Ch. 7: Money Back Policy Bonus - Know its Meaning, Types & How its Calcualted

A bonus is generally a reward or extra amount that you receive. For example, an employee of a company may receive a bonus during their appraisal for exemplary work.

A similar concept is seen with money-back plans as well. There are two types of policies, based on the bonuses you receive - Participating and Non-Participating.

Participating policies offer variable bonuses along with the maturity or death benefit. This bonus is linked to the profits a company makes from such participating policies by investing in bonds, securities, debt and equity instruments. On the other hand, Non-participating policies give you only the guaranteed1 benefits, i.e., the policy doesn’t ‘participate’ in the profits of the insurance company.

But wait! Where do these bonuses come from?

Let’s see!

When you purchase a money-back plan, you pay premiums to the insurer in exchange for the insurance cover. The premium amount you pay is the insurance company's asset. Similarly, when other people buy money-back policies, their premiums also become a part of the company’s asset pool.

This money is used to settle any claims that arise. But, claims aren’t raised everyday and hence, the company is in the possession of these accumulated funds. Instead of letting these funds sit idly, the company invests them in an assortment of assets like bonds, securities, and other debt and equity instruments - and earns a profit from these investments.

The bonus is determined by the company’s profitability. Profits fluctuate from year to year. Consequently, the bonus also changes every year. The bonus paid to you depends on the insurance company, the type of policy you buy, and how long the policy is in effect.

The method of calculation depends on two factors - the insurer and the policy you are planning to buy.

Bonuses are generally calculated in the following ways -

• As a percentage of the sum assured.
  For instance, let’s assume that your policy document states that the bonus will be 3% of your sum assured. The sum assured you have chosen is Rs 20 lakhs.
  Hence, the bonus you are eligible to receive = 3% of 20 lakhs = Rs 60,000.
• As a certain amount per Rs. 1,000 of the sum assured.
  For instance, let’s assume you have chosen a sum assured of Rs 25 lakhs and the bonus is calculated as Rs. 30 for each Rs 1,000 in your policy.
  
  Bonus = 30 x (25 lakhs ÷ 1000) = Rs 75,000

The 3 most common types of bonuses payable under a Money-back policy -
1. Reversionary Bonus
A reversionary bonus is a type of bonus that is declared by the insurance company at the end of each financial year. The bonus, however, is not immediately paid out. It gets accumulated under the policy every year. It is then paid either to you on policy maturity or to your nominee in case you pass away while the policy is active.

The reversionary bonus rate is expressed in terms of a percentage of the policy sum assured. It is calculated using the formula -

There are two types of Reversionary bonuses -

• Simple Reversionary Bonus
• Compound Reversionary Bonus

Let’s understand both these types of bonuses in detail.

Simple Reversionary Bonus
The computation of a Simple Reversionary Bonus is very easy. It is calculated by multiplying the reversionary bonus rate declared by the insurance company with the policy sum assured you choose at the time of buying the policy.

This bonus is added to the policy each year until it expires or the death of the life insured, whichever happens first. It is then paid out along with the maturity/ death benefit amount.

For instance, say Yash has taken a Rs. 10 Lakhs Participating Money-back policy. The policy offers a simple reversionary bonus at the rate of 2% of the sum assured.

So, Yash is eligible to receive a bonus of Rs. 20,000 every year. The bonus amount will be either paid to him with the maturity benefit or to his nominee along with the death benefit.

Compound Reversionary Bonus
The Compound Reversionary Bonus is similar to the Simple Reversionary Bonus - with just one exception. Here, the reversionary bonus rate is applied to both the sum assured and the bonus that has already been accumulated in the previous year.

Let’s take Yash’s example again, and let’s assume that his policy offers a compound reversionary bonus at a rate of 2%.

Year 1:

• Sum assured is Rs. 10,00,000
• Bonus will be Rs, 20,000 (2% of 10,00,000)

Year 2:

• Sum assured will become Rs. 10,20,000 (10,00,000 + 20,000 bonus)
• Bonus will be Rs. 20,400 (2% of 10,20,000)

Year 3:

• Sum assured will become Rs. 10,44,000 (10,20,000 + 20,400 bonus)
• Bonus will be Rs. 20,880 (2% of 10,44,000)

And so on…

2. Terminal Bonus
A terminal bonus, also known as a persistency bonus, is paid to you at the end of the policy term or to your nominee if you pass away while the policy is active.

It is offered by the insurance company to recognise your consistent premium payment and persisting with the policy throughout the money-back policy's tenure. This bonus is paid at the insurer's discretion, thus it is not guaranteed1 that you or your nominee will receive it.

3. Cash Bonus
The bonuses we’ve mentioned above get accumulated under your policy throughout the tenure and are paid either along with the death or maturity payout. This is not how the cash bonus works.

The cash bonus, as the name suggests, is given to you in the form of cash at the end of the financial year. This type of bonus is determined as a percentage of your annual premium and is paid to you on a yearly basis. It is calculated using the formula -

So, say Aashna takes a Participating Money-back plan worth Rs. 50 Lakhs. She pays an annual premium of Rs. 15,000, and the cash bonus rate is 5%. Let’s see how much cash bonus she’s eligible to receive every year.

Please note, there might be other types of bonuses payable under a Money-back policy - these are the most common ones.

On the whole, a bonus is definitely an exciting feature. But it is crucial that you inquire about the bonus aspects before purchasing a Money-back policy to avoid any issues later on. You can also view past records of bonus allocations for a better understanding of the manner in which the insurance company makes bonus payments. This information will enable you to understand the additional benefits you will be eligible to receive if you purchase a Money-back insurance policy.