Ch. 7: Bonus in Endowment Plans: Know It's Types & Calculation

Sometimes, it's the little things that mean the most to people. In light of this, many companies often offer promotional offers with any product or service they advertise. A bonus can be in the form of cash rewards, coupons, some free services, etc.

A similar concept is seen with endowment plans as well. Endowment plans offer bonuses on top of the cover amount. Generally, the bonuses are based on the type of policy you have chosen. There are two types of policies: Participating and Non-Participating.

• Participating policy
  It offers variable bonuses along with the maturity or death benefit. This bonus is based on the profits that a company earns from investing in bonds, securities, debt and equity instruments, etc.
• Non-participating policy
  It provides only guaranteed benefits, which means you do not "participate" in the insurance company’s profits. A Bonus is not provided in this policy.

Right? But wait! How are these bonuses calculated and added to your policy?

In the previous article, we discussed the different types of riders available under endowment plans. Let's look into the various bonuses offered under the plan in this article,

It is necessary to pay premiums on time to keep the policy active. Premiums collected from every customer become a part of the insurance company's assets.

Claims are settled using this money. Claims may not arise every day, and in such a case, these amounts shall remain with the company. Rather than keeping these funds at a standstill, they invest these funds in various instruments like bonds, securities, and other debt and equity instruments. The profits generated from these investments are given to you as bonuses.

Depending on the company's profits, these bonuses can vary from year to year.

Bonuses are determined based on -

• The insurance company
• Type of policy
• How long the policy is in force

The method of calculating the bonus may differ depending on the insurer and the policy. Generally, bonuses are calculated in one of the following ways -

• The bonus as a percentage of the sum assured.
  Let's say for the policy you have taken, the bonus is declared as 5% of your sum assured. The chosen sum assured is Rs 30 lakhs.
  
  Bonus = 5% of 30 lakhs
  = Rs 1,50,000.
  
  Thus, you are entitled to receive a bonus of Rs 1,50,000


• The bonus as a certain amount per Rs. 1,000 of the sum assured.
  Let's assume the chosen sum assured for your plan is Rs 25 lakhs. The bonus is calculated as Rs. 40 for each Rs 1,000 of the sum assured.
  
  Bonus = 40 x (25 lakhs ÷ 1000) = Rs 1,00,000
  
  Hence, you are entitled to receive a bonus of Rs 1,00,000

These are the common types of bonuses payable under an endowment plan -

Reversionary Bonus

The insurance company awards this bonus at the end of every financial year. The bonus won't be given to you immediately but instead gets accumulated every year under the policy. It is then paid either to you when the policy matures or to your nominee in the event of your death during the policy period.

The reversionary bonus rate is calculated as a certain percentage of the sum assured. The formula is as follows -

There are two types of Reversionary bonuses -

• Simple Reversionary Bonus
• Compound Reversionary Bonus

Let's explore each of these bonuses in-depth.

• Simple Reversionary Bonus

As the term implies, Simple Reversionary Bonuses are relatively easy to calculate. It is calculated by multiplying the reversionary bonus rate declared by the insurance company with the sum assured you choose while purchasing the policy.

This bonus gets accumulated every year until the policy expires or in case you pass away, whichever occurs first. So, the bonus is payable in addition to the maturity or death benefit.

For instance, say Raj has purchased a Participating Endowment policy with a sum assured of Rs 20 Lakhs. The policy offers a simple reversionary bonus at the rate of 3% of the sum assured.

Hence, Raj is entitled to receive Rs. 60,000 every year with the maturity benefit or this amount shall be paid to his nominee along with the death benefit.

• Compound Reversionary Bonus

Compound reversionary bonuses factor the reversionary bonus rate into both the sum assured and the bonus that has already been accumulated in the previous year.

Let's take Raj's example again, and assume that the policy offers a compound reversionary bonus at a rate of 3%

In the 1st year:

• Sum assured is Rs. 20,00,000
• Bonus will be Rs, 60,000 (3% of 20,00,000)

In the 2nd year:

• Sum assured will become Rs. 20,60,000 (20,00,000 + 60,000 bonus)
• Bonus will be Rs. 61,800 (3% of 20,60,000)

In the 3rd year:

• Sum assured will become Rs. 21,21,800 (20,60,000 + 61,800 bonus)
• Bonus will be Rs. 63,654 (3% of 21,21,800)

This cycle shall continue till the policy expires or in case you pass away.

A terminal bonus is also known as a persistency bonus. It is a type of bonus payable to you on policy maturity or to your nominee in case you pass away while the policy is still in force.

It is offered by the insurance company to acknowledge your on-time premium payments and your commitment to the policy throughout the plan's tenure. This bonus payment is based on the insurer's decision. Hence, there is no guarantee that you or your nominee will receive it.

Bonuses are typically announced at the end of the financial year. However, an interim bonus is paid if a policy matures or death occurs between consecutive bonus declaration dates. This bonus is calculated based on the remaining days from the previous bonus date. The main goal here is to make sure that you and your nominees don't lose out on any benefits.

For instance, let's say that your policy expires on November 31, 2030. The last reversionary bonus you earned would have been at the end of the financial year 2029-30. This interim bonus takes into account the last 8 months, i.e. from April 1, 2030, to November 31, 2030. Hence, you will receive the bonus accumulated during these 8 months.

Contrary to other bonuses that accumulate throughout the policy period, this cash bonus is paid to you in the form of cash at the end of every financial year.

This type of bonus is defined as a percentage of your annual premium and is payable every year. It is calculated using the formula -

Example - Let's say Madhav takes a Participating Endowment plan worth Rs. 30 Lakhs. The annual premium for his plan is Rs. 20,000, and the cash bonus rate is 3%. Let's find out how much cash bonus he is entitled to receive every year.

Note: The bonuses described in this article are the most common ones. However, there might be other types of bonuses payable under an endowment plan as well.

Hence, these are the types of bonuses payable under an endowment plan. Ensure you discuss the bonus aspects of an endowment plan with your insurer before purchasing one, as it may vary depending on the product.

Now that you are familiar with various aspects under an endowment plan, right from the customization options to the bonuses available, it is also important to know about what is not covered under the plan. Read on!