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HMRC internal manual

General Insurance Manual

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HM Revenue & Customs
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Taxation of general insurance: annual accounting: UPP

Unearned Premium Provision: history

This provision is the proportion of premium income relating to periods of risk after the accounting date, which is deferred to subsequent accounting periods. The tax treatment of this reserve was considered in the case of The Sun Insurance Office v Clark (1912) 6TC59. The company succeeded in claiming a deduction for an amount equal to 40% of premiums, and it became common for insurance companies to claim such a deduction. Until 1985 the Revenue allowed a deduction for a UPP equal to 40% of premiums, even if this exceeded the amount of the UPP in the accounts. The use of the 40% figure followed from the assumption that 20% of premiums would be absorbed by the commission and other costs of acquiring the business, and that the remaining 80% would meet the cost of claims, leaving the insurer to make its profit from the return on invested premiums. So, since on average a policy is taken out midway through the year, 40% of premiums will relate to the unexpired risk period.

As insurers began to replace provisions calculated as a crude 40% of premiums with more accurate methods of time-apportionment, such as the ’24ths’ basis, it was increasingly common for the 40% deduction claimed in the tax computation to exceed the UPP in the accounts. In 1985 the Revenue announced that the 40% method was no longer acceptable for tax purposes. However it still saw the underwriting year basis as the one correct method of accounting for insurance business and the UPP as a provision in relation to an unexpired risk period. The Revenue’s attitude after 1985 was, therefore, that the UPP (plus the amount of any separate unexpired risks provision, that is, against the possibility that the premium was inadequate to cover the risk) was tax-deductible only to the extent that it could be justified by reference to a sound estimate of the company’s unexpired risks.

Following the publication of the 1990 ABI SORP which recommended that premium income should be deferred by the creation of a provision for unearned premiums, the Revenue announced in 1992 that it was able to accept the deductibility of a UPP on the basis that it should in future be treated as a forward spread of premiums.

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Unearned Premium Provision: tax treatment

Until the Insurance Accounts Directive, the deferral of acquisition expenses was often netted off against the UPP. This was forbidden by amendments to Schedule 9A to the Companies Act 1985 which implemented the IAD in the UK, and is now reflected in the accounting Regulations SI2008/410 (GIM2030). Paragraph 50 of the Regulations provides that

  • UPP must in principle be computed separately for each insurance contract, although statistical methods may be used where they give approximately the same result as individual calculations
  • if the pattern of risk varies over the life of the contract it must be taken into account.

In accordance with the discussion at GIM4030 and GIM4040 the Case I computation must follow the results of the accounts, provided there is no over-riding tax provision. UK accounts will be in accordance with generally accepted accounting practice, including the ABI SORP, or IFRS (GIM4040). Movements in the UPP are allowable or deductible for tax purposes provided that the UPP, including the apportionment of premiums and the deferral of acquisition expenses, is calculated in accordance with established principles. UPP forms part of the technical provisions and may under FA07 be subject to the tax rules on provisions generally in GIM6000.

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Unearned Premium Provision: exchange gains and losses

For accounting periods beginning on or after 1 October 2002, the UPP is treated as a money debt, exchange gains and losses on which fall within the loan relationships legislation (FA96/S100 (11)(b)(i)). It was previously treated as a qualifying liability under the Forex legislation in Chapter 2 of Part 2 of FA93 - regulation 2(1)(a) Exchange Gains and Losses (Insurance Companies) Regulations 1994 (SI1994/3231).