Budget 2012 - Income tax and Life Insurance

The Union Budget 2012 has been the focal point of the articles in our blog over the past few days. We have covered various aspects of Budget 2012 and the Tax implications on the Indian Citizen. Now, it is time to take a look at how the Budget 2012 impacts the Life Insurance section of Income Tax. Though there was no significant announcement about the Insurance Sector in our 2012 budget, there is one small change that waw tucked away in the corners of the budget. This change will have much bigger consequences. The purpose of this post is to cover those areas…

Before We Begin:

Insurance is nothing but an agreement between the insurer (The Insurance Company) and the insured (You) to pay an amount as compensation if any unexpected event occurs. This amount may vary from a few hundred to even a few crores. The maximum amount the insured person can claim depends on the amount agreed upon as per the insurance policy

To read more about Life Insurance Click Here.

What this Small Change?

All Regular Premium Life Insurance Policies issued after April 1st (Except Pension Plans) must offer a protection cover of at least 10 times the annual premium. Otherwise, they will not be eligible for Tax benefits under Section 80C.

Note: Until now, the mandated cover was five times the annual premium

What will be the Impact on the Common Tax Payer?

The Impact will be pretty big. All Insurance Policies, where the sum assured (In case of Death) is less than 10 times the annual premium will no longer be eligible for tax benefits under Section 80C of the Indian Tax Laws.

In other words, if your yearly premium is Rs. 50,000/- the protection cover in case of death must be atleast Rs. 5,00,000/- (5 Lakhs). Otherwise the policy premiums cannot be used for tax exemption under Section 80C.

Almost all Insurance Products (Except Pure Term Plans) will be affected by this ruling. Until this year, the mandated cover was only 5 times the annual premium and Insurance Cos created products that catered to this requirement. Now that the budget has changed this requirement to 10 times, most insurance policies will no longer be eligible for tax benefits.

The Impact will be:

1. We may have to look at availing fresh insurance policies to cover for the existing ones that we can no longer use for tax exemption which means – Additional Expenditure
2. What will we do with the existing policies that are no longer viable tax saving instruments? This will be a dilemma that everyone will have. Should I continue to pay the premium or should I surrender the policy? We will probably cover this as a separate post in future. For now, lets not worry about what to do with those policies.

What will be the Impact on the Insurance Company’s?

Insurance company’s will not have to come up with new products that meet the mandatory requirement of 10 times the annual premium worth of protection. The problem is, all those products that offer less than that, will no longer be useful to customers and hence they wont buy them. One of the primary motivating factors in the sale of insurance products it the tax benefit that comes with it. So, if by purchasing a policy, I wont get tax benefits, why in the hell would I buy it?

The impact will be:

1. Insurance Cos will have to come up with new products
2. There is mandatory approval period for any new policy that a company wishes to propose. IRDA takes some time to review the policy terms and approve it. So, in the meantime policy sales might take a hit
3. Policies that don’t offer this 10 times protection maybe targets for premature surrenders. Customers might choose to surrender their policies before maturity and insurance cos may face issues in meeting the liquidity demand if this number goes up.

Why did the Government Do This?

My Guess – To Prevent People from Using Insurance Policies as Investment

I have always been saying this “DO NOT CONFUSE INSURANCE AND INVESTMENT”

Insurance Cos and Agents have been selling insurance products as investments for decades. The government feels that the primary purpose of Insurance Policies is to provide financial support to the survivors of the insured individual. Any proceeds they get if they outlive the policy is only of secondary importance.

Impact on Various Categories of Insurance Policies

ULIPs and Endowment Plans will be affected as follows:

1. Insurance Cos will be forced to increase the % allocation from the premium amount towards mortality charges (Actual life insurance coverage) to account for the increase from 5 times to 10 times
2. This effectively means that the actual amount available to invest is going to come down (If the same annual premium is to be maintained)
3. If the Insurance co as well as the customer want to maintain the same levels of returns, the annual premium will be significantly higher

Money-Back Plans – These are the plans that in my opinion that will be worst hit. These have effectively been sold as exclusive investment options and they provide very little life insurance coverage. It is possible that the premiums on these policies will go up significantly (much more when compared to ULIPs or Endowment Plans) or such schemes may be scrapped altogether because of the technicalities involved in maintaining 10 times insurance coverage as well as providing good returns on investment.

Pure Term Insurance Plans – These are plans that will have ‘0’ impact due to this ruling. As pure insurance products, they offer a much higher insurance coverage than what is paid as the annual premium. For a premium of Rs. 15,000/- I can get around 30 lacs worth of Insurance. That is nearly 200 times the Annual Premium.


Some Last Words:

If Investment is your primary objective in buying Insurance Policies – then you are better off purchasing investment products like PPF, ELSS etc. With this New Ruling, the returns offered by Insurance policies will come down significantly. As a result, they will start serving their main purpose “Providing Life Insurance”

When Buying a Life Insurance Policy “Focus on life cover, and not on the investment component”

So, personally, I WELCOME THIS MOVE!!!

Are ULIPs becoming Obsolete?

Well, you might think I am crazy to ask such a question and I would be surprised if you dint… yes, you read the title right, are Unit Linked Insurance Plans becoming Obsolete?

The purpose of this article is not to tell you what an ULIP is or whether to invest in ULIPs or not. I have already dedicated a few of my older articles to do just that. You may want to visit them to understand them better.

1. Introduction to ULIPs
2. Can ULIPs Really Guarantee Returns

Are ULIPs Really getting Obsolete?

It has been a testing time for all equity market investors world wide. The stock markets are volatile and people are cautious before they invest their hard earned money in stocks. But, at the end of the day, stock market instruments are still one of the best preferred investment options for everyone.

But, it is such testing times that can spell the doom for certain investment options. In this case ULIPs or Unit Linked Insurance Plans.

Insurance Agents have been selling ULIPs like crazy and People have been buying them for years. In the past few months, Equity investments made by insurance companies went downwards, as policyholders surrendered some unprofitable old ones to shift to more attractive new products. To add to the woes of the ULIP sellers, regulatory changes did not help either.

The net investment from Insurance companies in the Stock markets was over Rs. 34,000 crores last year (i.e., They received that much money as ULIP premium) whereas this year in the first 3 months, they have invested a net of only around Rs. 3000 crores. More than 50% down than what they invested in a similar timeframe last year.

Per, last years numbers, by the end of March 2011, the insurance companies should have invested Rs. 8000 crores in order to atleast reach the numbers they achieved last year, but unfortunately they are not even 50% close to it.

This is because:
1. A lot of people surrendered their ULIP policies they had invested a few years back
2. People are not willing to buy new ULIPs because the existing ones haven’t lived up to their promises
3. People have started preferring traditional insurance policies rather than ULIPs


I personally have not been a big fan of ULIPs and you might have sensed it, if you are a regular reader of my blog. Even though I am not a big fan, atleast for the benefit of my readers like you, it is my duty to analyze what went wrong for ULIPs. Isn’t it?

What Went Wrong?

Well, the reasons are numerous. Let us look at them one by one…

1. ULIPs are not Magical Investment Instruments

This is true. ULIP is nothing but a combination of Mutual Funds and Traditional Insurance policies. Unfortunately the Agents who sold these ULIPs and the companies that floated them, did not explain the ground reality to their investors. Every insurance agent in town went around with extraordinary projected returns, extrapolated for the next 10 or 15 years. Unfortunately, our Insurance advisors conveniently forgot that the equity market is not an upward moving machine and the equity markets lived up to their reputation. The past 3-4 years have been extremely uncertain and people have realized that, their net investments are not even worth what they invested.

So, people have started surrendering their ULIP policies as soon as the lock-in period of 3 or 5 years are over.

To Meet the Surrender Demand, Insurance companies are forced to sell their holdings or divert the fresh inflows to pay off customers.

This is the biggest reason for their downfall – Promising Unachievable or Impossible Returns to Investors and Failing to Achieve them!!!

2. OverSelling ULIPs

Any product that is over-sold usually goes out of favour in due course of time. When ULIPs were introduced as a revolutionary investment option, every tom dick and harry was selling them and naive investors were buying them just like crazy. And as time went by and the craze started to fall off, the reality struck the investors and because they did not perform as well as they were supposed to, people started selling as well as avoiding them.

3. Profit Involved

ULIPs have been a very profitable instrument for the companies that floated them and the agents that sold them. The same cannot be said about the investors who bought them. ULIPs have the highest commission margin for agents that sold them and the highest expense ratio among equity investment instruments for the Insurance companies. Everyone made merry by selling them while the investors who bought them weren’t having so much fun.

4. Regulatory Concerns

The Equity Market Regulators (SEBI) and Insurance Regulators (IRDA) realized the fact that insurance companies were making a killing by selling these products and by not disclosing all facts concerning them. Investors were even given pamphlets that said how much their money would be worth over the next 5 or 10 years. When the regulators realized this, they started tightening the noose on the rules related to these hybrid investment products and when the free-run was no longer possible, insurance companies had to disclose all concerned facts which made ULIPs less and less desirable among investors

5. Lesser Profits for Agents

Because of heavy competition, insurance cos were forced to reduce their margin on ULIPs. They did so by cutting on the commission they paid to the agents who sold these policies. An agent who used to get upto Rs. 45000 for a policy investment of Rs. 1 lakh by an investor 3 years ago, gets less than 10% of the same today. Making it a not so profitable sale prospect for the agents and eventually the agents are not as excited as they were before to sell them today.

6. The Lock-In Period

ULIPs are long term investment options. They come with a basic lock-in period of 5 years or more. Investors have no choice but to keep investing for 5 or more years even if the ULIP they chose was sinking. Considering the high expenses & fees involved with ULIPs and also considering the fact that the equity markets were choppy, investors realized the fact that, the current value of their investments at the end of 5 years is lesser than what they had actually invested, they started surrendering their investments. This resulted in huge losses for the insurance companies that sold them.

Did Investors Make a Mistake?

If you ask me, the answer is YES. A big YES. It is the responsibility of the investor to perform proper due diligence before locking in money for such long durations (5 years or more) By believing whatever was told to them by the agents, people invested vast sums of their savings into these products and ended up burning their fingers.

After all, every single action we do has a monetary repercussion. People sell things to make a profit and I wouldn't blame the insurance cos or the agents for selling them like pancakes because they were making solid gains by selling them. It was the responsibility of the person who bought it to be careful, when that doesn't happen, people stop buying and that is exactly what has happened!!!

That's it for this article folks…

Happy Investing!!!