With-profit shift angers insurers

By Julian Knight
BBC News personal finance reporter

With-profits have become with-out-profits for many investors

Norwich Union, the UK's biggest insurer, has accused the Chancellor of "raiding" the savings of the UK's with-profit investors.

According to an Inland Revenue document released on Budget day the tax rate on the income produced by orphan assets - investments held in with-profit funds not earmarked for the payment of policyholder bonuses - is to be brought into line with corporation tax.

This means that the tax paid on orphan assets could rise from a current average of about 20% to 30%.

The Inland Revenue is currently negotiating with insurers about the technicalities of how the change will occur.

But Norwich Union says the changes could drain its with-profits fund of £140m over the next decade.

The government says that it wants to increase the level of long term savings, and then they raid a key savings vehicle Gary Withers, Norwich Union

The Inland Revenue has calculated the move will net them £30m in the first year.

Impact

When announcing the tax changes, to take effect in July, the Inland Revenue was adamant that it will impact life insurance firms rather than policyholders.

But Gary Withers, chief executive of Norwich Union Life, told BBC News that the burden of the tax increases would fall squarely on the shoulders of policyholders.

"Under FSA rules the asset of our with-profits fund are entirely separate to the assets of Norwich Union. This tax change affects policyholders and not shareholders."

According to Mr Withers the danger for policyholders lies in impaired investment performance.

"These orphan assets act as a financial cushion, helping it secure the financial strength of the fund, allowing it to invest more heavily in riskier investments such as shares.

"Over time this tax will reduce the ability of with-profit funds to invest in shares.

"According to our calculations, funds investing in shares grow at 7-8% a year while those that don't grow at 5% a year.

"The government says that it wants to increase the level of long term savings, and then they raid a key savings vehicle."

Tough times

Any potential drag on performance is likely to worry many with-profit investors.

Traditional uses for with-profits University fees or paying off a mortgage Retirement savings An income from savings Pay for funeral costs How with-profits work

Investors in with-profits have suffered tough times in recent years.

The underlying concept behind a with-profits fund is its in-built safety mechanism known as "smoothing".

Smoothing means that in years of good investment growth companies should hold back profits, using them to top up bonuses in years when economic conditions are harsher.

But stock market falls in 2001 and 2002 forced many firms to trim policy values and impose exit penalties.

Only recently, have some with-profits funds shown signs of recovery.

This proposal would represent a significant extra charge on with-profits policyholders Malcolm Tarling, Association of British Insurers

Working together

The Inland Revenue denies that its move could harm a savings product still dusting itself off after taking a tumble.

"We are working with the industry to achieve the objective of finding the appropriate tax rate for income that is not needed to pay policyholders," an Inland Revenue spokesman told BBC News.

"We are trying to correct an unfair state of affairs without harming policyholders."

In response Malcolm Tarling, spokesman for the Association of British Insurers (ABI) told BBC News that he was "very concerned" about the tax changes.

"This proposal would represent a significant extra charge on with-profits policyholders and contradict the government's desire to encourage more saving in Britain," Mr Tarling said.