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What one can do with unwanted and mis-sold insurance policies

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By Dilshad Billimoria

Sometimes customers get misguided when buying an insurance policy. Here are some of the options you can explore if you have been sold a bad or unwanted insurance policy.

Let us examine some basic types of traditional insurance policies from the point of view of what corrective measures one can take if one has been mis-sold one of these.

Basic types of traditional insurance policies include:

1. Endowment Plans.

2. Money Back or Cash Back Plans.

3. Retirement / Annuity products.

4. Unit Linked Insurance plans.

An investor realises he has been mis-sold a policy when:

-- It does not meet the objective for which it was bought.

-- Returns don’t match what is stipulated in the policy document.

-- The maturity benefits don’t meet the requirements of the policyholder.

In such cases the investor must understand what is the best way to limit the loss from such a policy. If the free-look period of the policy is not over then the buyer can immediately return the policy and ask for a refund. Normally, the refund would be made minus certain charges such as administrative costs etc. However, if the free-look period is over then the investor has to look at other alternatives.

In such a case (after the free-look period is over) remaining options before the investor include:

a) Let the policy lapse

b) Surrender the policy

c) Make it a paid up policy.

d) Take a loan against the policy.

Let us examine these options in detail.

Policy lapse

A policy lapses if the policy holder stops paying premium anytime before the completion of three years or the period specified for this purpose in the policy. In case of traditional insurance policies, excluding ULIPs, this period is typically three years. Once a policy has lapsed the risk cover ends and no amount is payable to the policy holder.

Consequently, investors must keep a note of due dates of premium payable to prevent their policies lapsing. If premiums are not paid even within the grace period, the policy lapses and the only option is to reinstate the policy if one wants to continue it. Reinstatement of a policy means revival of the policy benefits. To effect this, the insurer will require the policy holder to pay the arrears of premium along with penalties and interest.

Letting one’s policy lapse is one of the options one can look at if one has bought a bad policy. More importantly, with decreasing costs of mortality due to reduced insurance costs and better claim ratios, it may be better to buy a new policy rather than reinstating an old one, although the maths has to be worked out on a case-to-case basis.

Surrendering the policy

Surrendering the policy means stopping payment of premium and cancelling the policy contract before the stipulated maturity date. For a policy to be eligible for surrender i.e. to have acquired a surrender value, premiums should have been paid for at least 3 years in case of traditional policies excluding ULIPs, or as specified in case of other policies. In case of traditional policies the amount the policy holder gets on surrender is called the cash value. This cash value is calculated as follows: First, the first year’s premium is subtracted from the total of premiums paid till date of surrender, then the resulting amount is multiplied by 30%. To this, bonus accrued, if any, till date, is added to arrive at the cash value payable. The longer the time period for which one pays premiums and the closer one is to the actual maturity date of the policy, the higher is the cash value received. If one surrenders the policy in the initial years, one would not even receive the principal paid fully.

For example, say you have taken a policy requiring annual premium payments of Rs 20,000 with a sum insured of Rs 5,00,000, and the policy tenure is 20 years. If you plan to surrender this policy after paying premiums for 5 years, you will receive only (Rs 20,000*4 = Rs 80,000)*30%= Rs 24,000 (assuming no bonus has accrued on this policy till date) while you have paid a total premium of (Rs 20,000*5) = Rs 1,00,000. Hence this is a loss-making option.

For Unit Linked Policies, surrender is possible only after 5 years at 100% of fund value. This means surrender is not possible at all before 5 years. As per proposed IRDA regulations, ULIP products need to build a reserve from premium collected every year in order to provide the customer a higher surrender value in case of pre- mature surrender before 5 years. This is aimed at protecting investor interests.

As per these proposed guidelines, insurance companies will have to set aside a portion of the annual premium paid for ULIPs, as a discontinuance charge meant to be used to meet the costs incurred by the insurer in case of premature surrender before 5 years.

Paid Up Value status

Once premiums have been paid for a minimum defined period (typically 3 years in case of traditional policies) if subsequent premiums are not paid, the sum assured is reduced to an amount equal to ( the total premiums paid/ total no. of premiums that were required to be paid) multiplied by the sum assured. This reduced sum assured is called the paid-up value of the policy.

It sometimes happens that one pays premiums for a policy for a specific period and then realises it does not meet one’s objective. In such as case, if the policy has acquired a paid-up value you can stop paying premiums on the policy and let it continue to maturity at a reduced sum assured and maturity benefit. You will then receive a reduced sum assured and maturity benefit on maturity of the policy.

This normally happens when large sum assured and consequently large premium policies are bought and later the investor realises that the returns would be poor on maturity.

Taking a loan against a policy

As surrender of a policy, even if mis-sold, would lead to a heavy loss, one can meet one’s funding needs by taking a loan from the insurance company against the cash value accumulated in a policy. As long as the interest cost of the loan is less than the yield from the policy you can use the loan to fund the future premium payments and finally encash the policy on maturity thereby avoiding a loss. This is because the return on the policy would recompense you for the interest cost of the loan. The percentage and quantum of loan offered on policies differs from one insurance company to another. Normally for unit linked insurance plans, loan against policy is only available when the entire investment is in debt / GOI instruments and normally a loan amount of only 60-80% of the market value of the policy is given.

The advantage of taking a loan against a policy from the insurer, is that rates of interest are normally lower than what banks charge and loan can be generally taken for the tenure of the policy.

The author is a Certified Financial Planner, Dilzer Consultants Pvt Ltd (SEBI Registered Investment Advisor).
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