What is a Bonus?
Bonus in life insurance context refers to the share of profits of the insurance company, which is distributed or shared with the policy holders.
Premiums paid by policyholders are pooled within the insurance company's life fund. The company uses these pooled resources 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 upon the earnings from the investments made by the company and its claims experience, a life insurance company may distribute a part of its surplus to the participating or with-profits policyholders in the form of bonus.
The bonus rate depends upon factors such as the return on the assets and investments, the level of bonuses declared in previous years and other actuarial assumptions.
Different Types of Bonuses:
Simple Reversionary Bonus: This type of bonus is calculated on the sum assured. This bonus is generally declared annually at the end of each financial year and attached on each policy anniversary as per terms and conditions of the policy contract, to be paid out at the time of a claim or on maturity.
Compound Reversionary Bonus: This type of bonus 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.
Terminal Bonus: The terminal bonus, also known as loyalty or 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. This form of bonus may be distributed after staying in the policy for a pre-determined long time period and is offered at the discretion of the insurer depending on the profit experience for the particular policy.
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: Some insurance companies may decide to pay the bonus on every policy anniversary in the form of cash payout, instead of accrued reversionary bonuses.