Budget : Impact on Insurance Sector- You Need to Know

The third Union Budget of the second regime of the Modi Government was presented on 1st February 2021. This budget had too many expectations given the economic struggle with the pandemic raging on…

The third Union Budget of the second regime of the Modi Government was presented on 1st February 2021. This budget had too many expectations given the economic struggle with the pandemic raging on since the last year. Therefore, the budget gave tremendous emphasis on increased expenditure across sectors to boost and revive the Indian economy. This fiscal spending increased the fiscal deficit target to 9.5% of the GDP (Gross Domestic Product). 

To boost healthcare, an estimated allocation of about Rs.2 lakh crores was set, which included Rs.35, 000 for the COVID-19 vaccine. The Finance Minister also stressed further funds for the vaccine if needed. 

Furthermore, in the insurance sector, some major reforms and tax changes were proposed in the Union Budget 2021. Here is how the budget has impacted the insurance industry –

Increase in FDI limit:

One of the major highlights for the insurance industry was the revision in the FDI limits. Against the prevailing limit of 49% FDI in insurance companies, the Finance Minister revised the limit to 74%, allowing more international funds to the insurance sector. This provision was made with the following conditions –

  • Most of the Board of Directors and key managerial employees would be resident Indians.
  • At least 50% of the directors should be independent directors.
  • A specific percentage of the profit should be allocated to the general reserve.

What does it mean for insurers?

An inflow of foreign funds would give insurance companies a capital boost enabling them to grow and expand. They would be able to launch innovative insurance solutions and price their policies more competitively.

What does it mean for consumers?

Consumers can expect better insurance products and lower premiums on their policies due to the increased competition in the market.

Disinvestment and IPO launch:

The LIC IPO is proposed to be launched in the financial year 2021-22 making LIC a listed life insurance provider. Moreover, the Finance Minister also proposed disinvestment is one general insurance company to privatize it.

What does it mean for insurers?

This IPO listing would bring in equity capital for LIC, thereby increasing its capital base. The capital inflow would help LIC offer increased and revamped products to customers and streamline its activities. The disinvestment in a general insurance company would give the managerial reins to private players that might boost the company's internal management and efficiency.

What does it mean for consumers?

Consumers can benefit from better services by LIC and the general insurance companies that would be privatized. Furthermore, the equity infusion in LIC might present customers with a better choice of policies.

Taxation on ULIPS:

In a rather unpleasant reform, the budget opened up ULIP returns to capital gains to bring in parity between ULIPs and mutual funds. According to the latest changes, ULIP policies, bought on or after 1st February 2021 where the premium paid is more than Rs.2.5 lakhs, would attract capital gains tax. Such plans' maturity proceeds would be subject to long-term capital gains similar to equity mutual funds.

Before the budget announcements were made, ULIPs fared better over mutual funds given their tax benefit. They provided tax exemption on premiums paid, death benefit, maturity benefit, and the switching between funds. On the other hand, equity mutual funds were subjected to long term capital gains tax if their returns exceeded Rs.1 lakh.

Though the other tax-saving aspects of the unit-linked insurance policy have been left unchanged, the taxation on maturity proceeds is a new directive. However, such a tax would be charged, only if the premium paid is more than Rs.2.5 lakhs in a financial year. If the premium is below this level, ULIPs will continue to enjoy the full tax-saving benefits.

If policyholders invest in multiple unit-linked plans, the aggregate premiums of all the plans would be considered for taxation purposes. If the aggregate premium exceeds Rs.2.5 lakhs, on policies sold on or after 1st February 2021, the capital gains tax would apply.

The tax implication is meant for new unit-linked policies. Existing plans will have no impact on the latest tax rule. They would continue to enjoy tax benefits on the maturity proceeds if the premium paid is within 10% (20% if the policy was issued on or before 31st March 2012) of the sum insured.

The death benefit, however, would continue to remain tax-free. Moreover, partial withdrawals and switching between funds would also not attract any form of taxation.

What does it mean for insurance companies?

The popularity of unit-linked plans might suffer a setback for insurers costing them a reduction in their premium collection numbers. Therefore, they would have to come up with other benefits that attract consumers to invest in ULIPs.

What does it mean for consumers?

Consumers who invested in high-ticket unit-linked plans might suffer the brunt of the new tax implication. They can escape from the tax liability if they limit their premiums to Rs.2.5 lakhs. Moreover, they should also understand that the tax would be applicable only if the capital gains exceed Rs.1 lakh. If the gains are below Rs.1 lakh, they can enjoy tax-exempt maturity proceeds.

These are the major changes in the Union Budget of 2021 with respect to the insurance sector. These changes are expected to increase the penetration of insurance as new capital is infused in insurance companies. Also, privatization might make the general insurance company profitable in years to come. As the insurance sector grows on the heels of these changes, the economy might get the recovery boost that it needs after the pandemic. Let’s wait and watch how the insurance industry embraces these changes.

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