Mr Jaitley said India's most vulnerable families would be able to access up to Rs 5 lakh a year for hospital cover through the initiative.
India spends a little over one per cent of its GDP (Gross Domestic Product) on public healthcare -- one of the lowest proportions in the world -- a sum the government is aiming to increase to 2.5 per cent by 2025.
The government currently provides Rs 30,000 toward healthcare for poor families, but that sum is insufficient to cover most medical procedures.
The programme would take public healthcare in the world's largest democracy "to a new aspiration level", said Mr Jaitley.
"This will be the world's largest government-funded healthcare programme," he told parliament in his Budget speech. "The government is steadily but surely progressing towards a goal of universal health coverage."
He said "adequate funds" would be provided to roll out the insurance programme to 500 million of India's poorest nationwide.
Patients face long delays for even minor treatment, and a consultation with a private doctor can cost Rs 1,000 rupees -- a huge sum for millions living on less than Rs 80 a day.
Mr Jaitley said the government was "seriously concerned" that millions of Indians had to borrow or sell assets to receive adequate treatment in hospital.
India only has an estimated 840,000 doctors -- one for every 1,674 people -- far fewer than the one per 1,000 people recommended by the World Health Organisation.
Prime Minister Narendra Modi won a thumping mandate in 2014 promising, among other things, a universal healthcare plan to protect India's poorest. This Budget is the Modi government's last before the country votes in May next year.