Life Insurance – Understanding Bonuses

Published by Sharekhan Education | June 2, 2021

Life Insurance – Understanding Bonuses

There are a lot of aspects about Life Insurance that are still shrouded and needs to be unveiled. One such an aspect: Bonuses, is our topic of discussion today. All know the importance of providing financial security to their families and do it in different ways using different tools. But undoubtedly, an important and integral tool to do so is: life insurance and surely you must be having one. We are not going to discuss the adequacy of the cover that you hold nor are we going to rebuke you for the same. The subject that we are going to take on is an understanding of the various Bonuses that are declared and accrue to a life policy.

Many may be aware and know that bonuses accrue to a life insurance policy but for those who don’t, let us answer a basic question first:

What is a Bonus?

With relation to life insurance, a bonus is usually an additional amount which gets accrued or attached to the policy on a yearly basis and is paid on the death of the life assured, surrender or at maturity of the plan, whichever happens earlier. Does this mean that bonus is given on every life insurance policy? Actually  No! These bonuses are available to participating or with –profit policies.  The insurance companies declare bonus out of the profits earned by the company. (To know more about the with-profit policies you may refer to our article “What are with-profit policies?”)

As a bonus is declared out of the company’s profits, the amount may vary in relation to the profits earned for that year. According to IRDA, the company has to distribute about 90% of the earned profit as bonuses to the with-profit policyholders. The insurance company has the discretion to decide on the rates of bonus; which is not fixed and varies with the profits earned. 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.

When are bonus declared?

There are 4 different types of bonuses viz:

Reversionary Bonus: Simple & Compound Reversionary Bonus, Terminal Bonus, Interim Bonus and Cash Bonus.

• Reversionary Bonus:

* Simple Reversionary Bonus (SRB):

This bonus is calculated as a percentage of sum assured for the financial year. It does not get added to the sum assured and is not used for next year’s bonus calculation. The SRB declared for different years are then added together and paid out at maturity or whenever there is a claim.

* Compound Reversionary bonus(CRB):

On the other hand, the company calculates CRB by applying a percentage to the sum assured as well as the accrued bonuses from previous years. It is declared annually and each year gets added to the sum assured. Hence the next year’s bonus is then calculated on the enhanced amount.

• Terminal Bonus / Final Additional Bonus:

This is a one-time bonus paid to indicate the overall performance of a participating policy. The terminal bonus is paid at the time of maturity or death of the life assured. The terminal bonus may be given after staying in the policy for a predetermined time and is offered at the option of the insurer.

• Interim bonus:

This is typically payable for those policies that mature or result in a claim in between two bonus declaration dates. This bonus addresses situations where a policy may mature or death may occur before the next bonus declaration. Insurers declare interim bonus to avoid putting such policyholders at a disadvantage. The amount of bonus, however, is added to the policy on pro-rata basis for that specific year.

• Cash Bonus:

An insurance company might decide to pay-out the yearly bonus accrued in cash to its policyholders when the year ends. This allows the insured to receive the bonus as cash annually, rather than accumulating it until maturity.

To wrap it up we can say that bonuses help hike up the maturity value of your policy. Remember that bonuses are payable to with-profit plans and may vary as they are declared out of the company’s profits. Also some policies may not give bonuses from the 1st year itself. So if you are buying a policy to meet some financial goal, do read up the policy documents carefully and confirm the benefits offered by the insurer before you do so.

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