New tax system raises concerns about `churning'

The new tax regime for life assurance investment funds next year may lead to "churning" by rogue salespeople, particularly if the Insurance Bill is not approved in time.

Churning means a customer is encouraged to replace an existing policy with an unsuitable new one solely to generate commission for the salesperson. This practice usually leads to financial loss for the customer. The introduction of a tax system on New Year's Day means bond and unit investments will be taxed when encashed. The levy is based on the net proceeds at the standard rate (currently 22 per cent) plus 3 per cent.

Historically, tax was levied on investment funds every year, usually at the standard rate.

Of course, there are circumstances where replacing an old policy with a new one is in client's financial interest.

The Irish Insurance Federation (IIF) said one example of this is where reductions in term assurance rates have meant that people were able to get new life cover at a lower cost than they had been paying under their old policies.

Some people may be better off switching over to the new regime, others should stay with their existing policy.

Each case will depend on a number of factors including the term of the policy, whether it is regular premium or lump sum and the charges involved in switching. Churning is an extremely serious issue for the insurance industry and all life companies will have procedures in place to deal with such cases, the IIF said.

However, life companies may protect themselves from accusations of churning by representatives in the future by allowing free switches into the new policies, consumer groups claimed.

Regulation: When allegations of churning surfaced in the media in 1998, the IIF said members discussed the introduction of an industry code of conduct to highlight the issue and guard against churning.

However, the Department of Enterprise, Trade and Employment proposed mandatory disclosure of early surrender values, life office charges and commissions.

The Insurance Bill, 1999, proposes that the regulation of insurance intermediaries passes to the Central Bank and includes the relevant anti-churning provisions. The Bill includes a requirement for salespeople to advise the client of the financial consequences when recommending a new policy to replace an existing one. Once the legislation is in force, a salesperson who fails to inform a client that the policy replacement will result in financial loss for the client will be guilty of an offence.

Unfortunately, when the Dail went into its summer recess, the Bill was only in the Committee stage, and it is uncertain whether it will be enacted by the New Year. The Government has also dragged its heels on the proposed Single Regulatory Authority (SRA). A decision must be made on whether the SRA will be housed within the Central Bank or elsewhere.

The debate centres mainly on the authority's need to balance a solvency supervision role with a consumer protection role. It is unlikely this new regulator will come into being until 2002.

Once again, a regulatory black hole threatens to engulf consumers and their investments.