June 6, 2011

Surrendering policies – a painful but necessary decision?

Sadique Neelgund

Insurance SurrenderOne of the important tasks on hand when we as Financial Planners take up a new case is to help clients clean up his insurance and investment portfolio. In the absence of unbiased advice, adhoc decisions and sales oriented financial advisors, many of the clients make mistakes with their investment decisions.

The most prominent among the common mistakes made of clients is buying of a wrong insurance policy pushed by an insurance agent. Almost all the clients I have dealt with have at least a couple of dud insurance investments. It’s a very hard decision both for the planner to recommend surrendering a policy and a client to execute such a recommendation.

Recently, there has been an active discussion on this very topic on Network FP’s LinkedIn Group. There are some very insightful thoughts thrown up by other financial planners especially Chenthil Iyer & Anad Kulkarni.

Do go through it to the nuances of surrendering a insurance policy and dealing with clients regarding the same. It’s a interesting read, add your thoughts too. I am re-publishing the comments here for your convenience;

Anad Kulkarni: While doing financial planning clients, many a times we find that the client has Insurance Policies which are Endowment policies with higher premium and very little Sum Assured. Also the policies are at such a stage that if we recommend surrender, they incur very higher loss and continuing them does not make any sense. Though the clients know after our recommendation that Term Insurance is best to protect his/her family, it’s painful for the clients to break their insurance policies. What are your thoughts on this, how do we communicate this to clients and any other alternative course of recommendations?

Ramkrishna SR: Proposing breaking of existing policies may not be wise as endowment policies have their own advantages in retirement planning. Further the quantum of available endowment policies is generally y low and hence additional converge through term insurance may be thought of instead of replacement alone.

Badarisha M N: It is true anyone who has bought these traditional policies would feel the pinch…. It is always prudent not to continue with endowment or moneyback with long duration and it is how we communicate so that we can make him understand the reality and advice him on the future value of these policies… Even we feel the same after understanding the Cashflows and future value of these policies… one should foresee and avoid these kinds of financial disasters….

 Sadique Neelgund:  I have come across this situation with almost all clients. Checking the net yield is the number one step. If the yield is very poor i.e. less than 5-6%, the policies should be seriously considered for a surrender. If the premium is small let it go to keep the client at peace (it’s painful to surrender policies). If the premiums are high, then a quantitative working of cashflows and a comparison chart for each of the surrender recommendation will do the trick. Clients need time to come to terms with their mistakes, but eventually they do realize.

 Chenthil Iyer: why not make the policies paid up? It works fantastic and is an excellent middle path. Surrender is very painful. In my opinion, there are only two options which are beneficial 1) make it paid up if <60% policy duration is completed or 2) else Continue the same till maturity.

 Sadique Neelgund: Chenthil, I have never explored this option so not sure about how it works. Can all the policies be made paid up? And is the following paid up value formula applicable to all?

Paid up value = Original sum assured * (Number of premiums paid / Total number of premiums that were required to be paid)

 Anad Kulkarni: Yes Chenthil, even I am not sure about paid up value, but mostly I hear from almost all clients that if they wish to surrender…they incur heavy loss. I think it may be applicable to selected policies…

 Manish Jain: I have been talking to a client about getting the ‘expensive’ LIC endowment policies paid up. Not yet put to action. But yes, it is better to cut your ‘losses/low returning policies’, if detected at an early stage than to continue with them with notional losses building up each year. The effect of ‘negative compounding’ can be disastrous for the investor at the end of the 2–25 year period. As a planner, we should give a logical and mathematical reasoning to our clients.

 Manikaran Singal: I feel that whether to continue or surrender the policy totally depends on cash flow arrangements. If client is generating good cash flow and all other requirements /goals are meeting up with the new fresh arrangements recommended than there’s no point surrendering the policy. But yes if premium payments towards endowment policies is big and thus creating problem in allocating enough money to other growth assets than it is very logical to making the policy surrender/paid up.

 Jitendra Solanki: I too have come across so many clients who have number of policies not yielding right returns. I make them understand the implication of these policies on their financial goals. Yes some clients do have hitch in discontinuing these policies especially if it’s traditional. Hence mostly I recommend making “Paid Up”. The problem is when they go to LIC to check this no one recommends them to make it paid up. In fact they deny any such option. Reason, making paid up will show in agent lapsation record. That’s where the most of the confusion is happening and clients get inclined towards continuing some of the policies.

 Chenthil Iyer: Sadique and others, the formula is very generic and can give us a good indicative figure. This indicative figure works without affecting the efficiency of the cash flow analysis. However, the specific formula that will apply would most probably be given in the policy document (it sure is in LIC policies), if you have the patience and a magnifying glass 🙂 Also, the paid up value, by virtue of reversionary bonuses accumulated in the policy as a percentage of sum assured, typically yields 4.5 – 5.5% p.a. which would be the yield even if the policy is continued till the very end. So it works excellently in the following ways,

1) helps you prevent inefficiency in the future premia
2) gives you surplus cash flows for your investment portfolio
3) The policy continues with reduced sum assured
4) The client is not worried since the IRR is effectively the same even if he continues the policy

Handling the insurance officials is a task in itself, since the problem mentioned by Jitendra very much exists. Even the Development Officers visit such clients to convince him not to make it paid up! Therefore this is something the planner can take it on himself with a letter of intent from the client and get this executed. I insist on it personally only if it makes a lot of impact on the cash flows. Otherwise I leave it to the client.

 Anad Kulkarni: As mentioned by Chenthil having patience and use of a magnifying glass, I found in the conditions mentioned about Guaranteed SV :

“This policy can be surrendered for cash after the premiums have been paid for at least 3 yrs. The minimum SV allowable under this policy is equal to 30% of the total amount of the within-mentioned premiums paid excluding premiums for the first year and all extra premiums and/or additional premiums for Accident Benefit that may have been paid. The cash value of any exiting vested Bonus Additions will also be allowed.”

I did not find anything regarding making paid-up in the terms and conditions, after reading 5-6 times….

My purpose of discussion is, forget for a time being to have a look from a planner’s view, client feels difficult to practically book a loss …..let’s have a look on with one case :

For a 20yrs traditional plan client had paid 7 premiums of 9733 = 9733 x 7 = 68,131. When asked by client in the insurance office he was told that he will get only 49,478 if he surrenders. A loss of approx. 20,000 hitches most of them in discontinuing although clients understand other benefits explained by us to him… but practically he feels difficult to surrender.
The above loss of 20,000 is just with reference to ONE policy, and we know a client usually has how many policies in his insurance portfolio.

 Prakash Praharaj: The Visual Magic Pro (DATACOMP) software provides the paid up value and SV factor if you input the LIC policy details. Surrender value is Paid up value* SV factor (which is decided by each company).But this excludes the term insurance policies.

I have been able to convince the clients to go for paid up/surrender but the resistance comes from the Insurance Advisor who has sold the policies. Another factor material to the decision is the track record in claim settlement in which LIC is the best. What if the new company’s track record in claim settlement is poor?

Ratan Kunkulol: It is difficult to surrender policies, but before recommending surrendering of a policy please check IRR of surrender values to maturity. If it comes to 10-12%, than do not surrender policy.

Authored by,

Sadique Neelgund

Network FP

25 Thoughts to “Surrendering policies – a painful but necessary decision?”

  1. Thanks for the article. Looks like getting the policy paid up is the best option but not the most practical one here. We live in an irrational world.

    • Paid up vs. Surrender is still debatable. Not much of clarity emerging even amongst the financial planners i.e. too complex products to be decoded 🙂

      • askgeo says:

        surrendering the policy like you said is painfull, most of the clients i met know that the endowment policy is of no good, this is where i suggest to do paid up, i have been doing this for the last 3 years, clients are happy not to surrender and see that on maturity they get their premium paid with what ever int, even though the money they would get would be nothing, but it allows me to make them understand the real value if they would have continued it. the future premium can be diverted to investment which can take care of their goals.

  2. puravmehta says:

    Please note that I am firm believer of not to link insurance and investment. But in case of old policies I believe it is better to continue if its not a strain on client’s portfolio in most of the cases.
    Please note that in case of surrendering a policy, planner needs to do what is the return if I surrender the policy vis-a-vis continue the policy. In most of the cases the cost of surrendering is very high. Let’s say for example taken by Anand Kulkarni, the surrender value of Rs. 49478/- vis-a-vis premium paid of Rs.68,131/-. Now assuming the original policy yield was 6.445% with a maturity value of Rs. 4,00,000/-.
    Now suppose the clients assigns this policy to another person who will pay him the surrender value and assigns the policy in his name. So hence the assignee will pay the remaining premium and will get the maturity value. For the assignee the return comes to 8.92% which is tax free and hence I will not suggest to surrender the policy. People will argue that he can get more return through SIP, but please remember you can not invest 100% of client’s money in Equity. So consider the investment in Insurance Policy as Debt and continue the same.

  3. Kiran Telang says:

    We should also check the IRR on the actual amount inveted (from the clients point of view, not as per the actual investment done by the insurance company). Say for example, if the sum assured is Rs.10lacs, what will be the cost of a term insurance for this amount at present age and rates. Reduce this amount from the total premium amount and then calculate the IRR. If the IRR is close to what a debt instrument will give, I feel the policy can be continued. Of course the cashflow will have to be taken into acount.

  4. Chenthil Iyer says:

    The typical irr of a traditional insurance policy works out to be only 4-5%! Surely this is not worthy of being part of any asset class in the portfolio except if we live in America or Australia!! Some one suggested to reduce the term plan premium and hence calculate the irr. This would not give the correct figure, since the Sum at risk keeps on changing in an investment cum insurance policy..

    Making the policy paid up is just like accepting the mistakes in the past and not repeating them in future… If you think this is not practical, you should rethink your role as a financial planner! Who’s in charge? the client or you? Its like asking who’s in charge the patient or the doctor?!!!

    • Chenthil, your insights on traditional policies have been very logical. What is your take on ULIPs?

      • Chenthil Iyer says:

        Hi Sadique, Sorry for the delay in reply. ULIP is a very interesting instrument in the following ways:
        1) It helps a layman do his shopping of insurance and investments one shot
        2) It has the ‘sum at risk’ concept whereby if and that is a big if, the life cover has been adequately taken, it gives a continuously reducing cover linked to the portfolio performance which practically is the ideal scenario, instead of getting stuck with a very high cover through out the life..
        3) The cost involved is mostly transparent
        The flip side is as follows:
        1) You are stuck with the investment philosophy for the entire life of the policy and cant change the AMC or the fund manager in the extreme event of severe and consistent under performance.
        2) Withdrawing and re-deploying from ulip to ulip is a highly expensive affair
        3) There is no flexibility in the portfolio and re-balancing wrt other asset classes is a major issue
        (Doing the re balancing within the same policy or company (through switching between funds) would mean that one’s entire portfolio should be parked in the same ULIP which is too high an expectation to have!!)

        In short, in the event of availability of a competent fund manager, ULIP looks highly inefficient. However in his absence, it is a decent solution ‘with tax benefits of course!!!’ 🙂

  5. Ranjith says:

    I was reviewing a policy which was wrongly pushed.

    This policy has SA of Rs.300,000, very low….!!!

    premium Rs.30k/PA for 20 yrs. 3 yrs paid.

    Life cover calculated as per minimum SA formula= 50%*Annual Premium*Policy Term.

    In this case client does not have enough risk coverage, it was pushed claiming maximum allocation.

    When client enquired about surrender, was told, he will be losing 38% of the fund value, towards charges.

    No coverage, no returns, policy name – Aviva-Save Guard.

    In this case, If it is made paid up, it will be a JOKE,

    it would look like = Rs.300,000*3yrs/20yrs = Rs.45,000 sum assured.

    Life coverage Rs.45,000 for 17 yrs for only Rs.90,000. Term Policy is way better…..!!!

    It seems that we should ask the client to get highest SA possible every time, even if he has to undergo some tests.

    • Yes, Ranjit many of the policies are a joke. Acturians among the highest paid of all the professionals. The insurance companies have to recover those costs 🙂 Simple terms policies are anyday better.

  6. At the onset, as a financial planner, i agree & firmly believe that Equity investing is the best for long tenures ( by now this is amply clear beyond doubt ) and Term insurance for risk management.

    Further, as a financial planner, it is our basic duty to educate our clients with this fact & help them invest accordingly by drawing up a “suitable” plan.

    Lets take a story ( I have discussed this on several of my media interactions )

    A South Indian Brahim wishes to up the intake of Protein in his diet and approaches a nutrionist for advise on the kind of food he should consume. The nutrionist knows that “eggs” are the best source of protein ( and it is also a known fact beyond doubt ) and thus advises this chap to consume atleast one egg daily.

    * So what is the outcome? Is there a mismatch. Yes there is… the client is a “pure vegetarian” !! The nutrionist is not wrong completely and thus tries to convince the client that he should start consuming eggs.

    My views: While we know that equity will give the best “returns” and is the best asset class for the long term, there may be some other compulsions that our clients may have which have prompted him to act in a particular manner – such as … he feels that he is not “lucky” with equity, his entire family has never invested a single rupee in equity due to some very bad experience in the past and many more…

    So in these circumstances, like the nutrionist we may come across many such instances where our belief / knowledge may not “match” with the demographics of our clients, and here it is imperative that we adjust ourself and see from the eyes of the client and advise him and thus make him comfortable. Our job here would be to then… explain in detail that what he is being advised is probably the second best option ( let him take a decision ) and advise him to consume “dal & pulses” instead of “eggs”.

    What i have just stated may not exactly answer the debate in question, but i guess, would atleast clear some of the practice issue faced by us.

    Harshvardhan Roongta

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