(Yicai) Aug. 5 -- The Chinese government’s decision to reinstate tax on bond interest income is expected to only marginally trim insurance company returns on fixed income and have a negligible impact on their profits and fund allocations, according to industry insiders.

While the new tax will impact fixed income returns to a degree, its drag on gross and net investment yields and overall profitability will be small, the people said.

China will impose a 6 percent value-added tax on interest income from treasury bills, local government bonds, and financial institution notes issued after Aug. 8, the finance ministry said in a surprise announcement on Aug. 1. Bonds sold before then will remain exempt until maturity.

The tax exemption on interest income was introduced in the 1990s to spur growth of the bond market and aid fundraising. China’s bond market is now the world’s second largest, and officials have said that the waiver has fulfilled its purpose.

Bond holdings accounted for about half of insurers’ total invested assets at the end of the first quarter, according to data from Kaiyuan Securities. Assuming 70 percent were interest-bearing treasury bills, the new VAT would trim the income yield by about 3 basis points, a relatively small drop, considering that listed insurers averaged a net yield of 3.64 percent and a total investment yield of 5.63 percent last year.

Huatai Securities similarly estimates the new VAT will trim annual net investment yields at insurance companies by only about 2 basis points.

The tax’s impact of the tax on insurers’ profitability is expected to be even smaller than on their yield. Analysts at China International Capital Corporation project the short-term negative impact on insurers’ bottom lines will be less than 1 percent.

VAT on interest income from treasury bonds is expected to have a minimal impact on the bond investment strategies of insurance funds, said Xu Kang, head of financial industry research at Huachuang Securities.

Based on past performance, insurance funds do not scale back their bond allocation when bond yields decline due to falling long-term interest rates, rather they increase, according to the brokerage.

Some analysts argue that insurers may tilt slightly toward equities over bonds as a result of the new tax, but insurance executives told Yicai that equity allocations remain constrained by various factors such as solvency requirements and risk controls. Even with marginally lower bond yields, fixed income assets will retain their status as “ballast” investments, they added.

Due to liability constraints, insurance funds usually adopt absolute return strategies, with bonds accounting for a significant share, Minsheng Securities analysts Zhang Kaifeng told Yicai. He said the tax will not undermine the role of bonds as a portfolio stabilizer, and long-term bonds will remain central to investment strategy.

Editor: Futura Costaglione