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June, 25th 2010

In a significant reform of unit-linked insurance plans (Ulips), the finance ministry will seek to harmonise the character of these popular investment schemes with that of designated long-term savings schemes like provident funds which are eligible for tax exemption at the time of withdrawal.

This means there will be strict guidelines which will disincentivise withdrawal of money from both Ulips and other savings schemes, making them truly long-term funds which could be invested in long-gestation infrastructure projects.

With these changes and a mandatory life/health cover, Ulips will acquire the character of pure life insurance products a prerequisite for complete tax exemption, as per the revised discussion paper on the direct taxes code (DTC) unveiled recently. The tax benefit coupled with the relatively higher returns Ulips could still yield are expected to retain their popularity.

More than Rs 2 lakh crore is mobilised annually as premium from Ulips and the tax exemption has been a major driver behind the huge success of this product. The paper says pure-insurance products along with designated PFs including EPF and specified pension schemes would continue to qualify for the exempt-exempt-exempt (EEE) tag or tax exemption at all three stages of contribution, accretion and withdrawal.

Under the extant Income-Tax Act, for a pure-insurance product, the premium paid by the investor should be less than 5% of the sum assured. While many Ulips qualify for the tag, there are some which do not. So, the proposal has raised doubts that the high-risk, high-reward Ulips could get taxed at the time of withdrawal. The finance ministrys move is to retain the EEE benefit for Ulips by aligning their character with that of other savings schemes, sources said.

Currently, investors can withdraw their Ulip funds after three years. The new guidelines will not allow withdrawal until five years. Even between the fifth and tenth years, only part of the money will be allowed to be withdrawn, sources added.

The withdrawal norms would be tightened for other approved PFs too, with a view to encouraging long-term savings. Currently, it is easy to withdraw money even from provident funds run by private entities.

The new guidelines, to be released shortly, will prevent easy withdrawals from EPFs too. These changes are being brought in to make effective use of these tax-exempt savings for investment in infrastructure, which is facing significant funding gap even after sundry initiatives of recent years.

Recently, a committee headed by HDFC chairman Deepak Parekh proposed a Rs 50,000-crore debt fund for infrastructure, relying to a great extent on resources to be mobilised from pension and insurance sectors.

Insurance regulator Irda is also planning to reduce agents commission in regard to Ulips. Once the new norms governing commissions are in place, the commission for the first year will come down to 10% of the premium from 35% at present.

In the case of Ulips, the front-loading is so high that it takes almost five years for the customer to recover the charges and another 10 years to earn a decent return. Last year, Irda had capped overall charges at 3% of net yield. Net yield is the amount a customer gets on maturity minus charges over the entire tenure of the policy for Ulips with tenure of 10 years.

The government is pushing for a change in the nature of the hybrid instrument Ulip after coming out with an ordinance last week that termed it an insurance product. Insurance companies will have to rework their products in line with the new guidelines in the offing. While Irda is considering offering Ulips which offer guaranteed returns, product development officials in insurance companies told FE that such products will not be as attractive because returns could come down in line with risks. Only pension-related insurance products offer guaranteed returns now.

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