Reversionary Bonus in Life Insurance

In summary

A reversionary bonus is an additional amount declared for a participating life insurance policy and added to its benefits. It can increase the amount payable when the policy reaches maturity or when a claim becomes payable, subject to the policy terms.

• A 3% bonus on Rs. 10 lakh sum assured equals Rs. 30,000 for that year.
• A simple reversionary bonus is generally declared annually and added to the policy benefits.
• A compound reversionary bonus can be calculated using the sum assured and previously declared bonuses, depending on the policy terms.
• Other bonus types include terminal, cash and interim bonuses.

If you are comparing life insurance plans with bonus features, review how the bonus is declared, accumulated and paid before choosing a policy.

Participating life insurance policies can offer bonuses, including some endowment plans, whole life insurance plans and money back policies. The bonus structure depends on the specific policy and its terms.

Bonuses can add to the benefits available under a participating policy. However, the amount and type of bonus depend on the insurer's declaration and the policy conditions. IRDAI requires policy documents to state whether a policy participates in profits and the basis of participation, including simple or compound reversionary bonuses.

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The bonus is generally not paid separately when it is declared. Instead, it is added to the policy and can accumulate during the policy term.

For example, if the sum assured is Rs. 10 lakh and a 3% reversionary bonus is declared, the bonus for that year is Rs. 30,000. The actual benefit payable depends on the policy terms and any other applicable bonuses or deductions.

1. Reversionary bonus:

Simple reversionary bonus: This is the most common type of reversionary bonus. It is declared annually by the insurance company and added to the policy's sum assured. The bonus amount is typically a percentage of the sum assured and does not change once declared.

Compound reversionary bonus: Unlike the simple reversionary bonus, the compound reversionary bonus is added to the sum assured and any previously declared bonuses. This means that each year's bonus is calculated on a progressively increasing base, leading to potentially higher payouts.

2. Terminal bonus:

This bonus is a one-time addition to the policy's value, usually paid out at the end of the policy term or upon the death of the policyholder. It is typically declared at the discretion of the insurance company and can significantly enhance the final payout.

3. Cash bonus:

Cash bonuses are paid out annually to policyholders as cash instead of being added to the sum assured. This provides immediate financial benefit to the policyholder, though it does not compound or accumulate over time.

4. Interim bonus:

An interim bonus is declared for policies that are terminated before the next bonus declaration date. This ensures that policyholders who surrender their policies or who die before the next bonus declaration still receive a fair share of the accrued bonuses.

Key benefits include:

• Additional policy benefits: Declared bonuses can increase the amount payable under the policy.
• Long term accumulation: Bonuses can build up during the policy term.
• Maturity or claim value: Accrued bonuses may form part of the amount payable at maturity or on a claim, depending on the policy.
• Participating policy structure: The bonus reflects the policy's participation in the insurer's declared surplus, subject to the applicable policy terms.

A declared and vested bonus should not be confused with future bonus rates. Future reversionary bonus rates are not automatically guaranteed; the applicable policy terms and future declarations determine them.

Reversionary bonus = Rs. 10 lakh × 3% = Rs. 30,000

If the same Rs. 30,000 bonus were declared each year for 10 years, the total accumulated bonus would be Rs. 3 lakh, assuming the same rate and calculation basis continued throughout the period.

This is an illustration, not a prediction of future bonus declarations. Actual bonus rates and calculation methods depend on the policy and insurer's declarations.

What is accumulated reversionary bonus?

Accumulated reversionary bonus is the total of the reversionary bonuses added to a participating life insurance policy over the policy term. For example, a 3% simple bonus on a Rs. 10 lakh sum assured gives Rs. 30,000 a year. If the same rate applies for 20 years, the accumulated bonus would be Rs. 6 lakh. This amount may be paid with the applicable maturity or claim amount, subject to the policy terms.

If a policy is surrendered before maturity, the amount payable against accumulated bonuses depends on the policy terms. It should not be assumed that the full accumulated bonus will be paid on early surrender.

Check the policy document for the applicable surrender value and conditions before deciding to exit a policy early.

1. Bonus declaration: The insurer assesses the participating business and declares a bonus according to its applicable valuation and policy terms. IRDAI requires the policy document to state the basis of participation, including whether the policy uses a simple or compound reversionary bonus. 
2. Bonus addition: Once declared and vested, the bonus is added to the policy benefits. For example, a 2% bonus on a Rs. 10 lakh sum assured gives Rs. 20,000 for that year.
3. Accumulation: Further bonuses may be added during the policy term. Under a compound reversionary bonus structure, previously vested bonuses can also be included when calculating subsequent bonuses, depending on the policy terms. 
4. Payout: The accumulated bonus can be paid along with the applicable maturity or death cover when the policy reaches maturity or a claim becomes payable, as specified in the policy.

Understanding the bonus structure can help you assess your overall life insurance needs. A life insurance calculator can then help estimate the premium for the cover you are considering.

• Investment returns:

Insurance companies invest the premiums they collect from policyholders in various financial instruments such as stocks, bonds, and real estate. The returns from these investments contribute significantly to the company's profits.

• Surplus distribution:

At the end of each financial year, the insurance company evaluates its overall performance, including investment returns and claims paid out. If there is a surplus after meeting all liabilities and expenses, a portion of this surplus is distributed as bonuses to participating policyholders.

• Actuarial valuation:

Actuaries play a crucial role in determining the bonus. They conduct a thorough valuation of the insurance company's assets and liabilities to ensure that the declared bonuses are sustainable and do not compromise the company's financial stability.

• Regulatory oversight:

Insurance companies operate under stringent regulatory frameworks that ensure they maintain adequate reserves and solvency margins. Regulatory bodies may also provide guidelines on bonus declarations to protect policyholders' interests.

Understanding the different types of bonuses, how they are declared, and their impact on a life insurance policy can help policyholders make informed decisions. By choosing policies with attractive bonus structures, individuals can ensure that they maximise the benefits of their life insurance coverage, securing a better financial future for themselves and their loved ones.