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PAGE Report
Jan 24 - 30, 2000

Finance Minister Shaukat Aziz has promised relief to the insurance sector of Pakistan during his meeting with a delegation of the Insurance Association of Pakistan, the representative body of some 58 local and foreign general insurers.

During his meeting with the IAP delegation, lead by its chairman, Zafar Iqbal Sheikh, on January 14 in Islamabad, assured all possible assistance to solve the problems faced by the insurance sector. He was also much receptive to the IAP’s demand for the withdrawal of 20 per cent compulsory cession of the net premium to the Pakistan Insurance Corporation, the state-owned reinsurer. Shaukat asked the insurance sector to expand its capital base to provide more security to the policy holders and to increase net retention of the industry.

The IAP delegation also presented a memorandum to the finance minister about the problems faced by the insurance sector. The memorandum highlighted the following four issues arising from enactment of highly damaging amendments/provisions through the Finance Act, 1999 in the Income Tax Ordinance of 1979:

Limitation on expenses of management

The amendment stipulated that any expenditure in excess of the limits laid down in 1958 in the Insurance Act shall be inadmissible and liable to tax at 33 per cent. The Insurance Act, in effect provided that expenditure upto 22 per cent of the premium of Rs 4.5 million and 15 per cent on the remaining premium shall be admissible subject to the condonation by the Controller of Insurance, of the excess expenses, on reasonable grounds.

Since 1958, some 42 years ago, the premium incomes of 99 per cent of the insurance companies were between Rs 1 million to Rs 3-4 million, these limits on management expenses were workable— being less than Rs 4.5 million as stated above. However, at present when the premium incomes of most insurance companies range between Rs 50 million to Rs 3 billion, the companies are still required to restrict their expenses to 15 per cent of their premium against the current average expense ratio of 22 per cent of the insurance industry.

There are no limits on the management expenses of any other trade and industry in the country. Limiting the expenses to 15 per cent of the premium income of insurance companies is thus quite unrealistic and unworkable. It should be withdrawn immediately.

Increased tax rate on dividend income from 5 to 33 per cent

The dividends received by insurance companies are now subject to company’s normal tax rate— 33 per cent compared to much lower tax rates for all other companies.

For instance, for a public company other than an insurance company it is 5 per cent. In case of a foreign incorporated company and foreign association it is 15 per cent while for ‘other companies’ it is 20 per cent. This is a case of sheer discrimination as other public companies, including banking companies, pay tax at the rate of 5 per cent on the dividend income. The tax rate on the dividend income of insurance companies, therefore, justifiably need to be brought at par with other pubic companies at the rate of 5 per cent.

Capital gains tax— exemption not continued

The income tax on capital gains was first exempted in January 1997 and 1998. It was allowed in two accounting years— 1996 and 1997. Thereafter, it has been denied. It is unfortunate that capital gains of insurance sector, which hardly constitutes 1.5 per cent of the total market capitalisation at the country’s three stock exchanges, are subject to 33 per cent tax. All other public companies which constitute the rest of the 98.5 per cent market capitalisation are exempted from the capital gains tax. This again is highly discriminatory and unjust. The tax exemption should be restored to the insurance companies to play their role in the capital formation through the stock market.

Tax reserves

The decision to levy a tax on public companies, excluding a scheduled bank or a Modaraba, at the rate of 10 per cent on the amount of Free Reserves exceeding 50 per cent of the paid-op capital on declaration of dividend below 40 per cent of the after-tax profit for the year.

As you are aware, like the banks, an insurance company builds up its reserves in order to safeguard the interest of its clients in case of losses. Building of reserves, thus, is an essential element of an insurance company’s financial strategy. The provision seeks to reward the shareholders at the expense of the clients. The insurance industry should also be exempted from this tax like the scheduled banks and modaraba companies.