Budget signals higher returns on Ulips3 min read . Updated: 28 Feb 2010, 11:34 PM IST
Budget signals higher returns on Ulips
Budget signals higher returns on Ulips
Mumbai: Investors in unit-linked insurance plans (Ulips), could see returns increasing by up to half a percentage point following a proposal in the Union Budget for 2010-11 to cap service tax on such products at 10% of fund management charges, according to insurance industry executives.
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Investors currently pay 10% on all the cost components associated with Ulips.
In his Budget speech on Friday, finance minister Pranab Mukherjee amended the definition of investment management services under Ulips. “The value of the taxable service for any year of the operation of policy shall be the actual amount charged by the insurer for management of funds under Ulip or the maximum amount of fund management charges fixed by the Insurance Regulatory and Development Authority (Irda), whichever is higher," Mukherjee said.
The changes, which effectively bring Ulips in line with mutual funds (MFs) on fund management charges, will come into effect after the Finance Bill 2010 is enacted.
Ulips are hybrid products in which premiums are predominantly invested in equities and bonds, while a portion of the fund is kept aside for insurance. They are popular with investors and in the first nine months of the current fiscal accounted for Rs35,722 crore of new business premiums.
For some private insurers, as much as 90% of premiums come from Ulips. Charges for Ulips primarily include policy administration charges, premium allocation charges, mortality charges, fund management charges, surrender charges, and fund switching charges.
Currently, investors must pay a service tax of 10% on all of these components, except on mortality charges. But by limiting this tax component only to fund management charges, investors can expect to get higher returns of up to 25-50 basis points (bps). One basis point is one-hundredth of a percentage point.
“This relieves the rest of the components like allocation charges etc., which are akin to the exempted levies like entry and exit load from service tax. This will add 40-50 bps on consumer IRR (internal rate of return) yields," said V. Srinivasan, chief financial officer, Bharti AXA Life Insurance Co. Ltd.
In July last year, Irda capped overall charges on Ulips at 225 bps, with a limit of 135 bps as fund management charges.
A Ulip fetching a 10% gross return had to effectively give 7.75% to the investor, excluding service tax and the mortality charges, which typically add up to another 50 bps. This meant the policyholder would finally receive only 7.25% after paying all charges.
With a maximum of 10% service tax on fund management charges, which itself is capped at 135 bps, policyholders will effectively receive returns of 7.6-7.65% after paying all charges, assuming the overall returns remain 10%.
“The Budget proposal to limit the service tax to fund management charges only in Ulips has removed the anomaly of not having a level playing field for various financial products," said Rajesh Sud, chief executive officer and managing director, Max New York Life Insurance Co. Ltd, adding that this would “improve the returns for life insurance policyholders".
Investors in Ulips may earn higher returns following the budgetary move, but would have to pay more than they would to invest in MFs. That’s because the service tax component in MF investments is included within the overall charge, itself capped at 2.25-2.5%, depending on the size of the investment. In Ulips, the service tax is charged over and above the overall permissible charge, capped at 2.25%.
“Service tax is levied only on the fund management charges in mutual funds, but this is included within the overall charge in a mutual fund product, which is capped. So, it is not right to say that this budgetary move will create a level playing field for Ulips," said Rajiv Anand, managing director and CEO, Axis Asset Management Co. Ltd.
MF charges include investment management fees (fund management charges) and its service tax, distribution charges, registrar and transfer charges, and custodian charges. The total of all these charges cannot exceed 2.25-2.5% in any MF scheme.
Interestingly, in an effort to maintain the profitability of their lucrative Ulips without hurting returns, life insurance companies recently hiked the minimum premium by 30-60%. This move followed the Irda’s move to cap the overall charges on Ulips at 225 basis points. Earlier, apart from paying up to 40% of the premium as agent commission, policyholders were required to pay up to 400 bps as overall Ulip charges.