Life Insurance Bonus

Life Insurance policies are of 2 types:

Pure Protection: These policies only cover mortality risk, are usually for a specific term of years, pay out the Sum Assured on death and will not refund premiums already paid if the policyholder survives the policy duration. Term insurance plans are the best example.

Savings Plans: These plans have an element of saving in addition to covering mortality risk. Endowment and Money Back are 2 examples of savings plans.

On a basic level, out of the premium collected by the insurance company under savings policies one portion is allocated to covering mortality risk, another portion is allocated to paying commission to distributors and managing the expenses of the company and the rest of it is invested on behalf of the policyholder. 

At claim (maturity or death), the Sum Assured and the “returns” are paid out. The Sum Assured, which is a pre-determined amount, is always guaranteed.

The returns generated by the company are proportionately allocated to each policy. Such returns may either be:

1.       Guaranteed in advance at policy purchase and is allocated to the policy account at the promised interval. Guarantees usually specify the rate at which payment will be made, the method of calculation and the periodicity of payout. The usual terminology used is “Guaranteed Addition”. Another type of guaranteed amount includes Return of Premium. Under these policies, called the Term Return of Premium (TROP) or simply Return of Premium (ROP), the insurance company will cover risk for a certain period of time and then return all or some of the premiums paid either with or without interest. It is common for companies to highlight the fact that a guarantee is offered. Policies with guarantees promised in advance are simpler to understand.

2.       Non-guaranteed returns are allocated to the policy on a periodic basis – usually annually. There are several types of non-guaranteed “returns”.

1.       Reversionary Bonus: The insurance company generates a return on the policyholder’s funds and decides to allocate a certain portion of the return to the policyholders in the pool. This is called reversionary bonus. Some of the common features of a bonus are:

a.       Bonuses are declared retrospectively and allocated retrospectively.

b.      Bonus rates are not known in advance and amount declared will depend on the investment experience of the company.

c.       Once bonus is allocated to a policy, it is almost always guaranteed to be paid out. What this means is that while the exact amount cannot be guaranteed and depends on the company’s performance and inclination to allocate, once allocated it is guaranteed to  be paid out.

d.      Once allocated, the amount so allocated is called vested bonus.

e.      Vested bonuses are of 2 types:

·         Simple Reversionary: The amount of bonus allocated is always a percentage of the original maturity Sum Assured.

·         Compound Reversionary: The amount of bonus allocated to a policy is added to the maturity Sum Assured and bonus is calculated as a percentage of the maturity Sum Assured and any bonus already vested.

f.        Reversionary Bonuses are usually paid out at the end of the policy term.

Let us take an example:

Maturity Sum Assured	Rs. 100,000
Year 1 Bonus Declared	4%
Year2 Bonus Declared	5%

Total Bonus under Simple Reversionary Method	Total Bonus under Compound Reversionary Method
Year 1:  (100,000X 4%) =  4000	Year 1:  (100,000X 4%) =  4000
Year 2: 4000 + (100,000X 5%) =  9000	Year 2: 4,000 + (104,000X 5%) = 9200

Bonuses declared under Compound Reversionary mechanisms are usually lower in absolute numbers than Simple Reversionary methods. Sometimes insurance companies declare reversionary bonuses other than as percentage. The most popular is as a value against Rs. 1000 Maturity Sum Assured. For example, 4% will be represented as 40/1000 Sum Assured. This larger number serves to create a sense of assurance in policyholders.

Some companies use the term cash bonus. These are usually simple reversionary in nature and by implication is paid out periodically – usually annually.

2. Terminal Bonus: Some bonuses are only declared, allocated and paid out towards the end of the policy term. These are Terminal Bonuses or (as LIC calls it) Final Additional Bonus. Like reversionary bonus, terminal bonus is calculated based on the company’s experience and is non-guaranteed. Terminal bonuses will not be paid out if the policy is voluntarily ended by the policy holder as when he lapses it or surrenders it.

3. Loyalty Additions: These are payments are calculated in a manner similar to reversionary bonuses with the exact amounts not known in advance. As the term implies, this kind of bonus is paid out only if the policy holder stays with the company for the duration specified.  

In a strict sense, rates of bonus allocated in the past do not guarantee that the same rates will continue in the future. However companies do try and maintain allocated bonus rates. Savings policies do not provide great returns but are steady assets, remaining hidden in one’s portfolio till needed. Coupled with any applicable tax advantage, these policies can serve as a good means to diversify financial risk.

You can now compare savings type insurance policies on www.policylitmus.com and take the most appropriate decision to meet your financial needs.