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Business News/ Opinion / Online-views/  Insurance plans that do not provide a cover
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Insurance plans that do not provide a cover

Insurance plans that do not provide a cover

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Two years back, unit-linked insurance plans (Ulips) were severely criticized because the insurance component they offered was very little. Following cost caps and other reforms, Ulips have now been given a back seat and traditional plans have made a comeback but they continue with the bad practices of Ulips as some of them offer too little insurance cover. The issue is serious enough for the regulator to point it out when it wrote a letter to the Life Insurance Council (LIC), a statutory body of life insurers, about the issues that need to be solved.

The problems

Instead of giving the sum assured on death in the middle of the policy term, these products give the beneficiary the sum of premiums paid on death along with the accrued interest. This amount is much lower than what you would get in a normal insurance plan, which pays the entire sum assured as death benefit. But if you survive the policy term, these plans pay a maturity benefit, which they call the sum assured.

The problem in these policies is not just of little insurance coverage but also of the tax grey area used. The maturity benefit in these plans is called the sum assured—sum assured is typically the death benefit that the beneficiary gets on the policyholder’s death—and since the maturity benefit is typically more than five times the premium, these plans enjoy the tax benefit. But these policies make the sum assured different from death benefit opening up a new road to confusion.

Says Malay Ghosh, executive director and president, Reliance Life Insurance Co. Ltd: “In insurance parlance, sum assured is still defined as the death benefit that the beneficiary of the policyholder gets. In traditional plans usually the sum assured is several multiple times the premiums paid. Policies that offer only the premiums paid are usually meant for individuals that are uninsurable or extremely unhealthy."

According to the letter written to LIC, the regulator has correctly pointed out that these products are not in sync with the income-tax requirements and, therefore, a minimum sum assured even on traditional plans should be thought about—currently, traditional plans don’t have a minimum sum assured as is the case with Ulips. They may not fit the requirement of the Income-tax Act in spirit, but in letter this has been done. This is how.

What does the Income-tax Act require?

According to section 80C of the Income-tax (I-T) Act, premiums paid towards a life insurance policy qualify for a tax deduction up to 1 lakh. But if the amount of premium paid in a financial year for a policy is in excess of 20% of the sum assured, then the tax deduction is allowed only for premiums paid for up to 20% of the sum assured.

As for the benefits, according to the section 10 (10D) of the Act, death benefit in an insurance policy is tax-free, but any other benefit like the maturity proceeds is tax-free if the premium is not more than 20% of the sum assured. In other words, the sum assured is at least five times the premium paid.

The I-T Act does not define the sum assured, but it is the amount on which the insurance companies pay a stamp duty. Says a senior HDFC Standard Life official who did not want to be named: “Insurers need to pay the stamp duty which is 20 paise per 1,000 sum assured. In Savings Assurance Plan, we pay the stamp duty on the sum assured and not on the death benefit."

The ‘innovation’ or trick

Both the policies have separated the sum assured from the death benefit they pay.

HDFC’s Savings Assurance Plan: In this plan, the policyholder needs to choose a sum assured on the basis of which the plan will throw up a premium. In the example given in the brochure, for a sum assured of 1 lakh, a policyholder needs to pay an annual premium of 12,016. In other words, the sum assured is around eight times the annual premium. If you buy this policy, you will get tax deduction because the premium is not more than 20% of the sum assured. However, the sum assured is not the death benefit in this policy.

In year one, if the policyholder dies the beneficiary gets only 80% of the premiums paid. In the following years, in case of death of the policyholder the beneficiary gets the sum of all premiums paid till date compounding at a rate of 6% per annum. This death benefit is capped at the sum assured chosen. On maturity though, the policyholder gets the sum assured along with any bonuses declared by the company.

ICICI’s Guaranteed Savings Insurance Plan: This policy lets the policyholder choose the premium. The sum assured is equal to the annual premium multiplied by the premium payment term. So for a premium payment term of 10 years if you chose a premium of 12,000 the sum assured will come to 1.2 lakh. The sum assured in this case is 10 times the premiums paid and fits the requirement of the I-T Act. But the death benefit here is the sum of all premiums paid compounding at a rate of 5% per annum.

On maturity you get the sum assured plus other guaranteed additions. The additional benefits are pegged to 10-year government securities’ yields and will be declared as a percentage of the sum assured every year.

If you are looking for an insurance policy even for the purpose of tax saving, these are not the plans to buy. You would be better off investing in an equity-linked savings scheme (ELSS), which invests your money in the markets and you enjoy the same tax benefits. ELSS, however, do not provide insurance but that’s also the case with the plans discussed here.

deepti.bh@livemint.com

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Published: 28 Feb 2012, 08:22 PM IST
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