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HMRC internal manual

General Insurance Manual

Accounting framework: funded accounting: general

Paragraph 82 of the 2005 ABI SORP requires the annual basis of accounting to be used for 2005 onwards. Funded accounting may still be encountered in modified form in the accounts prepared by Lloyd’s syndicates (see GIM2080 and, for more detail, LLM2000+) and in accounts prepared by some non-UK general insurers. The Insurance Accounts Directive, reflected in UK company law at SI2008/410 regulations 57 and 58, describes funded as ‘non-annual’ accounting, and requires that the final balance of profit be struck, at the latest, 3 years after the end of the underwriting year (which would be ‘4 year accounting’, though the custom was for 3 year accounting as still used at Lloyd’s). Some captive insurance companies (see GIM11000+) located in tax havens may not strike the balance of profit for many years, however.

Funded accounting was originally used where basic information about premiums and claims took a long time to reach the insurer, and results are always measured by reference to the ‘underwriting year’ in which the policy ‘incepts’ - GIM2150 gives further details. This approach solves the information problem (except where losses are anticipated) by simply entering a balancing figure in place of a provision until the accounts are closed. The difficulties that companies may face in making sensible estimates at the accounting date of claims incurred (or even of premiums earned) are particularly acute in some types of business. These may include marine insurance or non-proportional reinsurance where the reinsurer’s potential liability may not emerge until the direct insurer is nearing settlement of the claims incurred. It is for this reason that 3 year accounting has been retained for some Lloyd’s syndicates, notably those that employ ‘spread’ or private capital - see LLM2040.

The underwriting year reporting used in conjunction with funded accounting is also thought by some to be superior in principle to accident year reporting, because it recognises the nature of the insurance contract as one of indemnity. The insurer performs the service of providing cover, and earns the whole premium on the day on which the contract incepts. Claims are matched with premiums on the underwriting year basis. But is difficult to justify in comparison with accounting rules for trading undertakings generally.

Transition from funded accounting to annual accounting

The change from funded accounting to annual accounting is generally reflected in a single prior period adjustment in the accounts. Because the typical fund will be three years, this will reflect two restatements: one of a year that would otherwise be at its 24 month point and one of a year that would otherwise be at its 12 month point.

FA02/SCH22 deals with tax adjustments on change of accounting basis - see BIM34070. The principle is that, over time, the funded and annual bases should give the same result, ignoring time value factors. Any solution that ensures that the prior period adjustment is fully reflected for tax purposes at some stage will be acceptable. A straightforward approach is to treat the fund that is at its 24 month point as a two-year fund, and the fund that is at the 12 month point as a one-year fund; that is to close both at the end of the year prior to the year that annual accounting is adopted.