulations. When the policy is surrendered, there won't be any surrender fees applied to the remaining premium beyond this point.  For example, let us take a look at an endowment insurance with a 20-year policy term, and an annual premium of Rs 1 lakh. The guaranteed surrender value upon the payment of the third annual premium might be calculated using the following formula, assuming a threshold limit of Rs 25,000:

1) The threshold premium's guaranteed surrender value is equal to Rs. 25,000 x 3 x 35%, or Rs. 26,250.

2) If the premium exceeds the threshold premium, Rs 1,00,000 – Rs 25,000 x 3 = Rs 2,25,000 will be the premium return.

3) As a result, the total of (1 + 2) would be the amended guaranteed surrender value, or Rs 2,51,250.

4) The Special Surrender Value or the Adjusted Guaranteed Surrender Value, whichever is larger, would be the surrender value.

The surrender value would have increased significantly since, under the current laws, one would have been eligible to receive Rs 1,05,001, or 35% of the premium paid.

A simplified Customer Information Sheet, training programs, required policy loans to enhance liquidity, the introduction of variable annuities, an extended free look period, robust processes to address customer grievances, and higher value to customers on early exits are all announced in the Master Circular on Life Insurance products that was released on Wednesday. All of these announcements should help the regulator achieve its goal of insurance for all by 2047.