Budget 2012: Impact of new rules on Insurance Sector

Dear readers,
Insurance is very crucial and critical part of financial planning. In our country insurance policy sold as an investment and tax saving instrument. In budget 2012, some new rules has been framed for insurance sector  which is very crucial for the insurance sector and beneficial to the individual.

Traditional insurance plans don’t offer very high return in first place. According to new rule only those insurance policy would be qualify for tax benefit under Sec 80C which offer sum assured (Death Benefit) at least 10 times of annual premium. The going will get tougher if the DTC insists on the higher multiple of 20 times of the annual premium. However, market experts believe this is unlikely.

Returns from traditional insurance policy will be further fall. A bigger amount of premium  will go towards mortality charges and service charges which has been hiked this year from 10.3% to 12.36%. So there will be a smaller amount available for investment every year. A calculation shows that the net return from the investment will fall by almost 40-50 basis points to 4.1%. This is less than that being currently offered by some banks on the savings account balance.

So in my view it is right time for investors to stop looking at life insurance policies as investment vehicles. No doubt, they help you save and offer tax-free income, but the returns will be far too low to justify the investment. Besides, other tax-free options, such as the Public Provident Fund, ELSS, etc. is available.

Now onwards Insurance Policies will have to be for longer tenures as ideally insurance is a long term contract but still short-term plans of 5-10 years are in high demand because the buyer doesn't have to block his money for long periods.The 10 times rule in this budget puts an end to short-term plans. A policy whose term is less than 10-12 years will fail the eligibility test for tax benefits.

The worst hit will be money-back plans, which typically have a higher premium

compared to endowment plans. Buyers will have to opt for longer tenures (at least 20-25 years for money-back plans and at least 15 years for endowment plans) if they want the tax gains.

The budget has very clearly defined life cover as the death benefit payable to the

insured person's nominee. It will not include bonuses and other maturity benefits.

The focus on the long-term tenure will sharpen after the DTC kicks in. Right now,

insurance plans can be surrendered before maturity. Under DTC, the surrender value will be made taxaxble.

Early buyers will find it easier to get tax benefits because the premium are lower. Younger people get lower rates and can lock in for a longer period. A younger person will find it easier to comply with the new 10 times rule than somebody who is in his 40s. An older person can get around this problem by taking a longer term plan, but beyond a certain age, even a long-term plan will not help.

The new policy in this budget and the DTC will shift the focus to term

insurance plan. These pure protection plans will not be affected by the new rule because they already offer very high covers. Pure protection term plans offer covers of 200-500 times the annual premium. The good news is that term plan premium rates have come down and insurance companies have started advertising these more vigorously than ever before. Today online term plans offer very low rates. Though the data pertaining to term plans is not available, there has been a marked rise in the number of regular premium, non-linked, non-participatory policies in the past year. Term plans fall within this category, though it also includes other types of insurance policies.

The biggest impact of the change will be on single premium plans. The existing plans offer a cover of five times the premium as required by the current tax laws. This ensures that only a small portion of the premium goes as mortality charge and a larger amount is invested. The new rule means a smaller portion will be available for investment, which would require a complete overhauling of the single premium category.

In the light of new rule now insurance companies will obviously focus to pure term insurance and re-engineer their plans so that the tax benefits stay and at the end it would be also beneficial for individual.

Please do send your feedback and query after read this article.

Warm regards,

Arvind Trivedi

Certified Financial Planner