Types of bonuses in insurance plans

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IN THE most common understanding of the word, bonus is a reward or any extra amount that one may receive over and above the base amount. A similar concept is also applicable to your life insurance policy. In this context, a bonus is an additional sum that gets accrued to the policy on a yearly basis. This amount is paid out by the insurance company upon maturity of the plan, or in case of unfortunate death.

Understanding how bonus is determined: The premiums paid by policyholders are pooled within the insurance company's life fund. The company uses these pooled assets to pay out claims. A large part of the life fund is invested in government-secured debt instruments, with a small portion invested in equity to achieve a desired return. Based on the earnings from the investments made by the company and its claims experience, the company aims to distribute a part of its surplus to the with profits policyholders in the form of bonus.

The bonus rate is decided after considering a variety of factors such as the return on the underlying assets, the level of bonuses declared in previous years and other actuarial assumptions.

Bonus is offered on traditional plans that are built in to the plan structure. To avail of the bonus, it is important that the type of plan you have purchased is a `withprofits' one, often known as a participating policy as well.

Types of bonuses: The common types of bonus offered by insurers are simple reversionary bonus, compound reversionary bonus, terminal bonus, interim bonus, and cash bonus.

Simple reversionary bonus (SRB): This type of bonus is calculated on the sum assured only. This bonus is declared annually and is accrued to be paid out at the time of a claim or maturity.

Compound reversionary bonus (CRB): CRB is calculated as a percentage of the sum assured and all previously accrued bonuses. The bonus of each year is added to the sum assured and the next year's bonus is calculated on the enhanced amount.

Let's take an example to understand which type of bonus is beneficial for you.

Take for instance, Rahul Khanna owns two participating policies of Rs 5,00,000 each. Let's assume that on the first policy he gets a bonus using the simple revisionary method and on the second policy he gets a bonus using the compound revisionary method. The SRB declared on the policy is Rs 25 per `000 of sum assured, while CRB declared is 3 per cent throughout the policy term.

As seen from the table above, the CRB to be accrued at the end of the 10th year is much higher, compared with the SRB of the same year.

Terminal bonus: The terminal bonus, also known as a persistency bonus, is a bonus paid to indicate an overall performance of a participating policy. The terminal bonus is paid at the time of maturity or death of the life assured.

Interim bonus: Interim bonus is payable for those policies that mature or result in a death claim in between two bonus declaration dates. While the policy has already accrued the bonus declared at the end of the last financial year, there may be a short period in between the bonus declaration date and the maturity/claim date for which the policy has not received bonus. In such instances, bonus is added on a pro-rata basis using the interim bonus rates declared by the company. An interim bonus ensures that policyholders who claim benefits in midst of a year will receive credit for keeping the policy in force for that part of the year.

Cash bonus: The insurance company may decide to give the bonus in cash, that is, bonus accruing in a year will be paid to the policyholder at the end of the year.

This gives the policyholder an opportunity to receive the bonus year on year.

Things you should consider: Type of bonus offered: While evaluating a traditional policy, it is a good idea to consider beforehand the type of bonus that your plan offers. This would be mentioned in the brochure of the plan, or you could also check with your agent/intermediary.

Check bonus rates: While choosing your traditional plan, make sure to check the bonus rates offered by them over the years.

These rates are usually published on the insurer's website and will give you an idea of the kind of benefits you stand to gain from the particular policy. Additionally, it is recommended that you check the company's website as few insurers publish the declared bonus rate on their official website.

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