Bonuses in Life Insurance Policy
In simple words, a bonus is an additional sum of money or reward you receive on top of your base salary. There is a similar concept of a bonus in life insurance policies, where a bonus is an additional sum that is accrued to the life insurance policy on an annual basis and paid to the policyholder by the insurers. Depending on your policy's terms, this additional sum may be paid out either at policy maturity or upon the insured's demise.
How is Life Insurance Bonus generated?
A life insurance company's asset pool, which is used to cover claims in the future, is financed in part by the premiums paid by policyholders. A huge portion of the premiums collected by the insurance companies is invested government-secured debt instruments and some in equity.
The rate of bonus is determined on the basis of return on fundamental assets, the level of bonus announced in the previous year, the insurer’s claim experience, and actuarial factors. Based on the earnings received from the investments and the overall claim experience, the insurers distribute the profits as a bonus at the end of the financial year. Any excess of assets after the company’s assets and liabilities are valued, may also generate an extra amount to be distributed as a bonus.
Types of bonuses:
Reversionary Bonus: A traditional insurance policy which is in force, shall participate in the company’s profit and generate a return on the policyholder’s funds from the date of commencement of the policy. The insurance company decides to allocate a certain portion of the returns to the policyholders from the pool, which is called a reversionary bonus.
Some of the common features of a bonus are:
Bonus rates are declared depending on the investment experience of the company.
Once a bonus is allocated to a policy, it is almost always guaranteed to be paid out.
Once allocated, the amount so allocated is called a “vested bonus”.
Vested bonuses are of 2 types:
Simple Reversionary:
Simple reversionary bonuses are declared as a percentage rate, applied to the sum assured applicable to the basic policy benefit.
Compound Reversionary:
Compound reversionary bonus is also offered in few policies. In this case, the amount of bonus allocated to a policy is added to the maturity Sum Assured and bonus is calculated as a percentage of the maturity Sum Assured and any bonus already vested.
Compound reversionary bonus factors the reversionary bonus rate into both-
- Sum assured, and
- Bonus that has already been accumulated in the previous year.
Reversionary Bonuses are usually paid out at the end of the policy term.
Interim Bonus:
The life insurance company usually declares an interim bonus if the insured person dies or the policy matures before the deadline for bonus declaration, which is often the end of the fiscal year. Interim bonuses are paid on those policies that matured or are claimed between the two bonus announcement dates within the financial year. While the policy has already accumulated a bonus for the last year, there is a gap between the bonus declaration date and the maturity date of the policy. To ensure that the policyholder or their beneficiaries are not at a disadvantage, a bonus is added on a pro rata basis as per the interim bonus rates announced by the insurer.
Terminal Bonus:
A one-time bonus, also referred to as “persistency bonus” is declared and added only for policies that attain maturity. This bonus is paid to the policyholders at the end of the policy term for running the policy for a determined period as per the insurer’s discretion. This bonus is not applicable to surrendered or paid-up policies.
Cash Bonus:
The cash bonus is the bonus that is accrued in a year and will be paid in the form of cash at the end of the financial year. This bonus is payable on a yearly basis, rather than at maturity.
How is Life Insurance Bonus calculated?
The bonus is either computed as a percentage of the sum assured or as a certain amount per ₹1000 of the sum assured. For example, if the bonus is ₹ 50 per ₹1000 for a policy with a sum assured of ₹ 1 lakh, the annual bonus will be ₹ 5000. For a policy term of 10 years, the simple reversionary bonus comes out to be ₹ 50,000. The bonus rate is dependent on several factors, such as return on company assets, bonuses declared in the previous year, claims filed, expected interest rates in the future, and several other estimates.
Conclusion:
Kindly note that the bonuses are paid to the policyholders only if their policies are participating life insurance policies.
This applies to traditional plans such as endowment or money back plans. However, it is always advisable to check the plan and the types of bonuses applicable with the help of the plan brochure or your financial advisor.
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