New tax regime: Removal of exemptions to hit profitability, margins of insurers : 04-02-2020

The insurance industry is headed for a reset as most of the exemptions have been done away with under the new tax regime announced by finance minister Nirmala Sitharaman on Saturday. Insurers are of the view that the move will have a negative impact on long-term savings as tax breaks serve as a big incentive for new businesses.

While the removal of exemptions is slated to impact new businesses in the March quarter, which is the busiest, the abolition of dividend distribution tax (DDT) will also negatively impact margins and profitability of the insurers that have a higher proportion of unit-linked plans (Ulips) in their portfolio.

Stocks of most listed insurers fell around 6-11% on Saturday following the announcements made by the FM. While the move to do away with exemptions is a step in the right direction, in the near term the sector will be impacted, as 85% of the business is savings-linked. Motilal Oswal’s Nitin Agarwal is of the view that the removal of major exemptions/deductions under the new tax regime could adversely impact the sale of life insurance companies, as typically the fourth quarter of every fiscal is business-heavy owing to increased focus on tax-linked savings.

Around 45-60% of the industry’s premium income comes in the fourth quarter. The average ticket size of the premium is `15,000 to `45,000. Over the last few years, several private insurers have been shifting away from this tax-linked savings products to annuity and protection products. However, tax breaks have played a big role in the popularity of savings products of insurers.

Commenting on the recent developments, HDFC Life Niraj Shah chief financial officer says the way the company offers its products to customers has changed over time. It no longer depends on “tax season” for business. The fourth quarter, that accounted for 40-45% of HDFC Life’s a few years ago, is now down to 30-35%.

According to analysts, ICICI Prudential Life Insurance and SBI Life have a higher proportion of ULIPs at nearly 70% of annualised premium equivalent, while the share is much lower for HDFC Life and Max Life. The other blow that insurers have to deal with is higher tax rates, with the abolition of dividend distribution of tax the tax burden will increase for insurers. Dividend income constitutes a significant portion of pre-tax profit of insurers, ranging between 24-37% as of FY19 under the shareholders account.

With the tax incidence rising to 25% for insurers, the margins and returns would be impacted for Ulips. “On a net basis, the impact of this will be 1-1.5% on embedded value and the new business margin will be impacted by 0.5-1%,” Shah explained.
Future returns for investors of Ulips will depend on dividend payouts by companies after this change.

Source : Financial Express