Multinational Top-up Tax and Domestic Top-up Tax

MTT45440 - Particular entities and adjustments: Insurance: Exclusion of certain insurance reserve movement expense

Insurance companies may recognise returns that must be contractually paid over to policyholders within their financial statements as income, with a corresponding movement in their insurance reserves as an expense.

Insurance reserves cover all technical provisions calculated under relevant accounting standards and included in the balance sheet of the insurer. The insurance reserves may be described differently under different accounting standards, for example, as long term business provisions, claims outstanding, unearned premium reserve, insurance contract liabilities comprising items such as best estimate liabilities, risk margin and contractual service margin.

These amounts generally net off against each other such that there is no net impact on the member’s net profits. This result is appropriate because it means the member’s net profits will reflect only the profits that the member has made for the benefit of its shareholders and will not include profits that from an economic perspective belong to its policyholders.

However, this income may include dividend income and equity gains or losses that are excluded from the member’s underlying profits under sections 141 and 142 respectively. Absent a further provision, the section 141 and 142 adjustments would create a mismatch.

For example, the member earns £100 of dividend income which it is contractually obliged to pay over to policyholders. There is consequently an increase of £100 in the member’s liabilities to policyholders. This gives rise to a £100 expense so the net profit in the financial statements in respect of those dividends is nil. However, the £100 of dividend income is treated as an excluded dividend and is required to be removed from the accounting profits. If the £100 expense from the movement in the policyholder reserves is not excluded, the member will have a £100 loss even though it has not made an economic or accounting loss.

Section 153 addresses this by excluding the expense from the movement in the policyholder reserve from the member’s underlying profits when the expense is economically matched to an Excluded Dividend or Excluded Equity Gain or Loss. This adjustment ensures that there will continue to be symmetry.

The provisions only apply when the movement in the reserves is economically matched to an Excluded Dividend or Excluded Equity Gain or Loss. This ensures the adjustment is only required when the dividends or equity gains (or losses) are earned on behalf of policyholders and where there is a clear and direct relationship between the income and the movement in the policyholder reserves, for example in unit linked insurance policies.

It may be the case that the movement in reserves is not directly equal or proportional to the dividend or equity gain or loss. This could be the case for example when the insurer’s investment management fee is paid out of the dividend and only the net amount after deducting this fee is paid to the policyholder. In such cases, an adjustment is still required if the movement in reserves would be economically matched to an Excluded Dividend or Excluded Equity Gain or Loss if this investment management fee were disregarded. 

Where an adjustment is required, the adjustment will be equal to the amount of the Excluded Dividend or Excluded Equity Gain or Loss.

Where the movement in the reserves is not exactly equal to the amount of the dividend, for example because of investment management fees, this may mean that the difference, equating to the amount of the fee, remains in the member’s adjusted profits. This is because the provision is intended to maintain symmetry.

Example

Insurance company A invests €1,000 in shares with 3% dividend yield and a 1% investment management fee. Company A receives €30 dividend. €20 of this dividend is due to policyholders and so €20 is provided for in the reserve with a €10 profit on the investment for A (being the investment management income received).

The €30 dividend is an excluded dividend and is removed from company A’s underlying profits. The investment management fee is ignored when determining whether the excluded dividend is matched to the reserves. Without the fee, the dividend would be equal to the movement in the reserves and therefore the movement in reserves is economically matched by the €30 excluded dividend. A reserves movement of €30 is to be excluded from A’s underlying profits under section 153. 

A's adjusted underlying profits has a net €10 income as a result of these two adjustments, representing the management fee income received by A.

The accounting double entries are as follows (with the amounts excluded in bold):

Dr Cash/Dividends receivable €30

Cr Investment income (excluded dividend) €30

Dr P&L expense (movement in technical provision/insurance finance expenses) €30

Cr Technical provision/insurance contract liabilities €20

Cr Investment management fee income (Other technical income/Insurance revenue €10

Interaction between Section 152(3) and Section 153

Section 152(3) and 153 are both intended to prevent a mismatch or asymmetry in the treatment of policyholder investment income and the movement in the policyholder reserves.

The former addresses instances where there is a mismatch affecting the underlying profits because the relevant accounting standard recognises the policyholder investment return in Other Comprehensive Income, while recognising the movement in the policyholder reserve in the Profit and Loss Account. It requires an adjustment to include the policyholder investment return in the adjusted profits.

Unlike s152(3), the latter does not apply to cases where amounts are recognised in different financial statements. Rather, it applies when a mismatch is created in making the Excluded Dividends or Excluded Equity Gains or Losses adjustments. It applies to restore symmetry by excluding the equivalent movement in the policyholder reserve. It is possible that both provisions could apply. For example, an insurance company receives dividends from non-portfolio shareholdings which are received on behalf of policyholders. The relevant accounting standard requires the dividend income to be recognised in Other Comprehensive Income. In this case, Section 152(3) will apply in the first instance and require the dividend income to be included. Section 141 will then apply. In this case, as the dividends were earned in respect of non-portfolio shareholdings, they will be treated as Excluded Dividends. This would reintroduce a mismatch between the treatment of the dividend income and the policyholder reserve and so Section 153 will exclude the movement in the policyholder reserve.