I am often asked whether or not to surrender an insurance policy. Surrendering means to stop an insurance mid-term. The question is most difficult to answer in traditional life insurance because the analysis must factor in the downside of a surrender penalty, taxes not being returned and loss of death benefit against the possible benefit of better investment returns.
All insurances—life, general and health—have a provision for surrender if you have not made a claim. This provision is poorly understood because when you buy insurance the focus is on benefits and claim settlement. We do not expect to surrender insurance mid-term. However, circumstances do change, new products do get introduced or you may conclude that you bought the wrong product. Surrender is frustrating because you feel the pinch of penalties.
All insurance products allow early closures. In the free-look period, typically the first 15 days after you receive the insurance, you can claim a complete refund. There may be some minor deductions for administrative or risk-related costs. This free-look period is allowed in life, health and general insurance and the clock starts from when you receive the insurance contract. So the first thing to do when the documents reach you is to read them and decide that this is what you wanted.
Surrender costs increase dramatically once the free-look period is over. In health insurance, early exits are possible but refunds are made using the short period scale. This imposes a severe penalty—if you leave in the first three months, 50% of your premium will be refunded; between three and six months, 25% will be returned; and after six months, nothing. These are the minimum amounts that need to be returned but a few insurers pay more than the minimum scale. In travel insurance, refunds are linked to the trip start date. You can claim a full refund with minor deductions for administrative charges, if your trip is cancelled. You can also claim a deduction if you come back from the trip early. The rules vary by insurer but generally if you spend half the time you had planned for, you can get 25% of your premium back. Motor insurance also allows for surrender using short period scales similar to health insurance.
In life insurance, unit-linked insurance products (Ulips) have two different kinds of surrender periods. During the first five years, you do not get your money back. On surrender, the insurer will move your balance to a discontinuation fund where you earn a return of 3.5%; this will be paid after five years and after deducting mortality charges. If you surrender after five years, you may withdraw your accumulated funds without a charge. Traditional life insurance has more onerous surrender terms.
Most products have a tenure of over 10 years. In these, no money is refunded if you close the insurance in the first three years, after that 30% of premiums paid are refunded if you close in the fourth year or less, 50% is returned until the seventh year and 90% is returned in the last two years. In all these cases, the act of surrender destroys value because you do not even get your capital back. This surrender scale is the minimum prescribed and policyholder-focused insurers do pay more.
Surrendering an insurance is cumbersome because of the processes. Life insurers require that you visit the insurer’s branch with the original policy copy. In health and travel insurance, the process is simpler and may be done over email. Insurers insist on a physical meeting before accepting a surrender because they would like to convince you to retain the insurance. They also try to determine if you are being incorrectly pushed into this decision by an adviser who seeks to replace your insurance with the objective of earning new business incentives.
You should consider a surrender only if you really need the money or what you bought is completely different from what you expected. But once you have made the decision, see it through. I often see policyholders do a detailed analysis that suggests surrender as the best option. Yet they do not follow through with this because surrender is an explicit recognition that they made a judgment error. Vanity triumphs over practicality.