Don’t use credit cards like this!

Credit card companies offer reward points every time you use the card. Similarly, cashback is offered by e-wallet companies. Life insurance is no different as it rewards policyholders in the form of bonuses so that they stay invested with them for a long period.

Here we take a detailed look at how the bonus amount accrues and the types of bonus offered:

How life insurers calculate bonus?

First things first. The bonus is generally built-in with endowment plans that classify as participating (with-profit) policies. As the name suggests they take part in the investment profits of the insurance company which is shared with the policyholders in the form of bonus payment. The bonuses are distributed as a percentage of the sum assured and are generally announced at the end of every financial year.

Premiums paid by policyholders get pooled in a life fund. Thereafter, the money lying in this fund gets invested in government securities with small exposure to equities. This fund is also used to pay claims. Based on the claims experience and returns it generates, the insurer then distributes a part of its surplus in the form of a bonus. The policyholder receives 90% of the profits as the bonus and the remaining 10% of the surplus is kept for shareholders.

Types of Bonuses

Simple Reversionary Bonus: This type of bonus is calculated on the sum assured only. This bonus is declared annually but is accrued to be paid out at the time of a claim or maturity.

Compound Reversionary Bonus: This type of bonus is calculated as a percentage of the sum assured and all previously accrued bonuses.

Terminal Bonus: This bonus is paid at the time of maturity to policyholders who complete the term of the policy by paying all the due premiums as a reward for their loyalty towards the insurance company. Terminal bonuses are not guaranteed and depend on the company’s performance.

Interim Bonus: A bonus paid between two successive annual declarations of bonus. The final bonus is declared only at the end of the financial year when the final accounts of the life Insurer are made. Therefore, the policies maturing during the year are paid proportionate interim bonus till the date of maturity or claim of the policy.

Cash Bonus: The insurer may also give the bonus in cash, at the end of the year. The policyholder gets the opportunity to earn the bonus year on year rather than waiting till the maturity of the policy.

Last but not least, next time when you buy the policy check the track record of the company, as bonuses declared in previous years can give you some idea about future returns.