Life Insurance Bonus

The divisible profit is to be distributed amongst the policyholders and shareholders. The main problem is distribution of profit to policyholders.

Two methods are assured while distributing the profit to policyholders.

(1) Uniform Bonus Plan
(2) Contributory Plan

(1) Uniform Bonus Plan

Under this method, a uniform bonus rate is given to all policyholders of a particular type. The bonus rate is based on the policy amount.

For example, Rs.25 per thousand on whole life policies have been declared as bonus. Thus, the only equity with this plan is the amount of policy. Higher the policy amount, higher will be the bonus amount to a policy.

The bonus rate is determined simply by calculating the total amount of divisible profit and multiplying it with the amount of insurance of Rs.1,000 and again dividing the whole sum by the amount of insurance under participating policies, at the time of valuation.

Thus the bonus per thousand can easily be calculated for a particular period. Thus, this system is popular, simple and flexible, but it is not very much equitous or it makes no distinction between policies on the basis of their contribution to the surplus.

However, some persons argued that taking the long term duration, it would be equitous because in the early period of the policy when his contribution is smaller, he is getting higher amount and at the later stage when his contribution will be higher he will be getting lesser amount of bonus.

Thus taking the total duration of policy, he is getting equal share of his contribution.

(2) Contributory Plan

The essential principle of this method is that the divisible surplus be allotted to the various policies in proportion to the individual contribution of each policy to the surplus.

The higher the contribution of a policy, the higher should be the amount of bonus declared on it.

Since there are several sources of surplus, contribution of each source should be analyzed. For this purpose two things have to be taken into account.

(i) The contribution of a particular type of policy to the total surplus.

(ii) Contribution of each source of surplus of a particular policy to the total surplus is to be determined. Then, on the basis of contribution of each policy, the surplus is allocated.

The calculation has been made simple by taking only three sources of surplus viz. Mortality, Interest arid Expenses savings. This is called ‘Three Factor Contribution Plan’.

Sometimes, mortality saving is ignored and only two factors viz. excess interest and loading saving are taken into consideration for determining the amount of contribution of each policy.

This method observes mostly the equity principle. But in practice, the calculation is very hard and complicated. Therefore, it is not popular.

Classification of Bonus

The bonus can be classified on the bases of calculation, resting of bonus and results of calculation.

1. Bonus on Basis of Calculation

There are two methods of calculation of bonus. Therefore, the bonus may be either uniform bonus or contributory bonus. Where the rate of bonus varies according to the policy amount, that is known as uniform bonus and where the contribution method is applied the bonus is known as contributory bonus.

2. Bonus on the Basis of Vesting

The bonus may vest as soon it is declared or after a period when the declared bonus is payable soon as it is declared, it is known as the immediate bonus and when the bonus does not become a liability of the insurer as soon as it is declared, it is called as deferred bonus.

In the latter case bonus is payable only when particular conditions are fulfilled. The bonus having already been declared is only in the nature of one of contingent liabilities.

The bonus remains with the insurer and ultimately is shared by those policy-holders who satisfy the given condition.

3. Bonus on the Basis of Results

Under this category , bonus is determined on the basis of actual results or fixed on an adhoc basis.

When the actual valuation has taken place, the bonus declared is known Final Bonus, and the bonus declared before the actuarial valuation is known as Interim Bonus. It is a rough estimation of bonus that will take place in future.

It is required where the policy matures before the valuation takes place on the basis of guess the bonus for the interim period is declared.

Bonus Options

1. Cash Bonus

Under this plan, the bonus when declared is paid to the assured in cash and the original sum assured alone is payable at claim. However, the cash bonus can be converted into other options of bonus.

2. Reversionary Bonus

The bonus is allotted as a uniform percentage addition to the sum assured or sum assured plus existing bonus addition and is payable along with the sum assured according to the terms of the policy.

The former case is known as ‘Simple Reversionary Bonus’ and the latter is known as ‘Compound Reversionary Bonus.’

The former is simple, popular and flexible as every time a bonus is distributed some addition is made to the policy amount. The compound reversion becomes more equitable but is hard to calculate. So, the simple reversionary bonus is practically used today.

3. Reduction in Premium Bonus

When the bonus is not added to the assured sum but is utilised for permanent reduction in the future premium payable, it is called ‘Reduction in Premium Bonus’.

As soon as the yearly bonus will be equal to the yearly premiums payable, the policy becomes paid up and no future premiums are required.

After this point, the additional increase in bonus may be added to the policy amount.

4. Accumulation at Interest Bonus

The bonus on the policy is kept in deposit with the insurer. The insurer gives a fixed rate of interest on the deposited amount and the insured at any time can withdraw the accumulated bonus or can use it for payment of future premiums.

5. Endowment Option

Under this option, the bonus is accumulated with a certain rate of interest and when the accumulated value of the policy becomes equal to the policy amount, the policy amount is paid in full before maturity.

The accumulated value of the policy will increase with the amount of bonus reserves and interest thereon.

Thus, before maturity at any time the accumulated value of the policy will be equal to the policy amount.