Types of Bonuses in Life Insurance & How To Calculate It?

Receiving  extra cashback or free gifts always seems to be a great feeling, right? Well, a life insurance policy can give you that same thrill. 

Not only does it offer essential life coverage, but the plan also comes with various types of bonuses that are added to your basic sum assured annually. 

In this blog, we'll be understanding the types of bonuses in life insurance, how these are calculated, the bonus declaration process, and many more. 

How Many Types of Life Insurance Bonuses Are There in 2024?

Different life insurance policies offer different types of bonuses, depending on several factors, like how long the policyholder is holding the policy, whether it's a participating plan or not, and many more. 

Reversionary Bonus

The reversionary bonus gets accumulated every year and paid to the policyholder when the policy matures, or, in case the policyholder dies, it gets paid to the nominee. 

The bonus is calculated according to the below formula, as a certain percentage of the sum is assured. 

Reversionary Bonus = Sum Assured x Reversionary Bonus Rate (declared by the insurance company). 

Reversionary Bonus is of two types, i.e., Simple Reversionary Bonus and Compound Reversionary Bonus. Below, we have explained how these are calculated. 

1. Simple Reversionary Bonus

As declared at the end of the financial year, this type of bonus keeps accumulating until the policy matures or the policyholder dies. The simple reversionary bonus is paid in addition to the death and maturity benefits. 

Formula to calculate simple reversionary bonus: 

Simple Reversionary Bonus= Bonus Rate*(Sum Assured/1000)

Let's understand it with an example. 

Vijay bought a life insurance policy whose basic details are: 

• Simple Reversionary Bonus Rate: ₹40 per thousand of the sum assured
• Sum Assured: ₹20 lakhs

Then the bonus will be - 

40 x (20,00,000/1000) = ₹80,000

2. Compound Reversionary Bonus

Just like the simple reversionary bonus, the compound reversionary bonus is also added to a life insurance policy annually. But there's a catch! 

Along with the sum assured, it is also calculated on the basis of previously declared bonuses. This compounding effect increases the total maturity or death benefit over time.

Formula to calculate compound reversionary bonus:

Compound Reversionary Bonus = Bonus Rate*[(Sum insured+Accrued bonuses)/1000]

Let's understand it with an example. 

Let's say your company offered a bonus of 5% till the time your policy is active. And the assured/guaranteed sun for your policy is ₹10 lakhs. In this case, the bonus will be calculated as follows: 

1. First Year: The bonus for the first year will be 5% of ₹10 lakh, i.e., ₹50,000.
2. Second Year: For the second year, your total amount will be increased as the first year's bonus will be added to the original ₹10 lakhs. Thus, it'll become ₹10,50,000 (₹10,00,000 + ₹50,000). Moreover, the bonus again will be 5% of ₹10,50,000 = ₹52,500.

All in all, every year, your bonus adds up to the total amount, which means the bonus for the next year is calculated on the increased amount.

Interim Bonus

Generally, the tentative dates for bonus declarations are fixed, i.e., annually. But if the insured dies or the policy matures in between or before the company's annual bonus declaration dates, an Interim Bonus is paid. 

In short, an Interim Bonus helps make sure that no one misses out on their fair share of bonuses, even if their policy ends before the next official bonus declaration.

Terminal Bonus

Terminal bonus refers to the special payment you are entitled to receive after your insurance policy ends. Generally, this bonus is granted to you either when your policy term ends or if the beneficiary makes a death claim. 

Remember, if you surrender your policy before the agreed term, the terminal bonus will not be given. 

Cash Bonus

It is a regular bonus declared every year as a percentage of the base sum assured or annualised premium. The formula for calculating it is :

Cash Bonus = Annual Premium Amount x Cash Bonus Rate

How Are Life Insurance Bonuses Calculated?

Insurance policies are associated with insurance bonuses, which are actually additional benefits. Understand it this way – Your insurer does not keep your funds idle. They invest your money, hence earn returns. Part of the profit earned is given to you as a bonus. 

However, the amount of bonus depends on things like:

• How much did the insurer allocate as a bonus in the previous year?
• What is the rate of insurance claims?
• How much profit was made from the premium investments?
• Expected interest rates in the future.

Example:

Let's understand this with a scenario – Imagine you purchase a term insurance plan with a premium of ₹10,000 per year.  The insurer collects the premiums and invests them in different avenues. At the end of the year, they do an accounting of the profit obtained from those investments.

Assuming that the company made a profit of only ₹5,000 from its investments and that there were fewer insurance claims made by you than anticipated. In that case, they may offer you a bonus of about 3% of the accumulated value of your policy. This extra 3% is reinvested into your policy, therefore increasing the amount available upon maturity.

Factors Affecting Bonus Declaration

There are many factors that can affect the bonus declaration process by life insurance companies. 

1. Financial Performance: The declaration of bonuses is greatly influenced by the company's investment income as well as the overall financial condition of the company.

2. Mortality Experience: Generally, the lower the mortality rate, the higher the bonuses will be. Hence, the number of policyholders dying within a single year also impacts the declared bonus.  

3. Lapsation Rate: The number of policyholders surrendering their policy before maturity also reduces the bonus pool as surrender value is deducted. 

4. Competition: Companies in the insurance line may also determine the bonuses in order to remain relevant in the industry.

Impact of Bonuses on Policy Returns

Addressing the topic straight – Bonuses significantly increase the overall worth of your life insurance. The bonus increases the amount you or your nominee will get when the policy matures or if something happens to you.

If you maintain your policy for an extended period, more bonuses can be built, resulting in a much larger sum paid out later. The cherry on top is that bonuses help you tackle the increasing rate of inflation by increasing policy amounts over time. 

Bonus Declaration Process

When any insurance company earns profits, it declares a bonus for its policyholders. The amount of the bonus you receive depends on the specific rate declared by the company.

In case the company does not generate sufficient profits in a particular year, it may not declare any bonuses at all. Therefore, bonuses are not always assured on an annual basis and come with certain levels of risk depending on the financial performance of the insurer.

Maximising the Benefit of Bonuses

Here's how you can make the most of your life insurance bonuses:

1. Track Your Bonus: Keep records of the bonuses earned from the life insurance company and work out the total in order to know how much of it you should get.
2. Use Your Bonus Wisely: There are several ways that you can use the bonus. For instance, it might be added to the cash value of the policy or used to purchase additional coverage.
3. Know the Rules: Every bonus has some terms and guidelines that you have to learn in order not to lose the bonus.
4. Don't Cancel Your Policy: If you surrender or cancel your policy, you'll lose all the bonuses you've earned so far.

Conclusion 

A clear understanding of the life insurance bonuses and how they get calculated will help you choose a policy that matches your financial goals. To grow your savings, look for policies that offer a good amount of returns for the future. 

So check the factors that can affect your bonus declaration process and identify how you can maximise the benefit of the bonus. 

Before investing your savings, it is advised to consult a professional life insurance provider to under the policy-related bonuses in-depth! 

FAQs 

Ques 1. How many types of bonuses are there in life insurance?

Ans. The types of bonuses in life insurance are as follows - 

• Reversionary Bonus
• Interim Bonus
• Terminal Bonus
• Cash Bonus

Ques 2. How is the life insurance bonus calculated?

Ans. In most cases, the life insurance bonuses are calculated as a percentage of either the total sum assured of the policy or the yearly premium amount. However, the actual method to calculate a bonus will depend on the kind of bonus as well as the insurance firm.

Ques 3. How can one maximise the benefit of a bonus? 

Ans. Using your bonus in different ways, such as adding the amount to the policy's cash value, purchasing additional coverage, etc., can lead to maximising your bonus benefits. 

Ques 4. At what stage is a bonus declared?

Ans. A bonus gets declared at the end of a financial year and gets credited in the following financial year.

Ques 5. Are bonuses declared every year?

Ans. Bonus declaration depends on several factors, such as the insurance company's performance, market performance, etc. Hence, there's no guarantee that a bonus will be offered every year.