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HMRC internal manual

General Insurance Manual

HM Revenue & Customs
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Technical provisions: appropriate amount Regulations: enquiries: background

The issue of tax relief for the claims provisions of general insurance companies has been a thorny one for many years. Discussions on the subject go back at least to 1940, according to HMRC archives. GIM6080 to GIM6140 describe the position as it stood broadly up to 2000 (the position for Lloyd’s syndicates was slightly different). GIM6145 to GIM6440 describe the approach of FA00/S107 which attempted to tackle the problem in an objective and systematic way but this proved extremely complex and led to repeal - see GIM6180.

Market exposure clearly militates against general insurers over-provisioning to achieve a tax advantage, as this would mean understating profits declared to shareholders. On the other hand, not all general insurers are directly exposed to the market (captive insurers, notably), and in any event there is established evidence that a smoothing ‘provisioning cycle’ runs closely in phase with the ‘underwriting cycle’ - see GIM1240. The UK actuary Institutes published a General Reserving Issues Taskforce (GRIT) consultative paper in July 2005 which discussed the issues in great depth and produced proposals for improvement. In approaching this task the authors noted the statistical evidence for existence of the provisioning cycle. Their view was that it was impossible to say whether this was down primarily to companies being forced to strengthen their provisions because they were established at too low a level in a soft market, or whether they were taking the opportunity of profitable times to put money aside and increase prudence - it was probably a bit of both.

The taskforce also polled a sample of actuaries, both those working for insurance companies, and those in the international London Market. The company actuaries thought the most important reason for the cycle and movements in provisions was deliberately booking amounts different from actuarial best estimates. The London Market actuaries saw the main reason as being influence from underwriters. There was also some evidence of systematic flaws in the methodology.

General insurance companies produce accounts for both financial reporting and regulatory purposes. The UK regulator (Financial Services Authority) requires (IPRU(INS) 9.34) its returns to be properly prepared in accordance with IPRU(INS), INSPRU and GENPRU, and the latter (GENPRU 1.3.4) requires a firm to value its assets and liabilities according to applicable financial reporting rules, practices and standards, so for general insurance companies the financial and regulatory returns will be similar.

Analytical techniques and actuarial standards have improved in recent years. There may be a good reason for the directors, in signing off the accounts, to depart from the best estimate, where appropriate augmented by a risk margin, recommended by an actuary; but where this situation is identified it requires explanation. The case of Owen v Southern Railway of Peru 36TC602 (see GIM6080) remains good law as reflected in the speech of Lord Radcliffe - there is no accounting principle that contradicts it - and this requires the calculation of the provisions to be performed with sufficient accuracy in order to justify their allowance. The appropriate amount Regulations aim to work with the grain of this analysis, and ensure that emphasis is placed on attainable accuracy as well as sufficiency.