Many insurance businesses are struggling with the treatment of reinsurance held under IFRS17. Much of the struggle is to understand the accounting implications, but there are a number of tax issues that businesses should be addressing at the same time. This highlights the importance for businesses of making a place for their tax team within the leadership of the IFRS 17 implementation project.
What is the problem with reinsurance?
The problem is that, unlike IFRS4, IFRS17 requires insurance contracts written and reinsurance contracts held to be valued separately and these valuations are likely to be mismatched. The mismatch can be for a multitude of reasons including:
- The reinsurance CSM is recognised over the coverage period of the reinsurance. If the reinsurance coverage period is not the same as the insurance coverage period then there will be a different pattern of CSM amortisation even if the CSM’s are equal.
- A reinsurance CSM can be negative but the insurance CSM on the underlying business cannot be negative. Again, this could result in differences in the patterns of insurance and reinsurance CSM amortisation.
- There may be different discount rates for the insurance and the reinsurance.
- Then there are issues specific to GI and life business:
- For GI: it may be that the reinsurance does not meet the requirements for PAA while the underlying insurance does.
- For life business: the VFA is not permitted for reinsurance valuation which would be a problem where VFA insurance contracts are reinsured – for example with-profits business.
These are just a few of the ways that mismatches can arise and it is easy to see that, even in the simple case of a 100% quota share, the insurance and reinsurance valuations are likely to be different and hence that there may well be increased profit volatility compared to IFRS4.
Valuation differences result in a number of issues for tax, which we are already seeing in practice as businesses work through IFRS17 design issues.
As an example, one group that we are working with use intra-group reinsurance to finance the strain in a subsidiary that writes a considerable volume of new business. The insurance contracts are “onerous” for IFRS17 and so the subsidiary will record a day-1 loss on the insurance. However, it will only be able to recognise the corresponding reinsurance CSM over the reinsurance coverage period and so there will not be an equivalent day-1 profit on the reinsurance.
This gives them three particular accounting issues:
- On transition, the existing result in the subsidiary will need to be “unwound” with the insurance and reinsurance valued separately. This is anticipated to result in a transitional mismatch in the income statement.
- The new business subsidiary is likely to record continuing solo accounting losses while it maintains high volumes of new business.
These have tax consequences:
- It is not clear whether the group can utilise a transitional loss. They may be able to surrender it as group relief, but they have not been able to model the future expected results across the group with sufficient accuracy.
- Because the accounting result is not symmetrical between group entities their consolidated deferred tax accounting will also become more complex.
- The new business subsidiary’s stand-alone DTA modelling is also much more complicated and this feeds back into their Solvency II workings.
In response, they are considering a redesign of the intra-group reinsurance programme or even whether they should transition the entity accounts back to UK GAAP.
There is a lot of uncertainty around reinsurance under IFRS17 and tax teams need to get under the bonnet on the issues early to make sure that businesses understand the tax issues and avoid making design decisions that would bake in tax problems.