Archive / Investment Adviser (Level 2) / Basics of Insurance

nism-series-xb-itr-verification-high-value-life-insurance[ INVESTMENT ADVISER (LEVEL 2) ]

Why do life insurance underwriters mandatorily verify the last three (3) years of Income Tax Returns (ITR) when evaluating high-value life cover proposals (Sum Assured > ₹1 Crore)?

[ A ]To collect personal income taxes on behalf of the government.

[ B ]To cancel the applicant's PAN card.

[ C ]To establish financial justification for the requested sum assured, preventing over-insurance and mitigating moral hazard by confirming that the insurance cover is proportionate to actual demonstrated earning capacity.[ CORRECT ]

[ D ]Financial underwriting is illegal under IRDAI regulations.

Takeaway

The correct answer is C: underwriters check 3 years of ITRs to establish that the requested sum assured is financially justified by the applicant's genuine, demonstrated income, guarding against over-insurance and moral hazard.

Derivation

Life insurance is meant to replace lost future income for dependents, not to create a windfall on death that exceeds what the person could plausibly have earned. If sum assured is granted disproportionately to actual income, it can create a perverse incentive (moral hazard) -- either for fraud at inception or, in extreme cases, for the insured's life to be placed at risk by others. By cross-checking declared income against 3 years of filed ITRs, the underwriter builds an 'income multiple' (commonly a multiple of annual income, scaled down with age) to cap the sum assured at a level proportionate to actual earning capacity, which is the specific underwriting purpose being tested.

Why the others fail

A — To collect personal income taxes on behalf of the government.

Fabricated purpose; insurers underwrite mortality/moral-hazard risk, they play no role in collecting income tax on behalf of the government.

B — To cancel the applicant's PAN card.

Absurd and false; ITR verification is a risk-assessment tool, insurers have no authority to cancel an applicant's PAN card.

D — Financial underwriting is illegal under IRDAI regulations.

False; financial underwriting to control moral hazard is a standard, IRDAI-sanctioned underwriting practice, not an illegal one.