In the business of life insurance, it is the universal convention to issue life policies with or without participation in the profit of the company (insurer). The profit share that is allowed as such is commonly known as a bonus.
The policies, which provide for such a bonus, are known as PARTICIPATING POLICIES, and the policies, which do not provide for such a bonus, are known as NON-PARTICIPATING POLICIES.
In the earlier days, the life offices were mostly mutual associations wherein there were no shareholders (as in limited liability companies) for raising capital. Policyholders used to join and form ssociations/societies for transacting their own life insurance.
In fact, these policyholders were the owners of such mutual organizations and, therefore, all profits used to be distributed amongst them.
When during the later period joint- stock insurance companies entered the picture, they retained the practice of allowing the share of profit to those of their policyholders who used to take with-profit or participating policies.
The policyholders who take with-profit policies are required to pay a comparatively higher premium (as opposed to those who take non-participating policies), which entitles them to share the profit of the insurers.
It should be noted by the students that taking out a with-profits policy does not necessarily guarantee them a bonus or profit share. It simply gives them a right to share in such a surplus of a company as may be made available for profit distribution.
The method of bonus distribution or declaration is a technical process of a life office involving the VALUATION of its assets and liabilities.
Life offices, as a rule, value their assets and liabilities under existing insurance contracts at fixed intervals.
This interval is normally three years, although yearly valuation is becoming more common nowadays. Normally, if the office is sound, the valuation shall disclose a surplus of assets over liabilities, i.e., liabilities arising out of the sums required to meet all liabilities and contingencies.
If this valuation discloses a surplus as such, then such surplus is made available for those policyholders who are affected with-profit policies.
The students should note that the bonus, which is declared as such, is a Reversionary Bonus and, therefore, is not paid in cash as and when declared. It is added up to the policy and is paid at the same time as the sum assured (i.e., either on death or maturity).
Types of Life Insurance Bonus
Bonuses are mainly of two types:
Simple Reversionary Bonus
This is calculated at a rate percent on the sum insured based on the availability of the divisible surplus. The declaration is made periodically, and the amount of bonus is added up to the sum assured.
Compound Reversionary Bonus
This is almost like the simple reversionary bonus, the only difference being that each time the bonus is calculated at a rate percent on the sum assured, plus the previous bonus.
The students should realize that a simple reversionary bonus is calculated only on the sum- assured each time and never on the previous bonus.
For some reason or other, it is not possible on the part of the insured to continue the policy any further. Maybe he cannot pay the premium, but still wants some sort of life cover rather than totally surrendering the same. A Paid-up policy is a method of fitting into such a proposition.
Under a paid-up policy, the sum insured is proportionately reduced, normally to the extent of the bearing of the premium already paid on the premium that would have been paid.
This means that the sum insured is reduced to such an extent that the number of premiums paid bears the total number of Premiums payable.
Important Features of Life Insurance Bonus
- The contract is not terminated because of converting the policy into a paid-up one; the policy stands for a reduced cover.
- The Paid-up value proportionately increases if it takes place during the latter part of the policy period.
- The Paid-up value is not paid immediately but as per the contract’s original terms (i.e., death or maturity).
- No further premium is required to be paid from the time of Conversion of the policy.
The life cover still remains operative for this reduced sum insured and this sum insured is paid as per the original terms of the policy (i.e., death or maturity) The students should realize that no further premium is required to be paid from the time the policy is converted into paid-up.