Gratuity Payment Dilemma: Should Employers Handle It or Use Insurance Providers?

Kindly guide me on the gratuity payment. Is it good to pay gratuity by:

1) employer self or through
2) insurance provider?

And what are the benefits/losses of each option?

Legal position

Every employer shall obtain insurance for their liability towards the payment of gratuity under Section 4A of the Payment of Gratuity Act 1972, from LIC or another prescribed insurance company. Section 4A is detailed below.

4A. Compulsory Insurance

(1) With effect from such date as may be notified by the appropriate government, every employer, other than an employer or an establishment belonging to, or under the control of, the Central Government or a State Government, shall, subject to the provisions of sub-section (2), obtain insurance in the manner prescribed for their liability for payment towards gratuity under this Act, from the Life Insurance Corporation of India established under the Life Insurance Corporation of India Act, 1956 (31 of 1956) or any other prescribed insurer. Provided that different dates may be appointed for different establishments or classes of establishments or for different areas.

(2) The appropriate government may, subject to such conditions as may be prescribed, exempt every employer who has already established an approved gratuity fund in respect of their employees and who desires to continue such an arrangement, and every employer employing five hundred or more persons who establishes an approved gratuity fund in the manner prescribed from the provisions of sub-section (1).

(3) For the purpose of effectively implementing the provisions of this section, every employer shall, within such time as may be prescribed, get their establishment registered with the controlling authority in the prescribed manner, and no employer shall be registered under the provisions of this section unless they have taken insurance referred to in sub-section (1) or have established an approved gratuity fund referred to in sub-section (2).

Every employer knows they have to pay gratuity. It is a known financial liability, and it is wise to make adequate insurance provision for it. The employer pays the annual premium and need not then worry about gratuity bulk payment. They have tax benefits in the form of business expenses. Premiums paid become business expenses. Having a group gratuity policy is legally needed and also gives employees a sense of happiness as they know gratuity will be paid without delays.

Dear Nathrao ji,

I would like to draw your kind attention to the fact that although there was an amendment in 1987, Section 4A on compulsory insurance and setting up a gratuity fund, this section has not been enforced in Maharashtra until now. To my knowledge, it has also not been enacted in other states. However, I vaguely recall reading somewhere about a notification by the Andhra Pradesh Government regarding the implementation of this provision.

Dear KeshavJi,

Thanks for the clarification. I also have not specifically mentioned that every state or any particular state has made it mandatory to take insurance. It is legally a must where appropriate government notifies it.

Gratuity Payment Options: Self vs. Insurance Policy

To the point answer to your questions is: It is always better to go for a Gratuity Insurance Policy rather than paying gratuity from your own pocket or a created fund. Following are reasons in support of this:

1. Paying gratuity from your own pocket can be very difficult at times. Therefore, it is advisable to create a gratuity fund or opt for a Gratuity Insurance Policy.

2. You pay a premium to the insurance company for this policy, which is affordable.

3. The premium is calculated by professional actuaries, whose fees are high. When you choose an insurance policy, the insurance company covers the actuarial fees. If you create a fund, paying fees to actuaries becomes your responsibility.

4. With an insurance policy, IT approval is obtained by the insurance company, whereas, when you create a fund, it becomes your responsibility.

5. On the premium amount paid to the insurance company, you earn good interest. Additionally, the premium paid is considered a business expenditure.

6. By paying an extra premium, which is very nominal, for life cover (i.e., full-service cover of employees), the families of employees who die during service tenure are entitled to a good amount of gratuity.

7. Your administrative cost is nil if you take the policy. The administrative cost of the fund created is very high.

Every business must concentrate on its core activities. Running its own gratuity fund is a professional job and can be expensive. It is best to go for insurance schemes after comparing rates, benefits, and flexibility.

Gratuity Insurance Policy for Small Companies

In my view, for smaller groups or newly set-up companies, it is not cost-effective to set up a gratuity insurance policy until the actuarial liability has reached a point where it makes sense to outsource. To set up an insurance policy, you also need to first establish a trust, which brings with it trust-related obligations as well.

In addition, most private insurers and, to some extent, LIC discriminate against small funds in the setup costs and returns. I don't blame them, as for a fund size of INR 20 lakhs, for example, they make about 1% - 2% as fund management costs. But in the long run and for fast-growing firms, it's certainly the best and right thing to do.

Dear Ashley Dsilva ji, thanks for your contribution to this discussion. This is your first one ever since you became a member of this forum in 2009.

In my post #5 above, I have given the advantages of having a gratuity policy. In your view, for smaller groups or newly set-up companies, it is not cost-effective to go for a gratuity policy. But from my experience, I can tell you that this is a wrong assumption. The premium paid for this policy is much less than your liability when it arises. If you decide to take a policy in the later years to come, you will find the premium more expensive and not affordable at that time. The formation of trust and its approval is taken care of by the insurance company.

I will agree with you to some extent that for a smaller size of policy, the insurance company or the agent is not very interested. But as you are insured, you must have more interest in it.