Insurers Protest U.K. Plan To Tax Excess Reserves.

A British government proposal to increase taxes on the reserves that insurers hold against future claims has come under fire from a coalition of industry representatives.

The proposal in the budget released recently would seek to lessen some of the tax benefits insurers get by reserving on an undiscounted basis--that is, without accounting for interest to be earned on the funds from the time they are set aside until they are paid out. Undiscounted reserving is a widespread practice among U.K. insurers.

The government projects the increased revenue from the change to reach [pounds]250 million (about $395 million) after about 10 years.

The heads of Lloyd's, the Association of British Insurers and the London-based International Underwriting Association issued a joint statement March 24 warning that the proposal would hurt the competitiveness of U.K. insurers in world markets.

"We believe that this will be a tax on prudence," the industry leaders wrote. "It will hit hardest those classes of business where risks are most volatile and uncertain and where protection is most necessary[ldots]The insurance industry and its customers are being singled out for harsh treatment. This proposal would mean that insurers are taxed on a figure in excess of their real commercial profits and in conflict with prudent regulatory principles. This is inequitable and an exception to normal taxing practice."

The Inland Revenue, the U.K tax agency, said the measure would reduce the benefit to be gained by overestimating future liabilities and would bring U.K. insurers' accounting practices in line with those of companies in other industries and with "other major insurance markets." Companies would remain free to set their reserving levels as they saw fit, but if their estimates turned out to be high, they would pay what would amount to an interest charge to cancel the tax benefit gained by over-reserving.

In the case of Lloyd's, the measure would be applied to "reinsurance to close" contracts, the means by which Lloyd's syndicates provide for future claims from one year of account to the next. Members of Lloyd's who back only a small portion of a syndicate's business would be exempt.

David Clissitt, head of taxation at Lloyd's, said the problem with the proposal was that the discounting wouldn't be done on an actuarial basis but would be based on "an artificial tax calculation" that would be used to impose an interest charge for delayed payment of tax. He added that the trend in the United Kingdom has been to align the calculation of taxable profits with accounting standards, and he pointed to the government's agreement to let insurers create tax-deductible equalization reserves to help cushion the blow of unusually heavy losses.

In light of these moves, "it seems perverse" for the government to take on the issue of reserve discounting now, Clissitt said.

The change is proposed to take effect Jan. 1, 2001, with details to be hammered out by the Inland Revenue in consultation with the industry.

The government also seeks in its budget to nullify the tax advantages some companies gain by setting up captive insurers in offshore domiciles.