General insurance risk margins

Sections CR 4, DW 4 and YA 1 of the Income Tax Act 2007; sections CR 3 and DW 3 of the Income Tax Act 2004

Movements in a general insurer’s outstanding claims reserve (OCR), as determined by applying International Financial Reporting Standard (IFRS) 4, can now be claimed as a deduction for income tax. The amendment responds to uncertainty about the tax treatment of the OCR following the adoption of IFRS 4.

Background

Under IFRS 4, the OCR of a general insurer has two components: a “central estimate”, which is the average present value of expected future payments, and a risk margin, which is a prudential addition to reflect uncertainty connected with the central estimate.

IFRS 4 does not prescribe how the separate components should be calculated and reliance is placed on actuarial standards and practice.

For tax purposes, the law was not clear on the extent that deductions could be claimed for movements in the OCR connected with the risk margin. New sections CR 4 and DW 4 confirm that amounts calculated for both the central estimate and risk margin are income or deductible.

Key features

An insurer who uses IFRS 4 for accounting for its general insurance contracts may claim as a tax deduction (section DW 4) (or return as income (section CR 3)) the movement between the opening and closing OCR for the income year. Direct and indirect claim settlement costs are therefore deductible under section DW 4 to the extent they are included in the OCR.

Taxpayers applying sections CR 4 or DW 4 for the first time should use the closing outstanding claims reserve that existed before the insurer adopts IFRS 4. The term “OCR” is defined in section YA 1 to mean an amount relating to an insurer’s outstanding claims liability for general insurance contracts, as measured by Appendix D, paragraphs 5.1 to 5.2.12 of 
IFRS 4.

Corresponding changes (new sections CR 3 and DW 3) have been made for income years affected by the Income Tax Act 2004.

Application date

The changes apply from the 2009–10 income year. For taxpayers that elect, the change can be applied earlier – beginning from the first income year IFRS is adopted for financial reporting purposes.