New tax regulations could raise captive actuarial costs

25/08/2009

New regulations limiting the tax deductibility of insurance company reserves are likely to mean additional actuarial input and costs for insurers, including captive insurance companies, according to industry experts.

The General Insurers’ Technical Provisions (Appropriate Amount) (Tax) Regulations 2009, a statutory instrument that comes into force in the UK on 1 September 2009, is designed to prevent insurers from reserving too prudently for tax purposes.

According to a briefing issued by Deloitte, although the UK Government’s stated aim is not to target the vast majority of general insurers, the proposed rules will apply to and have an impact on all insurers, including UK-owned captives.

“In the case of a captive with a UK parent, normally the parent would be taxed on the captive’s profits, so the technical provisions would be in the parent’s tax returns,” said David Clissitt, partner in Deloitte’s financial services tax practice.

“The oddity in the new rules is that if you want to rely on the figures in the accounts to get a deduction you actually need to have a written opinion by an expert that the reserves are not excessive,” he said.

Nick Wild, managing director of JLT Insurance Management (Guernsey) said that while many of JLT’s clients already use external actuaries to confirm the level of reserving in the company, there are some captives that don’t.

“Now the taxman is basically saying if you don’t have an actuarial sign-off, or at least sign-off by someone who is suitably qualified to sign off on the level of reserving, then it’s going to be open to question and the Revenue may decide what the right level is and base your tax on that,” he said.

Wild said it didn’t necessarily follow that every captive will need an actuarial review, but some clients “may feel they need to get belt and braces on this and get an actuarial report, which of course is going to add to the cost of operating”.

“It’s difficult to know yet how much that will be but my gut feeling is that the use of actuaries will go up by about 50% above what it is today and actuarial costs could range from £5,000 - £25,000 ($8,194-$40,977), depending on how complex the programme is,” he said.

“We’re probably talking more the £5,000-£10,000 ($8,194-$16,389) range, but if you’re a modest-sized captive that’s probably another one-fifth of your overall operating cost, so it’s not insignificant.”

However, says Deloitte’s Clissitt: “Her Majesty’s Revenue and Customs (HMRC or the Revenue) has said throughout that you needn’t necessarily have a qualified actuary so long as the person can follow actuarial guidelines - and they accept that it might be a claims-reserving expert.”

“If you don’t have that, two things can happen: when the tax return goes in the Revenue can just accept the figure anyway; or, if they don’t accept the figure and you don’t have this written opinion the amount you can get a tax deduction for becomes the undiscounted best estimate,” he said.

Clissitt said that HMRC have indicated that they are interested in risk assessing captives. However, he added: “Those captives reserving on or around the undiscounted best estimate might have a hassle to prove it but they won’t necessarily have much additional tax to pay if they defaulted to that.”

JLT’s Wild said for smaller companies the cost of compliance might marginalise the benefit of owning or starting up cell captive rather than a standalone captive. “I’m not saying this is doomsday, by any means, but if it wasn’t marginal then, more than likely, you might have your own captive,” he said.

“It is more about perception than reality perhaps but it’s certainly not helpful with respect to doing business in a difficult market.”

Deloitte’s Clissitt said the amount of work done on reserving would have to be proportionate to the size of the insurer. “Although the law doesn’t say that, the Revenue has indicated that they are going to come out with guidance - we hope in the next month or so - on how they’re going to apply the law,” he said.