Scrapping GST on insurance premiums: A remedy worse than the disease?

Congress leader Rahul Gandhi immediately attacked the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) government at the Centre for “looking for a tax opportunity before every disaster". Later, the Congress-led INDIA grouping of opposition parties demonstrated on the steps of Parliament, demanding the removal of the prevailing 18% GST on such insurance premiums.

Strangely, just a couple of weeks before the issue erupted in Parliament, Union road transport minister Nitin Gadkari had written to Union finance minister Nirmala Sitharaman calling for a withdrawal of GST on insurance, arguing that levying such a tax amounted to taxing the “uncertainties of life".

The Union cabinet has now forwarded a proposal to scrap GST on health and life insurance premiums as part of a wider GST reform, which seeks to restructure indirect taxation into three slabs—exempt, 5%, and 18%—while retaining a 40% levy on ‘sin goods'.

And with both the Opposition and the government seemingly allied on the issue, the GST Council is likely to clear the proposal.

The flawed logic

While the proposal on scrapping GST on health and life insurance is a rare case of both the ruling party and the Opposition justifiably claiming a political win, it is based on fundamentally flawed logic. At first glance, it appears to be a win for consumers. The cost of their premiums will fall by 18% as the GST component is removed. But that is only in the short term.

In the long term, though, things will change. Insurers will lose the input tax credit on the GST they pay on the various goods and services they purchase to keep their businesses running. Everything insurers spend on—office space, computers, employee salaries, agent commissions, marketing, and advertising services—attracts GST, currently at 18% in most cases.

The GST paid by the insurer on operational costs can be set off against the GST due to the government on premiums collected, thus dropping the net tax liability sharply.

Under the GST Act’s anti-profiteering clause, these cost savings have to be passed on to consumers, that is, people who are buying the policies, leading to a lower overall premium cost. Removing GST on premiums means that nothing can be set off, and insurers are highly unlikely to absorb the increased costs on their own for too long.

The net gain could shrink to around 5% over the medium term, well under the headline number of 18% relief, show industry estimates.

The second-order effects

According to Telangana deputy chief minister Mallu Bhatti Vikramarka, a member of the Group of Ministers, which has proposed the removal of GST on insurance, the government will lose an estimated ₹9,700 crore in revenue in the first year.

This will rise further, given the 8.7% compound annual growth rate (CAGR) in health insurance and the 11% CAGR in the life insurance sector. This may be well covered up by increasing—or not reducing—taxes elsewhere, or at the least, a cut on some service or the other.

Exemptions also lead to compliance complexity and open up the possibility of regulatory arbitrage. Most life insurance products in the country are investment-oriented rather than risk-cover-oriented. In that sense, as anyone who has dealt with insurance agents and mutual fund marketers will attest, they compete with other financial products. An exemption will skew the market in favour of insurance-linked schemes.

There is also the question of equity. Wealthier consumers who invest in life insurance products and take higher health insurance will benefit disproportionately, while the poor, who take basic health insurance for emergencies, may see premiums go up as base rates climb.

A more sensible solution will be to optimize this. Keeping insurance premiums in the lowest GST bracket of 5% will allow insurers to avail input tax credit, thus lowering the rise in base premium rates. At the same time, it will offer a nominal 72% saving in tax (18% to 5%) for consumers.

The focus should be on increasing penetration. Health insurance penetration —excluding government-funded schemes like Ayushman Bharat or co-funded covers like Employees' State Insurance—is still only around 20% of the population, compared to 80% in developed economies. This can only grow if private insurers are able to offer cost-effective products, while retaining some margin.

A modest GST on insurance premiums offers an optimal way forward.