Surrender Value in Life Insurance Policy: Definition & Types

While buying a life insurance policy, you're not just ensuring financial protection for your loved ones but also making an investment. 

Now, to keep the policy active, you have to pay the premiums regularly, but what if a situation arises when you are unable to pay the premiums due to a cash crush? Or the policy you bought four years back is no longer meeting your requirements? 

In all such scenarios, you’ll prefer to exit the policy before its term ends. Right? 

But before surrendering, you need to understand the concept of "surrender value". 

In this blog, we’ll explain what surrender value is in life insurance, its types, advantages and how it is calculated. 

What Is Surrender Value in Insurance?

When a policyholder decides to terminate the policy before its maturity date, the life insurance company pays an amount called “surrender value.” As per the policy type, the surrender value will only get paid 

• If the policy is active for a particular period of time (3 to 5 years). 
• If the policy has a surrender value benefit.  

The surrender value is calculated depending on the number of premiums paid, policy duration, and various other factors at the time of surrendering. Also, the insurer charges a specific penalty, under “surrender charges”, for withdrawing the policy’s cash value before a particular period has passed.  

For instance, Amit purchased a policy five years ago but is now unable to pay the policy premiums for some reason and is finally surrendering it. In this case, he will receive the surrender value after deducting the surrender charges as per the terms of the plan, and policy benefits will be discontinued. 

(As per the IRDAI regulations, if the policyholder surrenders the policy after five years, the insurance companies in India cannot impose surrender charges).

What Happens When You Surrender a Life Insurance Policy?

To maximise the policy benefits, it is advisable to stay invested throughout the policy term. Still, in case the insured decides to surrender the policy due to some unforeseen events, here are some points that they should understand while surrendering a life insurance policy.  

• The policy term will end before maturity. As a result, the life insurance coverage ends, and you no longer need to pay premiums. 
• Because the policy gets terminated, the policyholder is not liable for any terminal benefits such as death benefits or maturity benefits. 
• The insurance company pays you the surrender value (as per the surrender clause mentioned in the policy terms and conditions.), which is a portion of the premiums you’ve paid. 
• In the case of the Unit Linked Life Insurance Insurance policies (ULIPs), the lock-in period is typically five years. 

So, can you surrender the policy before five years? Yes, you can, but you won’t receive any payout immediately. The money will basically move to another discontinuance fund, where it remains until the lock-in period ends. After the lock-in period, you receive the surrender value, but it will be subject to charges and may not include the full value of your investments. The profit completely depends on how your invested fund has performed. 

Types of Surrender Value in Life Insurance

Below are the types of surrender value in life insurance. 

• Guaranteed Surrender Value

Guaranteed Surrender Value is paid by the insurance company to the policyholder if they decide to surrender the policy before the end of the term. Generally, the payable amount is already mentioned in the brochure under the head, “Guaranteed Surrender Value” and is payable after a period of 3 to 5 years. 

It is calculated by adding all premiums paid in the entire policy period (excluding first-year premiums and any additional premiums paid for riders).

• Special Surrender Value 

Special Surrender Value is paid above the Guaranteed Surrender Value and depends on multiple factors such as total sum assured, total premium paid, policy term, and applicable bonuses. 

However, there is no guarantee that Special Surrender Value will be paid; it entirely depends on the insurer and policy terms and conditions. 

In the next section, we’ll explain how Guaranteed Surrender Value and Special Surrender Value are calculated. 

How to Calculate Surrender Value?

• Guaranteed Surrender Value

The Guaranteed Surrender Value is calculated as 30% of the premiums paid towards the plan. Generally, the total premiums paid are multiplied by the surrender value factor (percentage of total premiums paid). 

Let’s understand with the following example- 

Avi paid a total of ₹35,000 premiums for three years for a sum assured of Rs 3 lakh, and the surrender value factor is 30%, then the guaranteed surrender value will be 70,000 × 30% = 21,000. 

• Special Surrender Value 

To know how Special Surrender Value is calculated, you must first understand what the paid-up value is. 

So, when the premium payment discontinues, the sum assured will decrease, and the lower amount will become the paid-up value. By surrendering the paid-up policy, the policyholder will receive the particular surrender value, which is estimated by adding the paid-up value to the surrender value factor.

Below is the formula used to calculate SSV: 

Special Surrender Value = {Basic Sum Assured X (Number of Premiums Paid/Total Number of Premiums Payable) plus total bonus received}X Surrender Value Factor.

Let’s understand with an example - 

Anshuman paid ₹30,000 in premiums per year for a 20-year policy with a sum assured of ₹6 lakh. Now he stopped paying the premium after a period of 4 years, the bonus collected so far will be₹60,000, and because the surrender value factor in the fourth year is 30%, the special surrender value = (30/100) *(6,00,000*(4/20) + 60,000) = ₹54,000. 

Advantages and Disadvantages of Surrendering a Policy

Here are some pros and cons of surrendering a life insurance policy- 

Advantages 

• Fulfill Cash Needs- Surrendering a policy will help provide immediate access to cash, which can be helpful if you’re in need of funds. 
• Better Investment Opportunities: If the current policy does not meet your expectations, you can use the surrender value to invest in another plan to get more benefits. 
• No Premium Payments -  By surrendering a policy, the policyholder does not need to pay ongoing premium payments, which can be a financial burden for some. 
• Get Potential Bonuses - Depending upon the policy, you may get bonuses along with the surrender value. 

Disadvantages 

• Minimal Return - While surrendering the policy, the insurer only offers a small portion of the money according to the premiums paid. 
• Loss of Death Benefit - One of the significant drawbacks of surrendering a life insurance policy is that you will lose the death benefit it provides. After surrendering the policy, if something happens to you, your family will not be able to receive any financial protection in your absence. 
• Tax Implications - If the surrender value is higher than the premiums paid into the policy, surrendering a life insurance policy can have specific tax implications(depending upon the policy). 
• Surrender Fees - There are specific fees charged by insurance carriers that can take away a large part of the surrender value, leading to a reduction in the amount of cash available. Depending on when you surrender it, the charges can be up to 10-35% of the proceeds you’ll get. 
• Limited Options - While surrendering a policy, there is no room for negotiation; the insurance company will give you a take-it or leave-it offer. 

Surrender Value vs. Paid-Up Value

Parameter	Surrender Value	Paid-Up Value
Definition	It is the amount paid by the insurance company upon terminating the policy before the maturity date.	It is the value of the reduced sum assured after the policyholder stops paying premiums.
Terms and conditions	Surrender values get paid only after a policy has been active for a particular period of time, usually three to five years.	To acquire the paid-up value, the policy should be in force for at least 3 years (5 years for ULIPs).
Formula	Special Surrender Value = {Basic Sum Assured X (Number of Premiums Paid/Total Number of Premiums Payable) plus total bonus received}X Surrender Value Factor.	Paid up value = Original sum assured x (No. of premiums paid / No. of premiums due)
Example	Aman, with a policy term of 25 years, paid ₹40,000 per year for life insurance coverage with a sum assured of ₹8 lakh. After paying premiums for a period of 6 years, if the accumulated bonus is Rs ₹80,000 and the surrender value factor is 25% Then, in the 6th policy year, the special surrender value= will be {8,00,000* (6/25) + 80,000}* 25% =  ₹68,000.	Suppose you have an insurance policy with a sum assured of ₹10 Lakhs for 20 years with a premium of ₹30,000 p.a. paid for 8 years. The paid-up value will be - 10,00,000 * 8/20 = ₹4,00,000

Conclusion 

Surrender value in a life insurance policy assures the policyholder that they will get some money in case of terminating the policy if they no longer need the coverage. However, there will be no policy benefits to support your family in your absence. So, it is essential for policyholders to understand the pros and cons of surrender value and how it gets calculated so that they can get a clear picture of their financial decisions and future insurance needs. 

Finally, one should always understand the terms and conditions with the help of an insurance advisor and make a well-informed decision. 

FAQs (Frequently Asked Questions)

Ques 1. What is the surrender value in life insurance policy and its types?

Ans. The surrender value is the specific amount of money given to the policyholder if they decide to terminate the policy before its maturity date. It is of two types: Guaranteed Surrender Value (GSV) and Special Surrender Value (SSV). GSV is pre-decided and is written in the policy brochure, while SSV is paid according to the insurer’s specific terms and conditions. 

Ques 2. Is there any surrender value charge after five years? 

Ans. As per the IRDAI regulations, if the policyholder surrenders the policy after five years, the insurance companies in India cannot impose surrender charges. 

Ques 3. Who pays the surrender value? 

Ans. Surrender value gets paid to the life assured by the insurer if the policyholder decides to terminate the policy before the maturity date. 

Ques 4. Is surrender value tax-free?

Ans. The tax implications of surrender value depend on the specific policy. For instance, in ULIPs, if the policy is surrendered after five years, the surrender value will be tax-free.