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The Actuary The magazine of the Institute & Faculty of Actuaries

A new tax world?

In its Budget Statement of 21 March 2000 the government announced the intention of reforming the existing tax rules applying to insurance companies and Lloyd’s members to make them fairer, with the intention of bringing their tax treatment into line with other companies. Other businesses with long-term provisions must follow accounting standards, which require an estimate, discounted where material, with an allowance for any risk/uncertainty.
General insurance companies and Lloyd’s members will face a clawback of the tax benefit they get by not discounting their provisions for unpaid claims. This rule will also apply where they significantly overestimate their provisions for claims settled in future years. There will be an exemption for Lloyd’s members writing only small amounts of business.
The detail of the legislation will be in Inland Revenue regulations made under powers to be included in the Finance Bill. The Inland Revenue consultation period was open from early April and ended on 25 May.

Outline of the taxation proposals
The new rules will apply to provisions for unpaid claims, claims-handling expenses, unearned premium reserves, and unexpired risks reserves, and in the case of Lloyd’s, reinsurance to close (RITC) contracts.
Insurers will be free to decide the right level for these provisions. If it turns out they have had tax relief for significantly more than the discounted value of the claims actually paid, they will have to pay an interest charge on the tax deferred. These measures will apply for company periods of account beginning on or after 1 January 2001 and, in relation to individual members of Lloyd’s, for the tax year 2001/02.
The proposal for calculating the discounted value of liabilities is to use a rate linked to the rate of interest on medium-/long-term gilts. The proposed rate of interest to charge on the tax deferred will be based on the rate for late payment of corporation tax, adjusted by reference to the standard rate of corporation tax.
Insurance companies and Lloyd’s members will be allowed to limit the amount they deduct in respect of their claims provisions for tax purposes to a figure lower than that disclosed in their accounts. This will come into force for company periods of account beginning on or after 1 January 2000 (and for Lloyd’s members in the tax year 200001). This will help those who wish to establish their tax liability with certainty now, rather than risk the uncertainty of a higher tax bill in future years.
The need for tax adjustments will not apply in the case of companies where a provision is within plus or minus 5% of the discounted value of liabilities to which they relate, and for Lloyd’s members participating in only 4% of a syndicate’s business.
For Lloyd’s members the new rules will be introduced for the 1998 syndicate year of account. This is taxed in 2001 for corporate members and in 200102 for individuals.

Issues for consideration
Insurance companies and Lloyd’s members will have to review and make judgements on a number of issues:
– Whether to hold undiscounted reserves or discounted reserves, with or without any risk margins, in their company accounts.
– What assumptions to use for payment patterns and discount rates in the discounting of claims reserves.
– The effect on future cashflows, and what effect they will have on taxation, profitability, capital requirements, asset allocation, and business strategy.
– Quantification of the taxation implications of the new rules and the assessment of alternative strategies to manage this.
– The implications for new business strategy and future business mix, as the longer-tailed classes involve a larger element of discounting.
– For Lloyd’s members, what assumptions to use in the calculation of discounted reserves for RITC purposes, given the inherent uncertainty in such business.
– Strategies for groups owning captive insurance companies.
– Reinsurance strategy and the investigation of the use of any alternative risk transfer (ART) products.
– Additional compliance costs in terms of the additional data requirements, resources, and time needed.
The Institute of Actuaries, the ABI, and other interested parties have made representations to the Inland Revenue about the proposals. Issues raised include the amount of additional tax, the reduction in the competitiveness of UK insurers, the unfairness of the proposals compared to other EU member states, the unfairness of the proposals compared to other industries, and the additional costs of compliance.
Issues raised about the methodology have been varied, examples being:
– The absence of any risk margins in the Revenue’s calculation of discounted reserves.
– The appropriateness of a discount rate based on medium-/long-terms gilts for shorter-tail liabilities.
– The 5% margin not varying by class of business to reflect differences in the uncertainty of estimating reserves.
It is too early at this stage to predict the final form of any such regulations, as there are many issues and areas of uncertainty to be resolved. We await the outcome with interest.