Ch. 11: Reduced Paid-Up Policy - Everything You Need To Know

Life is unpredictable - you never quite know what will happen. Making a huge investment like an insurance policy is a life-altering decision and you obviously must be wondering about what would happen if you were to quit the policy at any point in the future. This could be because of multiple reasons. You might find a plan with better returns and would want to shift to it. Or you might not want to continue paying the premiums because of some financial obstacles. Or maybe your nominee isn’t financially dependent on you anymore.

It is important to be aware of the consequences of the same, so you know the returns you will get for the premiums you would have already paid - no matter when you stop the policy.

Once you purchase an insurance policy, the most crucial requirement is that you pay the due premium regularly, as per the schedule of your policy. You will be required to pay the premiums till the end of the policy term or you can even pay them off in a lesser time span, 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 have options -

• Take the surrender value and stop the policy.
• Continue the policy on a reduced paid-up basis.

Let’s understand these in detail.

If you surrender a Money-Back plan, you will be eligible to receive a Surrender Value for the same. You will need to inform the insurer about your intent to do so. Please note that the surrender value will be applicable only if you have paid the premiums for at least two years.

There are two types of surrender values -

a. Guaranteed¹ Surrender Value (GSV)
GSV is the percentage of total premiums paid minus already paid assured survival benefits. It differs as per the year in which the Money-Back Plan is surrendered. The 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.

b. Special Surrender Value (SSV)
SSV is declared periodically by the insurance company and is always higher or equal to the GSV.
You can read more about policy surrender in this article.

If you do not opt for the surrender value, the policy will continue on a reduced paid-up basis. You can continue enjoying reduced benefits of the Money-Back Plan without paying any future premiums.

How does a reduced paid-up policy work?

Once the policy becomes a reduced paid-up policy, the amount payable, i.e., the sum assured and other benefits such as assured survival benefits, 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.

Please note that -

• The terms of the reduced bonuses differ from policy to policy. 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 loyalty additions (if applicable) under the policy will not be payable once the policy becomes reduced paid-up, and rider benefits (if any) will cease too.

Now, let us have a look at how the sum assured and bonuses will be altered under a reduced paid-up policy.

The sum assured that you have chosen will be proportionately reduced, which will result in a reduced sum assured. This proportionate reduction is known as 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 Sum Assured -

Reduced Sum Assured = Sum Assured x RPU Factor

The bonuses up to the year of surrender will remain the same, i.e., you are entitled to receive 100%. They will not be reduced. However, the bonuses that have accumulated in the year you have discontinued the policy will be reduced proportionately in a manner similar to the sum assured.

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

So, since the sum assured and the bonuses change, the benefits payable under the policy will change too. Let’s understand how.

The survival benefit may be a percentage of the sum assured. It will be reduced in proportion to the RPU Factor, i.e, the number of premiums you have paid divided by the number of premiums payable.

Please note that if the survival benefit of your policy is a percentage of the annual premiums paid by you, it will reduce in the same way.

If you continue the policy on a reduced paid-up basis till the end of the policy term, you’ll be entitled to receive the reduced sum assured along with reduced bonuses, if any.

In case you pass away during the policy tenure, the insurance company will pay the reduced sum assured, along with any reduced bonuses to your nominee.

Komal buys a Participating Money-Back Plan. She buys the policy with a sum assured of Rs 30 Lakhs for a policy term of 30 years. She has to pay an annual premium of Rs. 30,000 for 20 years.

She will be paid the Survival Benefit once the premium payment term is over. The Survival Benefit will be 20% of sum assured and will be paid biannually from the 22nd policy year to the 30th policy year. And, she will be paid the bonuses as the maturity amount.

In the 15th policy year, Komal is laid off and is unable to pay the future premiums. The policy converts to a reduced paid-up. The bonuses accumulated under the plan for 14 years are Rs. 20,000. In the 15th year, she was supposed to receive a bonus of Rs. 3000.

So…

RPU Factor = No. of Premiums Paid/ No. of Premiums Payable
= 15/20
= 0.75
Let’s see how the bonuses, death benefit, maturity benefit, and survival benefit are reduced under Komal’s Money-Back Plan.
1. Bonus
In the 15th year, the bonus will be reduced as follows -

Reduced bonus for the 10th year = Bonus payable x RPU Factor
= 3000 X 0.75
= 2250
So, a total bonus of Rs 22,250 will be payable under the Money-Back Plan with the death benefit or as the maturity benefit, whichever happens earlier. (Bonus of Rs 20,000 accrued over 14 years, and reduced bonus of Rs. 2250.)

2. Survival Benefit
As per the policy T&C, Komal will receive the survival benefit payouts (20% of the sum assured) in 22nd, 24th, 26th, 28th, and 30th policy years. To understand how the assured benefits under her policy are reduced, we’ll first have to find out the reduced sum assured under her policy.

Reduced Sum Assured = Sum Assured x RPU Factor
= 30,00,000 X 0.75
= 22,50,000

The reduced assured payout benefit will be paid as follows -

3. Maturity Benefit
As calculated earlier
Reduced bonus for the 10th year = Bonus payable x RPU Factor
= 3000 X 0.75
= 2250

So, a total bonus of Rs 22,250 will be payable under the Money-Back Plan as the maturity benefit. (Bonus of Rs 20,000 accrued over 14 years, and reduced bonus of Rs. 2250.)

4. Death Benefit
The reduced sum assured along with reduced bonuses will be paid as the death benefit out to Komal’s nominee if she passes away anytime during the policy term.

Reduced Sum Assured = Sum Assured x RPU Factor
= 30,00,000 x 0.75
= 22,50,000

So, Komal’s nominee is entitled to receive a death benefit of Rs 22,50,000 along with the reduced bonuses, i.e., Rs 22,250.

The total death benefit = 22,50,000 + 22,250 = Rs 22,72,250.

We hope this article helped you understand how a Reduced Paid-Up Money-Back Plan works. Make sure you are aware of the amount you will receive from the insurer if you discontinue the policy. Go through the policy documents and ask your insurer or advisor about the same, before purchasing the policy so you or your family don’t have to face any unexpected surprises later.