Concept of Bonus, Bonus in Reduction of Premium and Interest Accrued on Investments
by Bonus in life insurance is an additional amount declared by a life insurance company and added to the policy benefits of participating or with-profit policies. It represents the policyholder’s share in the profits earned by the insurance company. Bonuses are generally declared based on the company’s surplus determined through actuarial valuation.
Meaning of Bonus
Bonus is an extra benefit paid by the insurance company to policyholders in addition to the sum assured under participating life insurance policies.
Definition
Bonus is the distribution of a portion of the insurer’s profits to policyholders in the form of additional benefits attached to their policies.
Calculation of Bonus
Formula: Bonus = Sum Assured × Bonus Rate × Number of Years
Illustration
- Sum Assured = ₹5,00,000
- Bonus Rate = ₹40 per ₹1,000 Sum Assured
- Policy Period = 10 Years
Calculation
Annual Bonus:
= ₹5,00,000 × 40/1000
= ₹20,000 per year
Total Bonus:
= ₹20,000 × 10 years
= ₹2,00,000
Maturity Amount:
| Particulars | Amount (₹) |
|---|---|
| Sum Assured | 5,00,000 |
| Add: Bonus | 2,00,000 |
| Total Maturity Amount | 7,00,000 |
Therefore, the policyholder receives ₹7,00,000 on maturity.
Bonus in Reduction of Premium
Bonus in reduction of premium is a type of bonus declared by a life insurance company in which the policyholder is allowed to use the bonus amount to reduce future premium payments instead of receiving it in cash or adding it to the sum assured.
Under this method, the bonus earned on a participating policy is adjusted against the premium payable in subsequent years. As a result, the policyholder pays a lower premium while continuing to enjoy the insurance protection under the policy.
Features
- Available only in participating or with-profit policies.
- The bonus is used to reduce future premiums.
- It decreases the financial burden on policyholders.
- It does not reduce the sum assured of the policy.
- It encourages policy continuation and regular premium payment.
Example: Suppose Mr. A has a life insurance policy with an annual premium of ₹20,000. The insurance company declares a bonus of ₹5,000 in reduction of premium.
Therefore, the premium payable for the next year will be:
| Particulars | Amount (₹) |
|---|---|
| Annual Premium | 20,000 |
| Less: Bonus in Reduction of Premium | (5,000) |
| Premium Payable | 15,000 |
Thus, instead of paying ₹20,000, Mr. A pays only ₹15,000 as premium.
Interest Accrued on Investments
Interest accrued on investments refers to the interest that has been earned on investments up to the accounting date but has not yet been received by the insurance company. According to the accrual concept of accounting, such interest is recognized as income even though the cash has not been received.
Insurance companies invest large amounts in government securities, bonds, debentures, and other financial instruments. Interest earned on these investments forms an important source of revenue and is shown in the Revenue Account and Balance Sheet.
Illustration
An insurance company holds Government Bonds of ₹10,00,000 carrying interest at 8% per annum. The interest is payable annually on 30 June, and the accounting year ends on 31 March.
Annual Interest:
= ₹10,00,000 × 8%
= ₹80,000
Interest accrued for nine months (July to March):
= ₹80,000 × 9/12
= ₹60,000
Therefore, ₹60,000 will be treated as Interest Accrued on Investments and shown as:
- Income in the Revenue Account.
- Current Asset in the Balance Sheet.
Importance
- Ensures proper application of the accrual concept.
- Shows the true income of the insurance company.
- Helps in accurate preparation of financial statements.
- Provides a fair view of investment earnings.
- Assists in determining the actual profit of the insurer.
Objectives of Bonus in Life Insurance
- To Distribute Profits Among Policyholders
One of the primary objectives of declaring a bonus is to distribute a portion of the insurance company’s profits among participating policyholders. Since policyholders contribute premiums that generate surplus funds, they are entitled to share in the company’s success. The bonus acts as a reward for their participation and strengthens their relationship with the insurer. Therefore, the distribution of profits among policyholders is an important objective of bonus declaration.
- To Increase Policy Benefits
A bonus increases the amount payable under a life insurance policy by adding extra benefits to the sum assured. It enhances the financial value of the policy and provides greater protection to policyholders and their families. Therefore, one of the important objectives of a bonus is to increase the overall benefits available under the insurance policy.
- To Encourage Long-Term Savings
Life insurance policies are long-term contracts, and bonuses encourage policyholders to continue their policies until maturity. The prospect of receiving additional benefits motivates individuals to save regularly and maintain financial discipline. Therefore, promoting long-term savings and investment habits is one of the significant objectives of bonus declaration.
- To Reward Policyholder Loyalty
Policyholders who continue paying premiums regularly and maintain their policies for many years contribute significantly to the growth of the insurance company. Declaring a bonus serves as a reward for their loyalty and continued association with the insurer. Therefore, one of the objectives of a bonus is to recognize and reward policyholder loyalty.
- To Improve the Attractiveness of Insurance Products
The availability of bonuses makes life insurance policies more appealing to prospective customers. Policies that offer profit-sharing opportunities are often preferred over those that provide only basic insurance coverage. Therefore, one of the objectives of declaring a bonus is to increase the attractiveness and competitiveness of life insurance products.
- To Enhance Customer Satisfaction
Bonuses provide additional financial benefits to policyholders and increase their satisfaction with the insurance company. Satisfied customers are more likely to renew their policies, purchase additional products, and recommend the insurer to others. Therefore, improving customer satisfaction is an important objective of bonus declaration.
- To Promote Policy Retention
The expectation of receiving bonuses encourages policyholders to keep their policies in force and avoid surrendering them prematurely. Higher policy retention improves the stability and profitability of insurance companies. Therefore, one of the objectives of bonus declaration is to promote the continuation and retention of insurance policies.
- To Enhance the Reputation and Goodwill of the Insurance Company
Regular declaration of bonuses reflects the financial strength and profitability of an insurance company. It increases public confidence and enhances the company’s reputation in the market. A company known for declaring attractive bonuses can attract more customers and expand its business. Therefore, one of the important objectives of a bonus is to strengthen the goodwill and market image of the insurance company.
Features of Bonus in Life Insurance
- Available Only on Participating Policies
One of the most important features of bonus in life insurance is that it is available only on participating or with-profit policies. Policyholders who purchase these policies are entitled to share in the profits earned by the insurance company. Non-participating policies do not receive any bonus because they provide only the guaranteed benefits specified in the policy contract. This feature makes participating policies more attractive to customers who seek additional returns along with insurance protection. Therefore, the availability of bonus exclusively on participating policies is a distinctive feature of life insurance bonuses.
- Declared Out of Surplus Profits
A bonus is declared only when the insurance company earns sufficient surplus after meeting all claims, expenses, taxes, and reserve requirements. The surplus is determined through actuarial valuation and forms the basis for the declaration of bonus. The amount of bonus may vary from one year to another depending upon the company’s financial performance. Therefore, one of the important features of bonus is that it is directly linked to the profitability and financial strength of the insurance company and represents the policyholder’s share in the profits.
- Increases the Value of the Insurance Policy
Bonus significantly increases the financial value of a life insurance policy. The declared bonus is usually added to the sum assured and becomes payable on maturity or death of the insured. As a result, the policyholder receives an amount greater than the original sum assured. This additional benefit enhances the attractiveness of life insurance policies and provides greater financial security to the insured and their family. Therefore, one of the significant features of bonus is that it increases the overall value and benefits of the insurance policy.
- Determined Through Actuarial Valuation
The declaration of bonus is based on actuarial valuation conducted by professional actuaries. The actuary examines the insurer’s financial position, mortality experience, investment income, expenses, and future liabilities before recommending the rate of bonus. This scientific and systematic process ensures that bonuses are declared only when the company has sufficient surplus funds. Therefore, one of the important features of bonus is that it is determined through actuarial valuation and is supported by careful financial analysis and professional judgment.
- Payable on Death, Maturity, or Surrender
Bonus generally becomes payable when the policy matures, when the insured person dies, or in certain cases when the policy is surrendered. The accumulated bonus is added to the policy benefits and paid along with the sum assured. This feature provides additional financial assistance to the policyholder or nominee at important stages of the policy. Therefore, one of the essential features of bonus is that it provides extra benefits that become payable upon the occurrence of specified events under the insurance contract.
- Rewards Long-Term Policyholders
Bonus serves as a reward for policyholders who continue their policies and pay premiums regularly over a long period. The longer the policy remains in force, the greater is the possibility of accumulating substantial bonuses. This feature encourages policyholders to retain their policies until maturity and promotes disciplined savings. Therefore, one of the notable features of bonus is that it rewards loyalty and long-term participation in life insurance schemes.
- Depends on the Financial Performance of the Company
The amount and rate of bonus declared by an insurance company depend largely on its financial performance and profitability. Companies earning higher profits and investment returns are generally able to declare larger bonuses. Conversely, companies experiencing poor financial performance may declare lower bonuses or no bonus at all. Therefore, one of the important features of bonus is that it is influenced by the financial condition, profitability, and efficiency of the insurance company.
- Provides Additional Financial Security
Bonus provides additional financial security to policyholders by increasing the amount receivable under the policy. The extra amount received through bonuses can help meet future financial requirements such as education expenses, retirement needs, or family responsibilities. It also provides greater protection to beneficiaries in the event of the policyholder’s death. Therefore, one of the significant features of bonus is that it enhances the financial security and economic well-being of policyholders and their families.
Types of Bonus in Life Insurance
1. Reversionary Bonus
A reversionary bonus is the most common type of bonus declared by life insurance companies on participating or with-profit policies. It is declared periodically, usually every year, and once declared, it becomes a guaranteed addition to the policy. The bonus is not paid immediately but accumulates over the life of the policy and becomes payable on the maturity of the policy or on the death of the insured.
The amount of reversionary bonus depends on the profits earned by the insurance company and the recommendations of the actuary. Since it is added to the sum assured, it increases the final amount payable to the policyholder or nominee.
This type of bonus encourages policyholders to continue their policies for the full term because the accumulated bonus can significantly increase the maturity benefits.
Example: Mr. A has a life insurance policy with a sum assured of ₹5,00,000. The insurer declares a reversionary bonus of ₹30 per ₹1,000 sum assured every year.
Annual Bonus:
₹5,00,000 × 30/1000 = ₹15,000
If the policy remains in force for ten years, the accumulated bonus will be:
₹15,000 × 10 = ₹1,50,000.
Therefore, the policyholder receives the sum assured of ₹5,00,000 plus a bonus of ₹1,50,000.
2. Simple Reversionary Bonus
A simple reversionary bonus is a type of reversionary bonus that is calculated only on the original sum assured and not on previously declared bonuses. The same amount of bonus is added every year, provided the insurance company declares a bonus.
This bonus is easy to calculate because the annual bonus remains constant throughout the policy period. It provides certainty to policyholders regarding the additional benefits that may accrue over time.
The simple reversionary bonus is commonly used by life insurance companies because it offers transparency and stability. The accumulated bonus is payable only on maturity or death and not during the policy term.
Example: A policy has a sum assured of ₹10,00,000, and the insurer declares a simple reversionary bonus of ₹40 per ₹1,000 sum assured.
Annual Bonus:
₹10,00,000 × 40/1000 = ₹40,000.
If the policy remains in force for fifteen years:
Total Bonus = ₹40,000 × 15 = ₹6,00,000.
Therefore, the maturity amount will be:
₹10,00,000 + ₹6,00,000 = ₹16,00,000.
Thus, a simple reversionary bonus substantially increases the benefits payable under the policy.
3. Compound Reversionary Bonus
A compound reversionary bonus is a bonus calculated not only on the original sum assured but also on previously accumulated bonuses. In this system, the bonus amount increases every year because each year’s bonus becomes part of the base for calculating future bonuses.
This type of bonus provides greater benefits to policyholders than a simple reversionary bonus because it follows the principle of compounding. However, it is less commonly used because of its complexity and higher financial burden on insurers.
Compound reversionary bonuses significantly increase the maturity value of long-term life insurance policies and encourage policyholders to continue their policies for extended periods.
Example: Mr. B has a policy with a sum assured of ₹5,00,000 and receives a compound bonus of 4% annually.
First-Year Bonus:
₹5,00,000 × 4% = ₹20,000.
Second-Year Bonus:
₹5,20,000 × 4% = ₹20,800.
The bonus continues to grow every year on the increased amount. Thus, the policyholder receives a larger accumulated bonus due to the effect of compounding.
4. Interim Bonus
An interim bonus is declared when a policy becomes a claim between two actuarial valuation dates. Since insurance companies generally declare bonuses only after periodic actuarial valuations, policies maturing or resulting in death before the next valuation may not receive the regular bonus.
To ensure fairness, an interim bonus is granted for the period between the last declared bonus and the date of maturity or death. It ensures that policyholders or beneficiaries are not deprived of their share of profits merely because the claim occurred before the next bonus declaration.
Example: An insurance company declares bonuses every year on 31 March. A policyholder dies on 30 September before the next valuation date.
The company grants an interim bonus of ₹10 per ₹1,000 sum assured for the six-month period.
If the sum assured is ₹8,00,000:
Interim Bonus:
₹8,00,000 × 10/1000 = ₹8,000.
Therefore, the nominee receives the sum assured plus the interim bonus of ₹8,000.
5. Terminal Bonus
A terminal bonus is an additional one-time bonus paid to policyholders when the policy matures or when the insured person dies after the policy has remained in force for a specified minimum period. It is generally declared when the insurance company has performed exceptionally well and earned substantial profits.
Unlike reversionary bonuses, terminal bonuses are not guaranteed and are paid only at the end of the policy term. They are intended to reward long-term policyholders and increase the overall maturity benefits.
Terminal bonuses are particularly common in participating endowment and whole-life policies.
Example: Mrs. C holds an endowment policy with a sum assured of ₹10,00,000. On maturity, the insurance company declares a terminal bonus of ₹2,00,000.
Therefore, the total amount payable is:
| Particulars | Amount (₹) |
|---|---|
| Sum Assured | 10,00,000 |
| Accumulated Bonuses | 3,00,000 |
| Terminal Bonus | 2,00,000 |
| Total Maturity Amount | 15,00,000 |
Thus, the terminal bonus substantially enhances the final benefits received by the policyholder.
Importance of Bonus in Life Insurance
- Provides Additional Financial Benefits
One of the major importance of bonus is that it provides additional financial benefits to policyholders over and above the sum assured. The bonus increases the amount payable on maturity or death, thereby enhancing the overall value of the insurance policy. This additional amount can help policyholders meet future financial needs and provide greater financial security to their families. Therefore, bonus serves as an important source of extra income and strengthens the economic benefits of life insurance policies.
- Encourages Long-Term Savings
Bonus encourages policyholders to continue their policies for the entire term. The possibility of receiving additional benefits motivates individuals to save regularly and maintain financial discipline. Since bonuses accumulate over time, policyholders are less likely to surrender their policies prematurely. This promotes a long-term savings habit and helps individuals build financial resources for future needs such as retirement, education, and family responsibilities. Therefore, bonus plays an important role in encouraging long-term savings and financial planning.
- Rewards Policyholder Loyalty
Policyholders who regularly pay premiums and maintain their policies for many years contribute significantly to the profitability of insurance companies. Bonus acts as a reward for their loyalty and continued association with the insurer. By sharing a portion of profits with policyholders, insurance companies recognize their contribution and encourage them to continue their policies. Therefore, one of the important aspects of bonus is that it rewards long-term policyholders and strengthens customer relationships.
- Increases the Attractiveness of Insurance Policies
The availability of bonuses makes life insurance policies more attractive to prospective customers. Policies that offer profit-sharing opportunities are often preferred because they provide both insurance protection and additional financial returns. Bonus therefore acts as an incentive for individuals to purchase life insurance policies. The expectation of receiving bonuses also improves customer satisfaction and increases the demand for participating policies. Thus, bonus contributes significantly to the popularity and marketability of life insurance products.
- Enhances Financial Security
Bonus enhances the financial security of policyholders and their dependents by increasing the amount payable under the policy. The additional funds received through bonuses can be used to meet unforeseen expenses, support family members, or fulfill long-term financial goals. In the event of the policyholder’s death, the accumulated bonus increases the financial assistance available to the nominee. Therefore, bonus plays an important role in strengthening the financial protection provided by life insurance.
- Reflects the Financial Strength of the Insurance Company
The declaration of bonus indicates that the insurance company has earned sufficient profits and possesses a strong financial position. Companies that regularly declare attractive bonuses generally enjoy greater public confidence and a better reputation in the market. Therefore, bonus serves as an indicator of the efficiency, profitability, and financial soundness of the insurer. It enhances the credibility of the company and attracts more customers to its insurance products.
- Promotes Policy Retention
The prospect of receiving bonuses encourages policyholders to keep their policies in force until maturity. Since bonuses accumulate over time, policyholders are less inclined to surrender or discontinue their policies. Higher policy retention benefits both the insurer and the insured. Insurance companies enjoy stable premium income, while policyholders receive enhanced benefits at maturity or death. Therefore, bonus plays an important role in promoting policy continuation and reducing policy lapses.
- Increases Customer Satisfaction and Goodwill
Bonus increases customer satisfaction because policyholders receive additional benefits without paying extra premiums. Satisfied customers are more likely to renew their policies, purchase additional insurance products, and recommend the company to others. Regular declaration of bonuses also enhances the goodwill and reputation of the insurance company in the market. Therefore, one of the major importance of bonus is that it improves customer satisfaction, strengthens public confidence, and contributes to the long-term success of the insurance business.