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Types of bonuses under a life insurance policy

Types of bonuses under a life insurance policy

Summary

A bonus in insurance is an extra benefit you get in addition to your standard coverage or base payout. Generally, the insurer declares it based on good financial performance. The types of bonuses in insurance vary by policy type, such as life, health, or auto insurance. It either rewards you for not making claims or allows you to share in the insurance company’s profits, depending on the type of insurance. The calculation of the bonus in insurance is majorly influenced by the sum insured, the insurer’s surplus profit, and returns on investment.

A bonus in insurance is an additional benefit you receive as a share of the profit a company earns. It enhances your policy’s value over time.

Life insurance is a vital financial safety net that every earning individual should consider. It helps to protect your family’s future. When you buy a participating life insurance policy, you may receive a bonus in addition to the guaranteed benefits of the plan. A bonus in insurance is an extra amount that a life insurance company shares with eligible policyholders from its surplus profits. You can view it as a reward for staying invested in the policy over the long term. This article explains the various types of bonuses in insurance, how insurers declare them, and provides a simple example showing how bonus amounts are calculated.

What is a bonus in life insurance?

A bonus in life insurance is an additional benefit that a life insurance company may add to eligible participating (with-profits or par) policies from its distributable surplus. It is a way of sharing a portion of the insurer’s profits with policyholders. Generally, a life insurer declares a bonus in insurance annually. However, the actual payout may happen at maturity, surrender, or claim settlement, depending on the policy terms. It is essential to note that bonuses are not paid on term insurance plans, unit-linked insurance plans, or non-participating (non-par) life insurance policies.

Also, read – Endowment policy: Meaning, types, benefits & tax advantages

How are life insurance bonuses declared?

Insurers declare life insurance bonuses after reviewing the performance of their participating funds and calculating the distributable surplus available for sharing with policyholders. The bonus rate is based on the surplus. It is often expressed per Rs. 1,000 of the sum assured, each year. The insurer then adds the declared bonus to eligible participating policies according to policy terms. Since bonuses depend on the fund’s performance, bonus rates are not guaranteed and can change from year to year.

What is a reversionary bonus?

Now that you know what a bonus in insurance is and how insurers declare it, let’s proceed to understand reversionary bonus’ meaning. A reversionary bonus is the most common type of bonus in insurance offered under participating life insurance policies. It is an amount declared by the insurer and added to your policy every year based on the announced bonus rate. However, this bonus is not paid out immediately. Instead, it accumulates within the policy and becomes payable when the policy matures or when a death claim is settled.

After an insurer declares the reversionary bonus and it is attached to the policy, it generally cannot be taken back. Reversionary bonuses are usually classified as either a simple reversionary bonus or a compound reversionary bonus. 

Also, read – Money back policy – Features, benefits & guaranteed returns explained

What is a simple reversionary bonus?

A simple reversionary bonus is calculated only on the original sum assured of the policy and not on previously declared bonuses. If the insurer declares a bonus each year, the same calculation method is used annually based on the base sum assured. As a result, the bonus accumulates steadily over the policy term. For example, if the sum assured is Rs. 10 lakh and the bonus rate is Rs. 40 per Rs. 1,000, the annual bonus would be Rs. 40,000.

What is a compound reversionary bonus?

A compound reversionary bonus is calculated on the original sum assured and the bonuses that have already been added to the policy. This means each year’s bonus can earn further bonuses in future years, creating a compounding effect. As a result, the accumulated bonus may grow faster than a simple reversionary bonus, especially over a long policy term. Due to this compounding nature, the final benefit can be significantly higher over time.

Also, read – Loan protection insurance – Coverage, benefits, costs & key factors explained

What is a cash bonus?

A cash bonus is a type of life insurance bonus that is paid directly to the policyholder during the policy term. It is not added to the policy’s maturity or death benefit. Life insurers declare this type of bonus in insurance annually on eligible participating policies and may be expressed as a percentage of the sum assured or in another specified form. Since the bonus is paid out immediately, policyholders can use the money as they wish without waiting for the policy to mature.

What is an interim bonus?

An interim bonus is a bonus that may be paid when a policy matures, or a death claim arises between two regular bonus declaration dates. It covers the period from the last declared bonus up to the claim or maturity date. This helps ensure that the policyholder or nominee receives a fair share of the surplus earned during that part of the year and is not disadvantaged simply because the claim occurred before the next annual bonus declaration.

Also, read – Loan against life insurance policy

What is a terminal bonus?

A terminal bonus in insurance is a one-time additional bonus that may be paid when a participating life insurance policy matures or when a death claim is settled. It is often viewed as a loyalty or persistence reward for policyholders who keep their policies active for a long period or until the end of the policy term. Unlike reversionary bonuses, a terminal bonus is discretionary and not guaranteed. The amount and whether or not it is paid depend on the insurer’s performance and bonus policy.

What is a vested bonus?

A vested bonus is not a separate type of life insurance bonus. Instead, it refers to the total reversionary bonuses that have already been declared by the insurer and attached, or “vested,” to a participating policy. Once vested, these bonuses become part of the policy benefits and are generally payable at maturity or on a death claim, depending on the policy terms. In simple words, a vested bonus is the accumulated value of declared reversionary bonuses.

How to calculate a life insurance bonus?

If you want to know how to calculate the insurance bonus, the formula is given below:

Bonus = (Bonus rate per Rs. 1,000 / 1,000) X sum assured X number of years

Let’s understand how to calculate the insurance bonus with the help of an example.

The sum assured is Rs. 10 lakh, the bonus rate is Rs. 40 per Rs. 1,000, and the policy runs for 10 years. 

Bonus = 40 / 1000 X 100000 X 10 = Rs. 4 lakh

Under a compound reversionary bonus, the bonus is calculated on the sum assured plus previously declared bonuses. Thus, the total bonus grows faster over time and is usually higher than the simple reversionary bonus.

Also, read – Which is recommended, individual or corporate health insurance?

When and how are bonuses paid out?

The timing of bonus payouts depends on the type of bonus in insurance.

  • Reversionary bonus: It is usually accumulated and paid at policy maturity or on a death claim. This includes a vested bonus.
  • Terminal bonus: If declared, the bonus is also paid at maturity or death.
  • Cash bonus: It is paid directly to the policyholder during the policy term.
  • Interim bonus: It may be paid when a maturity or death claim occurs between two bonus declaration dates, ensuring fair treatment for the policyholder.

How do different life insurance bonus types compare?

The following table elaborates on how different types of bonuses in insurance compare:

Bonus typeHow is it calculated?When is it paid?Is it guaranteed?
Reversionary bonusDeclared periodically and added to the policy based on the insurer’s bonus rate. Can be simple or compound.Usually paid at maturity or on a death claim.No
Simple reversionary bonusCalculated only on the original sum assured each year.At maturity or on a death claim.No
Compound reversionary bonusCalculated on the sum assured plus previously accrued bonuses.At maturity or on a death claim.No
Cash bonusDeclared by the insurer and paid directly to the policyholder, often based on the sum assured.During the policy term.No
Interim bonusCalculated for the period between the last bonus declaration and the claim or maturity date.When a claim or maturity occurs between bonus declaration dates.No
Terminal bonusA one-time additional bonus determined by the insurer for long-standing policies.At maturity or on a death claim.No
Vested bonusRepresents the total reversionary bonuses already declared and attached to the policy.At maturity or on a death claim. 

Conclusion

A bonus in life insurance can increase the value of participating policies by allowing policyholders to share in a portion of the insurer’s surplus. The calculation methods and payout timings vary for different types of bonuses in insurance, so it is vital to understand how each one works. Since bonus rates are not guaranteed and may change over time, reviewing the insurer’s past bonus history can provide useful context.

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FAQs

What is a reversionary bonus in life insurance?

A reversionary bonus is an additional benefit a life insurance company declares on a participating life insurance policy. It is added to the policy benefits. It is not immediately paid to the policyholder but accumulates over time. The payout usually happens at maturity or on a death claim.

What is the difference between a simple and a compound reversionary bonus?

A simple reversionary bonus is calculated only on the original sum assured. On the other hand, a compound reversionary bonus is calculated on the sum assured plus previously declared bonuses. It allows the bonus amount to grow faster over time.

What is a terminal bonus?

A terminal bonus in insurance is a one-time additional bonus. It may be paid upon the maturity of a participating policy or when a death claim is settled. Its purpose is to reward long-term policyholders, and it is not guaranteed.

What does a vested bonus mean?

A vested bonus is the total of all reversionary bonuses that have already been declared and attached to a participating policy. Once vested, these bonuses become part of the policy benefits and are generally payable at maturity or death.

Do all life insurance policies pay bonuses?

No, not all life insurance policies pay a bonus. They are available only under participating (with-profits or par) life insurance policies. Generally, there are no life insurance bonuses on term insurance plans, ULIPs, and non-participating policies.

How is a life insurance bonus calculated?

A life insurance bonus is commonly calculated using the insurer’s declared bonus rate, the policy’s sum assured, and the number of years for which the policy has been active. The formula for bonus calculation is: Bonus = (Bonus rate per Rs. 1,000 / 1,000) X sum assured X number of years

Are life insurance bonuses guaranteed?

In most cases, life insurance bonuses are not guaranteed because they depend on the insurer’s surplus and bonus declaration policy. However, once a reversionary bonus has been declared and vested, it is generally payable according to policy terms.  
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