Ch. 10: What is Reduced Paid-Up in Endowment Plan?

Buying an insurance policy is a long-term decision. You have to pay premiums for a certain number of years and this money is locked in until you receive the benefits of the policy. While this happens, you consider quitting the policy, maybe because you have no use for it anymore or you wish to stop paying the premiums. Whatever the reason may be, it is quite important to be aware of and prepared about what happens once you stop paying the premiums and whether or not you’ll receive any returns for the premiums you have already paid, whether it’s 3 years or 4 years or 7 years down the line.

As you must already know, you are required to pay premiums to keep your endowment plan active. You will need to pay the premiums till policy ends or you can even pay them off in a lesser period, say 10 or 15 years, if you choose the limited pay option.

Once you stop paying the premiums and the policy has acquired a surrender value, you shall have options -

• As discussed in the previous article, you can take the surrender value and stop the policy, or
• Continue the policy on a reduced paid-up basis

Let’s have a look at how these work.

If you surrender an Endowment plan, you are entitled to receive something known as a Surrender Value. Please note that it is important to inform your insurance company about your intent to receive a Surrender Value. The surrender value will be given to you only if you have paid the premiums for at least two years.

Types of surrender values -

• Guaranteed Surrender Value (GSV)
  GSV is the percentage of total premiums paid. It is calculated according to the year in which you surrender the endowment plan. GSV calculation factors will be mentioned in the policy document. It may depend on the year of surrender, policy term, premium payment term - depending on the product.
• Special Surrender Value (SSV)
  SSV is declared periodically by the insurance company. It is always higher or equal to the GSV.

Read more about policy surrender in this article. Click Here

If you do not choose to receive the surrender value, the policy will convert into a reduced paid-up basis. You will be able to continue enjoying reduced benefits of the endowment plan without paying any future premiums.

Once the policy converts into a reduced paid-up policy, the benefits (death benefit, maturity benefit, bonuses, etc.) will be reduced in proportion to the number of premiums you have paid to the total number of premiums payable during the policy term.

Things to keep in mind -

• Some policies may or may not pay you the reduced bonuses. Or some may pay you the complete bonus, instead of the reduced bonus. The terms of bonuses vary across products.
• The loyalty additions (if applicable) under the policy will not be payable once the policy becomes reduced paid-up.
• Rider benefits (if any) will cease.
• You may or may not receive guaranteed additions. If your policy states that you will be eligible to receive them, it can happen in two ways -
  
  • You receive all the guaranteed additions that have accrued till your policy becomes a reduced paid-up policy. Guaranteed additions will not accrue after that.
  • You receive the 100% of the guaranteed additions that have accrued till the policy becomes a reduced paid-up policy. They will be reduced after that. Future reduced guaranteed additions will be calculated and paid out according to the reduced sum assured.

Maturity Benefit under a Reduced Paid-Up Policy

The maturity benefit under an endowment plan may be -

• The sum assured you have chosen while purchasing the policy, or
• The total premiums you have paid, excluding extra premium, rider premium, and taxes
• A percentage of the premiums you have paid, excluding the taxes, rider premiums, underwriting extra premiums, and loadings for modal premiums.

The maturity benefit, under a reduced paid-up endowment plan, will be proportionately reduced. This is known as the reduced maturity benefit.

It is reduced in proportion to the number of premiums you have paid to the total number of premiums payable during the policy term. This is the RPU Factor.

The formula to calculate the RPU Factor -

RPU Factor = Total No. of Premiums Paid/ Total No. of Premiums Payable

Now, the formula to calculate the Reduced Maturity Benefit -

Reduced Maturity Benefit = Maturity Benefit x RPU Factor

Death Benefit under a Reduced Paid-Up Policy

If you unfortunately pass away during the policy term, your nominee is eligible to receive the death benefit. The death benefit is essentially the sum assured you have chosen while buying the policy.

It is reduced in proportion to the number of premiums you have paid to the total number of premiums payable during the policy term. This is the RPU Factor.

The formula to calculate the RPU Factor -

RPU Factor = Total No. of Premiums Paid/ Total No. of Premiums Payable

Now, the formula to calculate the Reduced Maturity Benefit -

Reduced Death Benefit = Death Benefit x RPU Factor

Bonuses under a Reduced Paid-Up Policy

The bonuses up to the year you surrender in will remain the same, which means that you are entitled to receive 100%. They will not be reduced. However, the bonuses that have accumulated in the year of discontinuing the policy will be reduced proportionately like the maturity/death benefit.

Please note that you may or may not receive the reduced bonuses, depending on the product. Whether or not the bonus will be reduced, also depends on the product.

Formula to calculate the Reduced Bonus -

Reduced Bonus = Bonus x RPU Factor

Guaranteed Additions a Reduced Paid-Up Policy

As discussed before, the guaranteed additions vary across products. They may or may not pay you the guaranteed additions if the policy becomes a reduced paid-up.

If you are eligible to receive them, they can be calculated in two ways, depending on the product -

• You receive all the guaranteed additions that have accrued till your policy becomes a reduced paid-up policy. Guaranteed additions will not accrue after that.
• You receive the 100% of the guaranteed additions that have accrued till the policy becomes a reduced paid-up policy. They will be reduced after that. Future reduced guaranteed additions will be calculated and paid out according to the reduced sum assured.

Let’s understand this with the help of an example.

Suppose Ajay buys a Participating Endowment Plan with a cover amount of Rs 50 Lakhs with a premium payment term of 24 years. This is the amount that will be paid at maturity or in the event of his death, along with any accrued bonuses. Let’s assume that he receives yearly guaranteed additions of Rs 10 per Rs 1000 of the cover amount till the policy term ends.

So, the guaranteed additions he will receive per year = 10 x [50,00,000 ÷ 1000]
= 10 x [5000]
= Rs 50,000

Ajay decides to stop paying the premiums in the 6th policy year. His policy converts to a reduced paid-up policy.

Ajay has paid premiums for 6 years. He will receive the Guaranteed Additions that have accrued over 5 years, because they get added at the end of each policy year.

So, guaranteed additions = 50,000 x 5 = 2,50,000

No guaranteed additions will accrue after it becomes a reduced paid-up policy. Hence, Ajay will receive Rs 2.5 Lakhs as the guaranteed additions.

Ajay has paid premiums for 6 years. He will receive the Guaranteed Additions that have accrued over 5 years, because they get added at the end of each policy year.

So, guaranteed additions = 50,000 x 5 = 2,50,000

Now, when the policy converts into a reduced paid-up policy, the sum assured will be reduced too.

RPU Factor = 6/24 = 0.25

Reduced Sum Assured = RPU Factor x Sum Assured
= 0.25 x 50,00,000
= 12,50,000

The reduced guaranteed additions will be Rs 10 per Rs 1000 of the reduced sum assured.

Reduced Guaranteed Additions = 10 x [12,50,000 ÷ 1000]
= 10 x 1250
= Rs 12,500

So, Ajay will receive guaranteed additions of Rs 2.5 Lakhs for the first 6 years, along with yearly reduced guaranteed additions of Rs 12,500 till the policy term ends.

Neha buys a Participating Endowment Plan. She buys the policy with a sum assured of Rs 40 Lakhs for a policy term of 25 years. She has to pay an annual premium of Rs 1,00,000 for 18 years.

In the 9th policy year, Neha decides to move to another insurer and stops paying the premiums. The policy converts to a reduced paid-up policy. The bonuses accumulated under the plan till 8 years are Rs. 40,000. In the 9th year, she was supposed to receive a bonus of Rs. 4000.

So….

RPU Factor = No. of Premiums Paid/ No. of Premiums Payable
= 9/18
= 0.5

Let’s see how the bonuses, death benefit, and maturity benefit are reduced under Neha’s Endowment Plan.

• Bonus
  In the 9th year, the bonus will be reduced as follows -
  
  Reduced bonus for the 9th year = Bonus payable x RPU Factor
  = 4000 X 0.5
  = 2000
  
  A total bonus of Rs 42,000 will be payable under the Endowment Plan with the death benefit or as the maturity benefit, whichever happens earlier.
  (Bonus of Rs 40,000 accrued over 8 years, and reduced bonus of Rs. 2000)
• Maturity Benefit
  The reduced sum assured along with reduced bonuses will be paid as the maturity benefit out Neha once the policy term ends.
  
  Reduced Sum Assured = Sum Assured x RPU Factor
  = 40,00,000 x 0.5
  = 20,00,000
  
  Neha is entitled to receive a maturity benefit of Rs 20,00,000 along with the reduced bonuses, i.e., Rs 42,000.
  
  The total maturity benefit = 20,00,000 + 42,000 = Rs 20,42,000.
• Death Benefit
  The reduced sum assured along with reduced bonuses will be paid as the death benefit out to Neha’s nominee if she passes away anytime during the policy term.
  
  Reduced Sum Assured = Sum Assured x RPU Factor
  = 40,00,000 x 0.5
  = 20,00,000
  
  Neha’s nominee is entitled to receive a death benefit of Rs 20,00,000 along with the reduced bonuses, i.e., Rs 42,000.
  
  The total death benefit = 20,00,000 + 42,000 = Rs 20,42,000.

So, this is how a Reduced Paid-Up Endowment Plan works. The benefits of the plan, i.e., the death/maturity benefit, bonuses, guaranteed additions vary, depending on when you withdraw the policy. Ensure that you know the amount you will receive from the insurance company if you discontinue the policy. Read the policy documents carefully and ask your insurer or advisor about the same, before purchasing the policy so you or your family don’t have to face any problems later.