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!!!