A bonus is an additional or extra amount that you receive over and above the entitled amount that you are eligible to get. The same concept applies to life insurance policies. Bonus payments in life insurance refer to the additional payments that the policyholder receives at the end of every year beyond the basic sum assured. The insurance companies generally pay the bonus upon policy maturity or the policyholder’s death as per the policy terms.
How do insurance companies generate life insurance bonuses?
When you pay the premium for your life insurance policy, it becomes a part of the insurance company’s asset pool. The insurer uses the money for administrative expenses and honouring the death claims. However, a larger portion of the funds is invested in different assets like debt and equity-related funds to generate profits.
The insurer then distributes the profits generated among the policyholder at the end of the financial year as a bonus. However, you must know that all life insurance policies are not eligible to get a bonus; it depends on the type of policy you hold.
Types of bonuses paid to life insurance policyholders
- Simple reversionary bonus
It is a type of bonus calculated on the sum assured, and it is payable on almost every traditional life insurance plan. A specific percentage of the sum assured is added to the policy every year until maturity or till the insured’s family member makes a death claim.
- Compound reversionary bonus
As the name suggests, the compound reversionary bonus is calculated based on compound interest. This is another type of bonus paid to life insurance policyholders. In a compound reversionary bonus, the bonus earned in the previous financial year is added to the sum assured, and the bonus for the current year is calculated on the consolidated amount.
However, since it is reversionary in nature, the bonus is paid only upon policy maturity or policyholder’s demise, whichever is earlier.
- Cash bonus
Sometimes, the insurance companies pay out the accrued annual bonus in cash to the policyholders at the end of the financial year. The cash bonus is calculated as a percentage of the yearly premium. It gives the policyholders the benefit of receiving the bonus at the end of each financial year rather than waiting till the policy maturity to receive the amount.
- Terminal bonus
Typically, the insurance companies pay this type of bonus to the policyholder when they keep the policy active through the entire policy tenure. In terminal bonus, the amount that the policyholder receives varies from insurer to insurer, and it is at the insurer’s discretion. It is paid only once upon policy maturity or the policyholder’s demise.
- Interim bonus
Generally, the insurance companies declare bonuses for life insurance policyholders at the end of the financial year. However, if the policy matures or the policyholder passes away before the end of the year, the insurance company declares an interim bonus.
This ensures that the policyholder or the beneficiary does not miss out on getting the bonus if the maturity date falls between two bonus declaration dates. The insurance company adds the bonus to the sum assured on a pro-rata basis at the interim bonus rate.
Now that you know what a life insurance bonus is and the different types of bonuses are available, you must do your due diligence and ask the insurance company if your policy is eligible for any of these bonuses. You should ideally do this even at the start when you are about to sign the policy document. Most insurance experts suggest that it is better to stay invested in the policy for a long time to allow the bonus to grow, and you can build a sizeable corpus.