intro Flashcards
life insurance v general insurance
A regulated insurance company may write various different types of insurance products. These can be grouped into short term (general) insurance and long term (life) insurance. Most insurance companies will only have regulatory permission to write one of these classes of business. There is such a thing as a ‘composite insurer’, who have the permission to write both short term and long term insurance, but these are comparatively rare in the UK. We can see examples of different policies here
The distinction between short term and long term insurance is the time period over which the insurance event may occur, with short term insurance generally expected to crystallise/extinguish within 12 months. Life Insurers will write long term insurance business.
Long term business is split between two main types: risk (protection) policies usually give a lump sum payment upon a specific occurrence (for example a life insurance policy taken alongside a mortgage) and investment policies which are generally savings products long term within a life insurance wrapper (for example a pension or investment bond product).
This distinction is important for the tax treatment of the policies.
LTB - types of trade
Categories of long term business:
BLAGAB is technically all life insurance business, except for a specified list of products. In practice though, there is not a large amount of business which is classified as BLAGAB following the changes to these rules in 2013. In particular, BLAGAB business will only be life investment business (typically investment bonds) and life protection policies written prior to 2013 (many of the latter have now fully run off).
This is illustrative of the market trends we have seen since 2013, with BLAGAB books of business typically declining in life insurers with relatively low new business sales (these books of business are still very significant in scale in many life insurance groups however).
There is a third category of long term business for friendly societies, which is exempt BLAGAB. This relates to Tax Exempt Savings Policy (‘TESP’) products, which may only be written by friendly societies, and are subject to very strict premium limits.
Overall, as the different categories of business are taxed on a different basis, the effective tax rate will depend on how amounts are apportioned between BLAGAB business and non-BLAGAB business.
LTBFC
Rules for BLAGAB and non BLAGAB business do not apply to assets forming part of the LTBFC or assets not held for the purposes of the insurance trade.
Section 122 Finance Act 2012 provides that assets forming part of the long-term business fixed capital are to be treated as held otherwise than for the purposes of the long-term business. These assets are then treated for tax purposes as being held as part of a separate investment (non-trading) business, with the tax rules for investment companies applied to these assets accordingly.
Changes to LTBFC
New Regulations have come into effect for accounting periods beginning on or after 1 January 2024.
The first regulation sets out which assets are regarded as structural assets of an insurance company’s long term business. There are two requirements for an asset to be regarded as a structural asset.
the asset is held by the company in a fund that is not a with-profits fund.
This is because assets held in with-profits funds of proprietary companies are available to meet policyholder liabilities. They will not be structural assets because they contribute to the benefits enjoyed by the policyholders.
the asset falls within the specified description of assets in Regulation 3. Assets which fall outside Regulation 3 or FA12/S137(3) are not to be regarded as structural assets.
Certain assets of an insurance company’s long-term business (FA12/S65 and S63) qualify as structural assets. Shares, debts and loans held in a 51% subsidiary qualify as structural assets, but only if the entity falls into one of the following categories:
an insurance company or non-resident insurance company
a company whose principal activity is to provide services to group members
a holding company, or a holding company held by that holding company, whose business consists wholly or mainly of holding shares or securities in one of the qualifying companies listed above.
Assets ceasing to be structural assets
The effect of FA12/S122 is to treat long-term business fixed capital assets as held otherwise than for the purposes of the long-term business. This means that assets which are no longer structural assets within FA12/137 will cease to be deemed to be held outside the insurance company’s long-term business and will be treated as assets of the insurance trade.
This can give rise to a box transfer under FA12/S116(6).
Types of fund policies
An insurance company’s business may be divided between different funds, representing the different classes of business written by the insurer and regulatory/commercial protections given to certain groups of policyholders.
With profits business:
The with profits funds each hold a ring-fenced pool of assets which relate to certain policies written by the fund. These policies generate a return from this pool of assets and a share in this fund is given to each policyholder.
This is generally higher risk for the policyholder as returns are directly related to performance of these assets.
For example, a common scenario is that 90% of profits from the investments go to the policyholder. The remaining 10% of profits will go to the insurer.
The investment risk is then shared between the policyholder and the insurer (but primarily borne by the policyholder in that case). In some cases, this business is written on a 100/0 basis, with all investment returns belonging to the policyholder.
Whilst the assets of each with-profits fund are ring-fenced from a commercial/regulatory perspective in line with the specific rules of each fund, a with-profits fund does not have legal personality in its own right and the assets of the fund are still all legally owned by the insurance company.
Non-profit business:
In essence, this is any other life insurance policy written by the insurance company. Most insurance companies will only have a single non-profit fund, separated from their with-profits funds
Aside from unit linked business, the policyholder does not generally receive any of the investment return generated from non-profit policies
Instead, non-profit policies typically give a fixed benefit to the policyholder which may be contingent on certain events. Generally this is lower risk but lower reward for policyholders, as the investment risk is assumed entirely by the life insurer.
Unit linked policies:
Unit linked policies are a type of non-profit business, so are written out of non-profit funds in life insurance companies.
The benefits of these policies directly depend on the value of assets in the specific fund invested in by the policy. Classic examples would be unit linked pensions or investment bonds.
Typically, the policyholder (or strictly their insurance policy) will be issued a set number of units, representing their share of the underlying assets of the fund. The policyholder’s benefit on crystallisation of their units is then directly linked to the value of the underlying assets (and is usually repriced on either a daily or weekly basis).
Consequently, the insurer bears no investment risk on this business, and receives only a fee for managing the policies.
Cash flows
Cash flows of a life insurer:
Policyholders will pay cash to the life insurer in the form of premiums. The life insurer will invest those premiums in different types of assets.
These investments can be in the equity or bond markets, in properties or in collective holdings, such as unit trusts. These will then generate investment income and gains, which will flow back to the life insurer as the holder of the investments.
The form of this income will depend on the asset from which it is being derived. For example, the income could be as dividends, interest, capital gains or rent. The life insurer will incur expenses through managing its insurance business and their investments. Depending on the products held by the policyholders, the life insurer will pay out claims and returns to its customers.
Why use I-E
Insurers are taxed on an I-E basis for their BLAGAB business. That is essentially on investment income and gains less expenses to manage the business.
From the insurance company’s perspective:
They will receive premiums (P), pay claims (C), invest funds to generate income (I) and incur expenses in managing these funds (E).
From the policyholder’s perspective:
They will pay premiums (P) and receive claims (C).
This demonstrates that I-E gives us an assessment of the overall return made by the policyholder from their life insurance policy. By taxing this return as the investment income accrues, the company ensures that the policyholder has in effect paid tax at the basic rate of income tax on this return. The policyholder is only then taxed at the point the policy crystallises if they are a higher rate taxpayer.
The non-BLAGAB category of the business is not relevant for this calculation. This is because the policies in this category are either tax exempt (for example ISAs and CTFs), or they are expected to be taxed when the funds are redeemed (for example pensions). So we solely tax shareholder profits in respect of any non-BLAGAB business.
