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The Actuary The magazine of the Institute & Faculty of Actuaries

Taxation of disability business

a gross basis, a number of surprising issues
arise. It is most unusual for this business to
be written on a with-profits basis, hence
this is not considered here.
Disability business, largely permanent health
insurance and critical illness, is taxed on a case I profits
basis at the corporation tax rate (currently 30%) using
Companies Act report and accounts figures, ie UK
GAAP basis (generally accepted accounting principles).
Three major issues are:
°ª profit includes movements in deferred acquisition
costs (DAC);
°ª unrealised gains are
°ª tax computations are
based on the reserves
in the accounts
which are likely to
differ from the FSA
reserves used for
mean fund and modified
mean fund
As regards gains,
realised gains on equities
are calculated on a
‘book’ basis with no
indexation, and bond
gains are taxed under
loan relationship rules,
again with no indexation,
even for indexlinked
Note that historically
the valuation of bonds
in UK GAAP could be
on either a market
value basis or an amortised
cost (accruals)
basis. If the former,
there was an election
in the tax computation to substitute an accruals
basis for any or all bonds. This election was intended
to be temporary and has not been extended beyond
31 March 2000.
There is significant flexibility to offset losses against
other profits in a corporate group. Losses can be group
relieved, or carried forward against future disability
profits, or offset against profits of any description in
the current year or the previous year.
In computing profit, mismatching reserves, contingency
reserves, etc are disallowed and UK dividend
income is excluded from taxable income.
Practical issues
°ª The presence of DAC defers tax relief on initial
expenses, so consideration needs to be given to this
in pricing.
°ª Where one has a unit-linked disability contract, it
is likely that the fund link will be shared by a
BLAGAB contract, so that the fund will be treated as
‘mixed-linked’ and not ‘sole-linked’. Thus income
and gains of that fund are apportioned by reference
to the liabilities of that fund, giving rise to potential
tax distortions not likely to be reflected in unit
pricing. In principle these are the same distortions
as those which occur in mixed-linked BLAGAB/
pensions unit funds.
°ª There are further issues around situations where
policies have benefits which are partly in the
BLAGAB fund and partly in the disability fund, for
example a flexi whole life product with a disability
component. How does one split revenue between
the funds? On the one extreme, the disability fund
might only receive the disability risk premium component
of the product, or it might receive a fully
loaded share of the premium. Similarly, how do you
charge the related expenses to the different funds?
There may be tax advantages in establishing one
method rather than another because of expense
relief or because of the incidence of profits tax.
°ª Some products have disability benefits as riders, eg
waiver of premium, permanent total disability. It is
possible, but not essential, to include these benefits
in the fund to which the major part of the policy’s
benefits belongs. Again, there could be tax
advantages or disadvantages in taking a particular
approach, although one might decide that the system/
administration costs outweigh the benefit of
splitting the figures.
°ª For notional case I calculations PHI profit is
excluded on a FSA return basis, with investment
returns allocated on a mean fund basis. If there is
more than one fund, this will be done by reference
to the funds with PHI business. This can lead to
considerable distortions if there is a large tax
investment reserve, because the allocation of taxable
income and realised gains is on a modified
mean fund basis by reference to the long-term
business as a whole, although recent changes in
legislation have reduced the distortion.
The above does not constitute a full description of
the taxation of disability business, but is intended to
highlight the most important issues which may