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Indexation allowance impact for life insurance companies

Indexation allowance impact

Given the sizeable equity portfolios of many life insurers the industry may be more interested than most in this proposed change.x

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The Chancellor announced in the Autumn Budget that the indexation allowance on corporate capital gains is to be frozen for disposals made on and after 1 January 2018. Although detailed proposed legislation is not presently available, the inference from the Budget announcement is that the freezing of indexation allowance would apply to life insurance companies as it would for any corporate body, and given the sizeable equity portfolios of many life insurers the industry may be more interested than most in the proposed change.

Loss of future increases in indexation allowance could have a significant impact on the life insurance sector. Investment returns on life bonds (to the extent invested in equities) would be subject to increased tax, potentially reducing overall returns to policyholders (as the increased tax would ordinarily be borne by policyholders).

The potential additional tax burden on such products may over time cause investors to further favour other investment vehicles (for example open-ended investment companies (OEICs)) rather than life investment bonds. Although life investment bonds continue to offer a number of significant benefits, both tax and non-tax (for example being able to churn investments without triggering immediate tax charges, the ability to withdraw five percent of premiums per annum without incurring a tax charge, and broader deferral of the tax point utill exit), many investors perceive OEICs to be tax advantageous as investor returns are subject to capital gains tax rather than income tax as for life bonds. This perception may be exacerbated with the proposed changes.

In addition to the impact on policyholder returns, and perceived future attractiveness of life bonds, the change may have a number of practical implications which insurers need to consider, including:

  • Impact on the methodology for calculating charges to unit linked funds in respect of tax;
  • Depending on individual methodologies, the potential impact on the valuation of capital losses in deferred tax, particularly in LACDT (Loss Absorbing Capacity of Deferred Tax) may need to be considered; and
  • In addition, much of the practical tax complexity of dealing with indexation for CoACS investments may fall away.

There may also be immediate practical considerations regarding amendments to, and the testing of, systems changes to implement the new proposals in time for 1 January.

In terms of wider impacts, the financial assumptions as to future life fund and unit price growth will potentially need to be updated, including adjusting down projections due to the higher tax arising. Future fund related charges are also expected to be lower.

For further information please contact:

Dan Gallon

Carol Newham

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