New rules for taxing the life insurance business

1.1 Although the provision of life insurance undoubtedly has benefits for those for whom it is intended, there is no compelling reason for giving life insurance companies greater tax benefits than are enjoyed by other producers of goods and services. Tax concessions effectively exist for them, nevertheless.

1.2 Since the tax rules relating to life insurance companies were enacted in 1990, there have been significant changes to life insurance products, to New Zealand’s business environment generally, and to the way income in collective investment vehicles is taxed. They all make it timely to review the rules relating to the provision of life insurance and to bring them up to date.

1.3 Individuals who save through life insurance products face a higher tax burden than do other savers who invest directly or through managed funds that become portfolio investment entities (PIEs). To remove this disadvantage, the proposed rules extend PIE tax benefits, where applicable, to investment income earned for the benefit of policyholders.

1.4 On the other hand, term insurance, a major part of life insurance business now but a minor part when the rules were enacted, is significantly under-taxed and, in many cases, profitable business generates artificial tax losses for the insurers. It is this sort of unintended concession for the life insurance industry that the proposed changes seek to remove.

1.5 The changes proposed in this discussion document have emerged from a government review of the taxation of the life insurance business. Most of the life insurers that were consulted in the course of the review agreed with the need for reform of the tax rules, although they did not always agree on the details of the changes that were needed.

1.6 A core objective of the rules proposed here is for life insurance companies to pay no less and no more tax on their profits than would any other business.

1.7 This discussion document looks at problems relating to the taxation of the life insurance business in New Zealand and outlines proposals for changing the rules. Chapters 1 to 3 are intended for a wider, non-specialist audience, while the remaining chapters assume a certain degree of specialist knowledge about the business of life insurance.


Will the changes raise the cost of insurance premiums?

1.8 In the development of the proposed changes, extensive consultation has taken place over the last year with the life insurance industry, actuarial and accounting professionals and their professional associations, representatives of life insurance advisers, the home equity release industry, and other people interested in life insurance taxation. In the course of that consultation, some life insurers argued that if the current rules were changed they would have to increase the cost of life insurance to their customers.

1.9 The government’s response is that tax is a business cost, and life insurance companies should not rely on tax benefits to make a profit. They should be able to conduct their business on an equal footing within their industry and with other businesses. Again, there are no compelling arguments for the life insurance industry to be preferred over other sectors of the economy.

1.10 Furthermore, there should be minimal tax-related reasons for prices to increase on policies taken out before 1 April 2009. Profits on those policies will not be subject to the proposed rules for a further five years from the application date (in other words, not until the 2014–15 income year) and, in some cases, will remain taxed under current rules until the policies expire or mature. The proposed rules will apply only to products sold after 31 March 2009.

1.11 Even then, the impact on premium prices is uncertain and will not be the same for all members of the life insurance industry. Not all life insurers or products enjoy the same effective level of tax benefits under the current rules, and, as occurs in any industry, some insurers have cost structures that are more efficient than others and can respond to economic changes better.

1.12 Premium prices are also affected by general market forces as well as factors such as overall health and mortality, and the rate of commissions to advisers who sell life insurance. Commissions are the biggest expense, after death claims, for the majority of term insurance products On the other hand, other recent tax reforms such as the reduction in the company tax rate to 30% and the application of the PIE rules and fair dividend rate rules to life insurers should tend to reduce the price of life insurance.
For a recent discussion on the rate of commissions for life insurance products see “Adviser Commissions Dominate Discussion”, Good Returns, 27 July 2007.