The Hindu Business Line : Tax breaks make it attractive

In India, insurance plans, besides covering the risk factor, also have an investment angle associated with them. These plans fuse the benefits of a pure term assurance plan with a savings component built in.

Till about three years ago, the only organisation that came to mind at the mention of the word insurance was the Life Insurance Corporation of India (LIC). Even more so, if it were towards the end of a financial year, as people sought recourse to an insurance policy to minimise their tax outgo. Circa 2000, the insurance sector was thrown open to private participation. Since then, a dozen players have entered the market with their offerings. LIC continues to have a stranglehold on the market; what the new players have achieved is to heighten awareness levels, emphasise the importance of insurance, and launch a clutch of innovative plans.

The taxation angle

Unlike in the West where insurance plans are taken up purely for the purpose of providing a lump sum should the policyholder meet with an unfortunate development, plans launched in India also have an investment angle associated with them. Examples of such plans are endowment plans, money-back plans, children's plans, whole-life plans and pension plans, which fuse the benefits of a pure term assurance plan with a savings component built in.

What make these plans relatively more attractive in the Indian context are the tax breaks that are available for investments made in insurance schemes. Under Section 88 of the Income Tax Act, a rebate on income tax to the extent of either 20 per cent or 15 per cent is available, depending on one's income level. In the case of pension plans, for instance, investments up to Rs 10,000 would be allowed as a deduction from income, in much the same manner as standard deduction and interest on housing loans. Such rebates and deductions serve to magnify returns to the investor.

But, the relative attractiveness of such insurance schemes hinges on the continuance of the tax breaks extended to them. Should tax benefits be gradually phased out or removed at one stroke (the latest Budget saw an announcement that rendered single premium plans unattractive as a tax-saving option), the investment components of such a scheme would acquire a similar hue as that of a mutual fund. In such a situation, performance should be the only yardstick to determine the suitability of investment.

Guaranteed additions

With the advent of private players, guaranteed additions have become a rarity. Barring a few plans offered by LIC and private players that offer guaranteed additions (in some cases, even these additions are limited to a particular duration), the rest offer bonuses at rates that are determined by their investment performance. Guaranteed additions did hold out the attraction that the promised returns would be paid out, irrespective of the company's investment performance. For instance, some plans offered by LIC a few years ago paid additions that guaranteed additions in excess of 10 per cent. They might have been unattractive at those times; in the present circumstances, the returns may well prove be a bonanza for investors.

What such guaranteed addition plans do is to insulate the policyholder from the vagaries of interest rate movements. In a falling interest rate regime, a guaranteed addition of 6.5-7 per cent might still translate into a yield in excess of 6 per cent, assuming that the tax breaks are in place.

Take LIC's Komal Jeevan, a child plan that guarantees additions at the rate of Rs 75 per thousand sum assured. The yield-to-maturity for such a plan works to about 6.5 per cent, if one reckons a policyholder who falls under the 15 per cent tax break category. (The calculation also does not account for any loyalty additions that LIC might pay).

However, with most players having migrated to declaring bonuses on the basis of their investment performance, the cushion provided by such plans is fast disappearing. Going forward, if some of the insurance players can come up with plans that offered guaranteed additions in a soft interest rate scenario, investments in such plans can be contemplated.

Term insurance, way to go

Are we suggesting that investing in an insurance plan is not a wise option? Absolutely not. After all, isn't it imperative that the financial security of your dependents should be protected in case of an unfortunate development? It is to take care of such a happening that a pure term assurance plan comes in handy.

As the most basic of all insurance plans, the objective of a term policy is to provide for pure risk cover without any savings element built into it. It also permits one to opt for a high cover amount for a relatively lesser premium outgo. In case the policyholder survives the term, no benefits are payable. If he meets with death during the policy's tenure, the beneficiaries of the policyholder would receive the sum assured.

The term plan's attractiveness is the sheer simplicity of its working. To compute the yield of a savings-oriented plan, one needs to be conversant with functions such as the internal rate of return, apart from making a reasonable projection about what the returns over the policy's duration are likely to be; on the contrary, the term plan is easy to comprehend. With a term plan, what you see is what you get.

As a variant, companies have also introduced a term plan that returns premiums paid in case the policyholder survives the policy's term. The premiums for such plans are typically higher; however, such plans may be skipped, as they are not efficient from an investment standpoint.

The investment argument

When one chooses to invest, it is only appropriate that he seeks to get the biggest bang for his buck. This, however, would vary from person to person, depending upon his risk appetite. A risk-taker may want to invest in equity-oriented schemes; someone who is risk-averse might well choose a pure debt mutual fund.

Moreover, if one purchases a savings-oriented insurance plan, one is also locked in for the duration of the policy (in the case of a non-unit-linked plan). If one is not satisfied with the investment performance, shifting investments to a better-performing plan is not possible at present. Even if one opts to surrender the policy, this comes at a price.

Cut to a mutual fund. They have a longer performance history, and if one is invested in a fund that does not meet expectations, the units held can be redeemed immediately and the proceeds reinvested in a better-performing fund. One might argue that this is possible in the case of even unit-linked insurance plans. However, for one, they have a short history on which their future performance cannot be predicated; moreover, the charges that are levied in the initial years of such plans are stiff and these would chip away at returns.

If at all one needs to invest in a combination of an insurance product and a savings instrument, a unit-linked plan that invests only in debt may be considered. Such an insurance plan appears to have the best chance to out perform regular debt funds, if one assumes that the tax breaks would continue to be in place. Even in such a plan, choose the lowest possible life cover and complement it with a regular term plan.

Picture by K. Ananthan

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