Direct Tax Code Impact Analyis

[sunil]

The direct tax code proposes a limit of Rs50,000 for insurance (life, health) and education but not loan-tuition fees. Currently, insurance is one of the components u/s 80C with an overall cap of Rs100,000.

In order to avail income tax benefits, insurance policies will be need to have a cover of 20X on the annual premium as against the current industry average of 5-7X. This will likely pressure the regulatory capital requirement of insurance companies although most large companies are currently well-capitalized.

The tax benefits on withdrawal will be available only on maturity (as compared to a cap of three years currently). Currently, most policyholders exit the policy before maturity. Policyholders will hence need to make a much longer commitment for availing the tax benefits on withdrawal. This could augur well for persistency ratios in the long term but business volumes may decline in the medium term.

[sunil]

Profits from life policies with protection < 20x annual premium will be taxed on withdrawal - even those policies with protection >20x annual premium will be taxed on premature withdrawals. Equity MFs, on the other hand, are exempt from long term capital gains. Though the document is unclear, we presume that old policies would be grandfathered - if not, there would be huge pressure on surrendering existing policies (hence, outflows from insurers) before 31 March 2012.

An additional category of Rs 50,000 has been created for children's tuition fees, life and health insurance - this is good news, though its been diluted by restricting it only for policies with protection > 20x annual premium. The concern, however, is that the original limit of Rs 100,000 - hitherto shared between life insurance, provident funds, etc - has been kept intact but the eligible asset classes have not been specified.