Insurance in India was traditionally bought by customers more as a tax saving investment rather than to protect the family’s future from adversities in life. The Insurance Regulatory and Development Authority (Irda) effected changes in September 2010 that made selling of unit-linked insurance plans (Ulips) less attractive and selling traditional insurance products more attractive for agents.
These changes along with a slowing capital market (that impacted returns from Ulips) have changed the course of the industry with insurers now selling more traditional products than Ulips while making customers more receptive to them.
While these traditional products are simple on the face of it, very few customers actually understand the benefits/returns offered by these products. What is more popular among traditional products are participating products.
These are products which offer a share of insurer’s profit in the form of bonuses that are declared from time to time by the insurer. Declared bonuses (disbursed at the time of claim) are a very important aspect of any insurance plan that affects the returns one gets from the policy.
Bonuses are expected to be smoothed from one year to the next so that there is minimum volatility in the returns given to the policyholders.
My attempt here is to demystify the perceived complexity around the bonuses offered in the participating insurance products, which should help a consumer take an informed decision while buying an insurance plan.
A traditional insurance policy, if in force/fully paid, shall participate in the profits of the company’s policyholders’ fund from the commencement date of the policy. It gets a share of the profits in the form of bonuses.
These bonuses declared regularly and paid at the end (at the time of claim) are called reversionary bonuses. They are declared as a percentage rate, which applies to the sum assured of the policy, in respect of the basic policy benefit.
Once declared, they form a part of the guaranteed benefits of the policy. The two common forms of declaring reversionary bonuses are given below:
I) Simple reversionary bonus
II) Compound reversionary bonus
Simple reversionary bonuses are declared as a percentage rate, applied to the sum assured in respect of the basic policy benefit.
Compound reversionary bonuses are a percentage rate, which apply to the sum assured in respect of the basic policy benefit, and to the reversionary bonuses already attached to the policy. The difference is in the way the bonuses are accrued.
Given the same rate of bonus every year, simple bonuses are accrued in a straight line, whereas compounded bonuses increase with duration due to compounding.
As you can see, the benefit accrued is almost the same after 20 years, although the simple bonus is at 5% and the compound bonus is at 3.6%. This is because of the way the bonuses are accrued under different methods.
The reversionary bonuses are normally declared annually at the end of each financial year based on the statutory valuation carried out under the prevailing regulations.
A reversionary bonus would normally be declared at the end of every financial year. They are payable at the time of claim i.e. at maturity or on the death of the life assured or surrender during the policy term.
Similarly, during the term of the policy, if there are some profits arising due to a one-off reason, and the same profits are not expected to repeat again, this profit is passed on to policyholders as a one-time bonus which is called as special reversionary bonus. This bonus is declared immediately but paid at the time of claim/maturity.
Terminal bonus is paid at maturity or at the time of claim. After declaring reversionary bonuses if there are still residual profits available in the policy, they are declared as terminal bonus.
Terminal bonuses are quite common with many insurers, although one-off bonuses are not very common.
It is important to understand reversionary bonus in your policy while buying a participating product. Don’t be misled by just looking at the bonus rate, projected rate for future or the bonus rate declared by a company last year. Understand what bonus it is and what it means to your final benefit.
Also, don’t be misled by making a direct comparison of bonus rates between two companies. One company may follow a simple reversionary bonus approach and the other company may follow a compound reversionary bonus approach. Compound bonus may look small initially but can become big towards the later years of the policy as your bonus will earn further bonus.
The different bonuses mentioned above are the critical ones for a customer. There are other types of bonuses, such as cash bonus. So, understand the bonuses before making a decision. If not clear, ask for more information.
Look at your sales illustration. Look at the benefit accrued each year and make an informed decision. And finally, please note that the bonuses shown in your illustration are only indicative and not guaranteed.
So, don’t be misled by higher bonuses shown (if at all they are shown higher), but look at the company profile and past records and its ability to make profits. Companies which make profits only can give you better bonuses, not the ones who just show better bonus rates in their illustrations.
By: Sai Srinivas Dhulipala, Appointed Actuary, Future Generali India Life Insurance