Surrender value vs paid-up value: Know the key differences

For life insurance policyholders in India, understanding financial outcomes during policy terminations or modifications is crucial. Two commonly misunderstood terms in this regard are surrender value and paid-up value. Both have distinct implications on the benefits policyholders receive.

With recent changes introduced by the Insurance Regulatory and Development Authority of India (IRDAI), it’s essential to revisit these concepts in the context of the updated guidelines.

What is surrender value?

Surrender value refers to the amount a policyholder receives upon prematurely terminating a life insurance policy. Under IRDAI’s revised norms effective October 1, 2024, policyholders can now access surrender value after paying just one annual premium. This is a significant departure from earlier rules requiring two years of premium payment for eligibility. This aligns with the changes in IRDAI regulations and emphasises flexibility for early policy exits.

Surrender value includes:

Guaranteed surrender value (GSV): A fixed percentage of premiums paid, based on the policy's term.

Special surrender value (SSV): A calculation involving paid-up value, bonuses, and future benefits.

How it works:

For example, in a 10-year policy with a sum assured of ₹2.5 lakh, if premiums for two years are paid, the SSV formula calculates 20% of the sum assured (₹50,000), adding accrued bonuses. This flexibility ensures liquidity for policyholders facing financial emergencies.

What is paid-up value?

When policyholders decide to stop paying premiums but keep the policy active, it becomes a paid-up policy. The paid-up value is calculated as:

Paid-up value = (Premiums Paid / Total Premiums Payable) × Sum Assured.

For instance, if a 15-year policy has premiums paid for five years, the paid-up value will be one-third of the sum assured. The policyholder will receive this reduced benefit either as a lump sum or at maturity, maintaining the policy’s coverage without additional payments.

Implications of IRDAI’s New Regulations

The recent IRDAI guidelines enhance policyholder benefits. Key highlights include:

Early surrender options: Policyholders are now eligible for a surrender value after the first premium, addressing liquidity needs sooner than before.

Increased flexibility: Higher SV ensures better payouts, especially for policies surrendered early in the term.

Encouragement to stay invested: Enhanced paid-up value calculations incentivise continuing coverage without further financial obligations.

When to choose surrender value or paid-up value?

Opt for surrender value if immediate financial relief is needed. However, surrendering a policy early results in reduced payouts, as bonuses and other benefits may not fully accrue.

Opt for paid-up value if you want to retain insurance coverage without additional premium payments. This choice is beneficial when long-term protection is a priority, even if the payout is reduced.

If the policy is proving to be a strain on cashflows and if the internal rate of return (IRR) is low, surrender the policy.

If the policy maturity is near, make the policy paid up.

Conclusion

For Indian policyholders, the distinctions between surrender and paid-up values are now more pronounced under the revised regulatory framework. By understanding these concepts and leveraging recent changes, policyholders can make informed decisions to align their life insurance policies with their financial goals. The new rules not only improve liquidity but also ensure that premature exits do not excessively penalise policyholders, striking a balance between flexibility and long-term benefits.

(The author is Founder, Managing Director, and Chief Financial Planner at Dilzer Consultants Pvt Ltd)