Life Insurance – Surrenders and closures exceed maturity payouts

The latest RBI Financial Stability Report (FSR) brought out an interesting piece of data. Life insurers were seeing more payouts due to policy surrenders and premature withdrawals, compared to payout of maturity benefits. What does it signify?

What the RBI FSR said about life insurance?

According to the data put out in the RBI FSR, surrenders and premature withdrawals had accounted for 38.3% of payouts by life insurance companies in FY26. In comparison, payouts for maturity benefits accounted for just 36.9%, while the death benefits accounted for 8.1%. In short, lot more people are terminating their life insurance policies well before its maturity, despite the risk of losing life cover. An endowment life insurance policy that participates in future profits, attains surrender value after premiums are paid for 3 continuous years. What exactly is inducing this myopic behaviour?

Understanding the idea of life insurance surrender

Typically, an endowment policy that participates in profits attains surrender value after premiums are paid for 3 years. However, surrender value is generally just about 30% of the premiums paid plus accumulated bonuses. Past experience has been that if the life policy is surrendered after around 7 years, then the 30% surrender value of premiums plus bonus is sufficient to compensate the insured for all premiums paid till date. Life insurance endowment policies also allow loans against policies up to 90% of the surrender value. A good number of policies also get terminated when the insured takes a loan but lets the policy lapse when they are not able to repay the loan.

Two major reasons are mis-selling and policy consolidation

Let us first look at mis-selling, the most common reason for surrender of policies. Quite often, the salesperson in their enthusiasm to close the sale, makes questionable promises. Not only are such returns expectations misplaced, but quite often, the wrong policies are sold to the wrong persons. Mis-selling of risk is very common in life insurance. The second reason is more genuine; consolidation of policies. People who started buying life insurance about 20 years back, did it in a very random fashion. Policy cover was inadequate; they just held too many policies or were stuck in the wrong policies. This consolidation helps to rectify such mistakes by consolidating life policies meaningfully.

Why the RBI considers this trend risky?

It is necessary to understand why RBI is concerned about this trend of premature closure of policies. A typical life insurance company assumes long-term risk and also invests its corpus accordingly. Most of the investments of an insurance company are parked in long term assets like deep maturity bonds, equities, illiquid assets etc. The current situation is not too alarming, but if the premature withdrawals and redemptions become a deluge, the life insurer may be left with a genuine mismatch between assets and liabilities. That may not be a serious issue for the large well-capitalized life insurers. But for the smaller life insurance companies, such maturity mismatch can pose a serious balance sheet risk.