Why scrapping GST may not cut life insurance premiums by 18%

While the government is considering removing the Goods and Services Tax (GST) from insurance premiums, a move that many believe will lower insurance costs, the actual impact for policyholders may not be as significant as it seems. Broadly, we all know that health and term life insurance premiums are subject to an 18% GST. However, in many life insurance policies, such as endowment plans and unit-linked insurance plans (Ulips), this tax is not always applied to the entire premium amount.

For policies that include an investment or savings element, such as Ulips or endowment policies, GST is only charged on the part of the premium that covers risk such as protection against illness or death. The portion allocated to investments is not subject to tax. This means that even if GST is removed, the full 18% reduction will only apply to pure risk policies, such as term life insurance or standard health insurance.

"GST on life insurance incurs a substantial cost, ranging from 4.5% to 18% depending on the type of policies, which discourages uptake, especially among middle- and lower-income groups," says Gautam B. Boda, group vice chairman of J.B. Boda Group.

Generally, endowment plans attract a GST rate of 4.5% on the first year's premiums, but 2.25% on premiums from the second year onwards. The GST rate for Ulips is 18%; however, it only applies to the premium, not the investment amount.

"In the case of traditional life insurance policies, it is understood that approximately 30-40% of the premium is invested in early years, and for Ulips, approximately 80-95% of the premium is invested, depending on charges and policy year," says Jignesh Ghelani, partner, Dhruva Advisors.

"The aim is to tax the part of the premium that is due to ‘risk’ coverage. Therefore, it is clear that the direct effect of the exemption might not necessarily lead to an 18% decrease in the premium for all types of insurance policies," adds Ghelani.

But there is a catch. Insurance companies pay GST on their own expenses, such as office rent, technology, and advertising. They claim that amount as input tax credit (ITC), which decreases their total costs.

Therefore, if insurance becomes GST-exempt, insurers will lose this benefit, potentially leading to increased costs. They might pass this extra expense to customers by raising premiums, which could offset some of the savings from removing the GST.

In short, removing GST will likely make life insurance cheaper, especially for pure protection policies; however, customers should not expect a straightforward 18% reduction in premiums everywhere. For savings-linked policies, the actual benefit may be much smaller, and insurers’ higher costs could also diminish the advantage.