From expectations of a separate investment window for life insurance policies for the purpose of tax benefits to anticipating higher FDI limit, investors and analysts had pinned hopes on the Budget offering a big push to the insurance sector. Instead, the Budget, by way of introducing a new personal tax regime — lower tax rate sans most exemptions and deductions — and abolishing the dividend distribution tax (DDT), making dividends taxable in the hands of recipients, has rattled investors. In a knee-jerk reaction, the stock of listed life insurance companies fell, notably post-Budget announcements.
While they have recouped some of the losses in the past few days, concerns about the impact of the Budget moves persist.
We break down the impact of the Budget proposals on life insurance companies.
In India, insurance policies are mostly being sold with a ‘tax-saving’ pitch. Many taxpayers make a beeline to buy insurance policies in the fag end of the financial year to save on taxes.
It is possibly due to this perception that life insurance stocks took a hit when Finance Minister Nirmala Sitharaman announced a lower tax structure, but without most exemptions or deductions (including deduction of up to ₹1.5 lakh on life insurance premium under Section 80C).
At the first glance, it appeared that moving to the new tax regime would lead to a lower tax outgo for individuals. But detailed workings across various income brackets suggest that if a person is claiming most of the exemptions — Section 80C, Section 80D for health insurance premiums, Section 24 for home loan interest, etc — then staying with the extant tax regime would make better sense. Hence, not many people are likely to move immediately to the new tax regime.
Sales of life insurance policies could hence, witness only a marginal impact in the near term.
But the real worry is the tone of the Budget which suggests a slow phase-out of most exemptions in future. If one considers the number of taxpayers in the ₹5-15 lakh income bracket (most sensitive towards tax exemptions) and the fact that they constitute a sizeable portion of the new policies issued, it would suggest that there could be some impact on life insurance companies’ sales in the medium term.
As per taxpayers’ data for AY2018-19, about 1.8 crore taxpayers who filed returns earned between ₹5-15 lakh. During the same year, about 2.8 crore new policies were issued. Hence, taxpayers in the ₹5-15 lakh income level constitute over half the number of new life policies, which implies that there could be some impact on sales of life policies if the exemptions go.
Still predominantly savings
There are broadly two types of life insurance policies — savings and protection. Savings products essentially comprise unit-linked (ULIPs), participating and non-participating policies.
Protection products provide cover for life, disability, critical illness and accidental death.
Savings products are the ones that could be most impacted by the removal of exemptions.
The product profile of the life insurance industry in India is still skewed towards savings products (80-85 per cent). The product mix for private players suggests that about 30 per cent constitutes ULIPs (new business premium basis) and the rest are still traditional policies. Hence, there will be some impact on sales owing to removal of exemptions. But the impact will vary depending on the product mix of players.
SBI Life and ICICI Prudential Life have a relatively higher proportion of ULIPs at 68-70 per cent of APE (Annualised Premium Equivalent). HDFC Life and Max Life have a relatively higher share of par and non-par policies.
The real impact on each players’ portfolio will be known over a period of time.
But there are a few factors that mitigate the risk in the long run.
Our interactions with various life insurance players and an analysis of data from various market reports suggest that the proportion of premium written in the fourth quarter of a financial year has been declining over the past years. According to data from the Insurance Regulatory and Development Authority of India (IRDAI), from about 37 per cent in FY16, the share of the Q4 first-year premiums (of private players) has fallen to about 34 per cent in FY19. This implies that from just tax-saving, consumers are increasingly taking insurance for other reasons such as protection and retirement planning.
Then there is Section 10(10D) that still exists (despite removal of 80 C exemption). This implies that proceeds from insurance plans are tax-exempt, making ULIPs still an attractive option for many, particularly those in the higher income bracket. While traditional policies, in general, are not an ideal option for those looking for life cover, these products offer some form of tax-free income for a long period of time or even whole life, which make them attractive.
Participating insurance plans which offer assured tax-free returns (though modest 4-5 per cent) over a long period of time still trump other fixed-income options such as bank FDs (don’t have many long-term options).
Above all, over the long run, there is huge scope for life insurance players in India, given the favourable demographics and under-penetration. Customers will increasingly look to cover their risk around mortality (life cover), morbidity (illnesses such as cancer), longevity and interest rate risk (through annuity and non-par assured guarantee products).
Private life insurers that have been driving business through product diversification and innovation appear well-placed to ride the near-term volatility on account of tax changes.
As such, private players have been focussing on protection business in recent years to drive value of new business.
Removal of DDT
The removal of DDT in the Budget and the move to make dividends taxable in the hands of recipients will result in higher tax rates for life insurers. Given that dividend income constitutes a significant portion of life insurers’ profit before tax (24-36 per cent in the shareholders’ account), the effective tax rate for these companies is likely to go up. However, players say that Section 80 M would cushion the impact as it allows them to net out the dividends they distribute to their shareholders from the dividend income they receive. Hence, the real impact on companies’ profitability and embedded value (present value of shareholders’ interests in the earnings after sufficient allowance for aggregate risks) is difficult to ascertain at this juncture.
While the Budget proposals can impact life insurers in the near term, long-term prospects remain sound. The top seven private insurers still constitute 79 per cent of the total private market (in terms of Individual Weighted Received Premium). Of these, the four listed players are well-placed to ride out the near-term challenges (though some may be relatively more impacted than others).
Scale, product innovation and diversification and a balanced distribution mix will remain the key drivers of the life insurance business.
The government’s intention to sell its stake in LIC through an IPO in the coming year will need to be watched closely. While competition for private players could intensify, over the long run, it could lead to better disclosures and kindle more investor interest in the sector.