Types of Bonuses in Life Insurance: Exploring Terminal Bonus and More

At a Glance

• Introduction: Why understanding bonus types in life insurance matters.
   
• What Are Bonuses?: Definition and role in participating policies.
   
• Types of Bonuses: Reversionary, terminal, cash, interim, and loyalty bonuses.
   
• Focus on Terminal Bonus: How the terminal bonus in insurance works.
   
• How Bonuses Are Calculated: Factors Influencing Payouts.
   
• Benefits and Considerations: Pros and cons of bonuses.
   
• Key Takeaways: Summary to guide your policy choice.

In India, life insurance is a cornerstone of financial planning, offering security and wealth creation. Participating life insurance policies, unlike non-participating ones, share insurer profits with policyholders through bonus types like the terminal bonus in insurance, reversionary bonus, and more.

Such bonuses can greatly boost your policy’s payout, making it essential to understand them. This blog explores the various bonuses, with a focus on the terminal bonus in insurance, to help you choose the right policy in 2025.

What Are Bonuses in Life Insurance?

A bonus in life insurance is an additional sum paid to policyholders of participating (with-profit) policies, over and above the sum assured. These bonuses come from the insurer’s surplus profits, generated through investments in government securities, bonds, and equities. Governed by the Insurance Regulatory and Development Authority of India (IRDAI), bonuses are declared annually and vary based on the insurer’s financial performance. Only participating policies, such as endowment or whole life plans, qualify, unlike term insurance or non-participating plans.

Types of Bonuses in Life Insurance

Indian insurers offer several bonus types, each with unique features and payout structures. Below are the main bonuses, including the terminal bonus in insurance.

1. Reversionary Bonus

Overview: A reversionary bonus is an annual bonus added to the policy’s sum assured, payable at maturity or upon the policyholder’s death. It’s declared as a percentage of the sum assured and becomes guaranteed once added.

Sub-Types:

• Simple Reversionary Bonus: Calculated solely on the sum assured. For example, if the sum assured is ₹10 lakh and the bonus rate is 4% (₹40 per ₹1,000), the annual bonus is ₹40,000. Over 10 years, this adds ₹4 lakh.
   
• Compound Reversionary Bonus: Calculated on the sum assured plus previously accrued bonuses, leading to higher payouts due to compounding. For instance, a 5% bonus on ₹10 lakh yields ₹50,000 in year one. In year two, the bonus is 5% of ₹10.5 lakh (₹52,500).

Suitability: Ideal for long-term wealth creation, as it accumulates over the policy term.

2. Terminal Bonus

Overview: The terminal bonus in insurance is a one-time bonus paid at policy maturity or upon the policyholder’s death, provided the policy runs its full term. Also called a persistency bonus, it rewards policyholders for staying invested. It’s discretionary, based on the insurer’s performance, and not guaranteed.

Example: For a ₹25 lakh sum assured policy with a 20-year term, a 1.25% annual terminal bonus rate might add ₹6.25 lakh at maturity, significantly boosting the payout.

Suitability: Best for those committed to long-term policies, as it’s not paid if the policy is surrendered early.

3. Cash Bonus

Overview: A cash bonus is paid annually to the policyholder as a cash payout, rather than accumulating until maturity. It’s calculated as a percentage of the annual premium or sum assured, offering immediate liquidity. For example, a 5% cash bonus on a ₹1 lakh premium yields ₹5,000 yearly.

Suitability: Suits policyholders seeking regular income alongside insurance coverage.

4. Interim Bonus

Overview: An interim bonus is paid if a policy matures or a death claim arises between two bonus declaration dates (typically annual). It ensures policyholders don’t miss out on profits for the partial year, calculated pro-rata from the last declaration. For instance, if a policy matures six months after the last bonus, the interim bonus covers those six months.

Suitability: Benefits policyholders with policies ending mid-year.

5. Loyalty Additions

Overview: Loyalty additions are bonuses paid at specific intervals (e.g., every 5 years) or at maturity for continuing the policy. They can be guaranteed or non-guaranteed, varying by insurer. For example, Tata AIA’s Shubh Life plan offers loyalty additions of 22–58% for 15–20-year terms.

Suitability: Encourages long-term commitment, ideal for endowment or savings plans.

Focus on Terminal Bonus in Insurance

The terminal bonus in insurance is a standout feature for Indian policyholders due to its potential to enhance payouts significantly. Unlike the reversionary bonus, which accumulates yearly, the terminal bonus is a one-time reward for completing the policy term or upon a death claim. It’s calculated based on the insurer’s investment performance, mortality experience, and policy duration.

Key Features:

• Discretionary: Not guaranteed; depends on insurer profits.
   
• Payout Timing: Paid only at maturity or death, not on surrender.
   
• Impact: Can increase the final payout by 10–30%, depending on the policy term and insurer. For example, ICICI Pru Savings Suraksha declares terminal bonuses as a percentage of the sum assured plus vested bonuses.
   
• Eligibility: Requires the policy to remain active for the full term, making it a loyalty incentive.

Example: Priya has a ₹50 lakh endowment policy with a 25-year term. At maturity, the insurer declares a terminal bonus of 1.5% per year on the sum assured. This adds ₹18.75 lakh (1.5% x 25 x ₹50 lakh) to her payout, on top of the sum assured and reversionary bonuses.

Considerations: The terminal bonus in insurance is attractive but risky due to its non-guaranteed nature. Policyholders must stay invested, as surrendering the policy forfeits this bonus.

How Bonuses Are Calculated?

Bonuses depend on several factors, as per IRDAI guidelines and insurer practices:

• Insurer’s Profits: Derived from investment returns (government bonds, equities) and low claim rates.
   
• Mortality Experience: Fewer deaths than expected increase surplus funds.
   
• Policy Duration: Longer terms accumulate more bonuses, especially for compound reversionary and terminal bonuses.
   
• Lapsation Rate: High policy surrenders reduce the bonus pool.
   
• Bonus Rate: Declared annually (e.g., ₹40 per ₹1,000 sum assured) based on financial performance.

Formula Examples:

• Simple Reversionary Bonus: Sum Assured x Bonus Rate (e.g., ₹10 lakh x ₹40/₹1,000 = ₹40,000/year).
   
• Compound Reversionary Bonus: (Sum Assured + Prior Bonuses) x Bonus Rate.
   
• Terminal Bonus: Sum Assured x Terminal Bonus Rate x Policy Years (e.g., ₹50 lakh x 1.5% x 20 = ₹15 lakh).

Read More: How Does Life Insurance Work? Everything You Need to Know Before Buying

Benefits and Considerations of Bonuses

Benefits

• Higher Payouts: Bonuses like the terminal bonus in insurance and reversionary bonus boost maturity or death benefits, enhancing financial security.
   
• Wealth Creation: Compound reversionary bonuses and loyalty additions support long-term savings.
   
• Liquidity: Cash bonuses provide annual income, ideal for meeting financial needs.
   
• Tax Benefits: Bonuses are tax-exempt under Section 10(10D) of the Income Tax Act, 1961, subject to conditions.
   
• Incentive for Loyalty: Terminal and loyalty bonuses reward policyholders for staying invested.

Considerations

• Not Guaranteed: Except for declared reversionary bonuses, others (like terminal bonuses) depend on insurer performance.
   
• Participating Policies Only: Non-participating plans (e.g., term insurance) don’t offer bonuses, and premiums for participating plans are higher.
   
• Surrender Risk: Surrendering a policy forfeits future bonuses, including the terminal bonus in insurance.
   
• Complexity: Bonus calculations vary by insurer, requiring careful review of policy documents.

Choosing a Policy with Bonuses in India

Understanding bonus types like the terminal bonus in insurance and reversionary bonus empowers you to select a life insurance policy that aligns with your goals. If you seek long-term wealth, opt for policies with compound reversionary or terminal bonuses, offered by insurers like LIC, ICICI Pru, or Tata AIA. For regular income, cash bonus plans are ideal. 

Always check the insurer’s bonus track record, claim settlement ratio (e.g., LIC’s 98% vs. industry average), and policy terms via OneAssure.

Key Takeaways