The new budget has announced a service tax at the new rate of 10% on insurance premia that is related to risk coverage. The premium component that is savings related will not entail service tax. The usual risk coverage proportion varies from 10-100% depending on the scheme.


In a move that could have far-reaching implications for insurance policy holders, the Finance Minister P Chidambaram has announced as part of the new 2004-2005 budget, levy of service tax on insurance premium.

This provision would apply to all new policies being issued as well as all new premia that would be paid for existing policies. The service tax will be levied at the new rate of 10%. Service tax until now was at the rate of 8% and this budget has increased this to 10%.

The finance minister has clarified that the service tax will apply only to the risk coverage component of the insurance premium and not to the savings component.

Insurance schemes were originally designed for risk coverage and many schemes still continue to operate on this principle. You pay the insurance company a fixed rate every year and in return the insurance company covers you for an assured sum in case of an eventuality. The company spreads this assurance over a large number of customers so that it would be able to provide the assured sum and continue to be profitable.

However insurance companies have since broadened their offerings to also include for savings and growth. This has helped them strengthen their relationships with customers and also boost revenues. There are many schemes that provide insurance cover and also fixed income or a growing principal on maturity. How do these work ?

What insurance companies do is internally separate the premium that you pay into two components

1. Risk Cover Premium
2. Savings / Growth Principal

The risk cover premium is retained by the company as income and it goes towards paying out insurance to claimants. The savings / growth principal is invested in businesses, equity, government securities, deposits, debt instruments and other investment channels to generate income / returns as well as provide appreciation. The returns that the company gets from this principal is paid back to you as money back, monthly income, pension, bonus, etc.

Every policy that you take has these two components except if it is a pure risk policy like Jeevan Adhaar of LIC.

The finance ministry wants to only levy service tax on the risk cover premium and not the savings principal. So for all your policies you will now need to find out how much of the amount you are paying each time is towards risk cover and how much towards savings. Then you need to assume that your next payment will be increased by 10% on the risk cover.

To simplify this we at MEM will help you estimate your additional premium on all your policies. Call or email us and let us know the policy and the premium that you are paying each year and we will break this down and tell you how much more your premium will be once the service tax levy is applied.

This policy announced in the budget still has to be passed by Parliament to be effective. The insurance companies have been making representations to the Finance Ministry against this provision since it will mean for them major updates in their billing and accounting systems and having to compute the additional premium on millions of insurance policies. The final decision on this is still awaited.

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