Life cover cost could rise 20 pc to pay for tax changes

Life insurance premiums are set to rise as the insurance industry adjusts to a heavier tax regime.

The tax rules were reviewed after the Government become concerned that a shift in people's policy preferences had left life insurers undertaxed.

According to one industry operator, premiums need to rise by about $150 million to accommodate tax and other changes.

By the time grandfathering provisions come off in three years' time, he estimates premiums will be 15 to 20 per cent higher from when the changes took place in mid-2010.

Deloitte tax expert Greg Haddon says the old tax rules treated all life insurance policies as "whole of life", which had a large savings component.

That meant policies were largely taxed as an investment rather than income.

Over the last 20 years, however, most policy-holders have shifted toward yearly renewable policies, which are cheaper but don't make a payout on retirement.

Life insurers acknowledge the changes are fair but say they cannot absorb the full tax bill.

Milton Jennings, chief executive of Fidelity Life, said the tax changes had come at a time when low interest rates were eroding their investment income.

There was also "quite fierce competition in the life insurance market so you're not seeing rates going up too much".

"People have had about half the increases already and there's probably another half to go."

Haddon said insurers had a five-year adjustment period, which kept policies held before the changes temporarily at their old tax rates.

So "while they'll be paying more tax, they'll certainly be paying more tax in three years' time", he said.

Insurance company Tower agreed life insurance premiums needed to eventually rise 15 per cent but said they had to also reflect the market.

It had increased premiums for new policies 7 per cent in 2010 and another 3 per cent the following year.

"We'll be reviewing older policies towards the end of the grandfathering period, with a view to adjusting premiums as necessary," a spokesperson said.

Life insurance had changed markedly from the days of the once-popular whole-of-life policies, which were taken out by young workers or by their parents when they were born, Haddon said.

"You paid a very small premium each month and part of that premium went towards a savings so that by the time you retired there was a surrender value that you could get back."

Whole-of-life made sense when interest rates were low but were eroded by rising inflation, said Fidelity's Jennings.

The one permanent exception from the new tax rules is "level term" policies, which keep premiums static for an agreed term of sometimes 50 years.

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Jennings said level-term contracts were "golden" and holders should hang on to them.

"The sad thing is, I see people cancelling these contracts and going back to YRTs (yearly renewable term policies) to get it cheaper, but that's just absolute madness."

In 2008 Treasury estimated the extra tax take from the changes would be a net $9m by 2012.

The IRD says that figure would apply to 2013 because the changes were made later than expected.