I. General Insurance

20.2. This first section deals with the operations of fire, general and marine insurance companies, which are concerned with the insurance of losses other than those covered by life insurance and those personal accident losses covered by insurance policies written by the life insurance offices. The basis of the insurance contract is that, in consideration of a payment or premium by the insured, the insurer will, on a certain event happening during a given time, pay to the insured, or some nominated person, either an agreed sum or the amount of the loss caused by the event. Fire, general and marine insurance companies insure various kinds of risks, such as loss at sea, loss by fire or accident, by burglary or breakage, by default of staff, and loss of profits consequent upon another loss.

20.3. Division 15 of the Act contains particular provisions covering insurance with non-residents. But apart from these provisions, the Act is silent on the treatment of the income of general insurance companies. Because of the nature of their business, however, the taxable income of such companies has in certain respects come to be calculated differently from the taxable income of other companies. Four special features of the industry are dealt with in turn: deferment of unearned premiums; claims incurred but not reported; catastrophe fund; and insurance with non-residents.

Determination of Earned Premiums

20.4. Throughout the tax year an insurance company receives premiums, a proportion of which will cover risks for a period after the end of that year. For this reason it has been the custom of the Commissioner to agree to the accounting practice of insurance companies to exclude from their assessable income for a year an amount equal to a proportion of the premium income for that year and to bring that amount to account in the following year.

20.5. Until 1965, the proportion of premiums received in a year that could be deferred to the next year was set at 40 per cent and representations to the Commissioner that the percentage be increased met with no success. The 40 per cent rule rests on the principle, dating back to a Court decision in the United Kingdom as long ago as 1912, that 50 per cent of premiums received as twelve-monthly business is unearned at the end of the year; and as 20 per cent is customarily allowed for costs of acquisition and documentation, the deferred amount should be 50 per cent of 80 per cent, which is 40 per cent.

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20.6. The 40 per cent rule has been criticised as it is unreal to assume that premium income and risks are necessarily distributed evenly over the year. For example, a substantial proportion of a company's contracts may be for periods of more or less than one year; or the company may receive during one year a substantial total of premiums on a new type of policy which it first commenced to write midway through that year; or part of the premiums received may refer to risks which did not commence during the year of income; or a sizeable proportion of premiums may be received in one calendar month.

20.7. The 1965 decision in the Arthur Murray Case note lent support to the Commissioner's practice of excluding unearned premiums from assessable income and led the Commissioner to amend his view as to a reasonable deferment of premiums in special circumstances. The Commissioner now began allowing individual companies to defer amounts in excess of 40 per cent of premiums received if, upon a careful examination of all the circumstances, a larger percentage was thought to be justified. Since 1968, the rules for deferment of premiums have been widened to allow for calculations by the ‘24ths rule’. Behind the latter is the assumption that a premium in connection with an annual risk is deemed to have been received in the middle of the month, and that a risk attaching to a premium received in the first month of the income year falls due as to 23/24ths in the current year and as to 1/24th in the next year. The proportions for a premium received in the second month are 21/24ths and 3/24ths respectively; and so on. The calculation is based on net premiums (that is, gross premiums less returned premiums, reinsurances, commissions and a proportion of administration expenses).

20.8. The Committee is satisfied that submissions to it calling for methods of assessing an allowance for the deferment of unearned premiums more accurate than the 40 per cent rule are met to an extent by the present acceptance of the 24ths rule. It therefore recommends that the 24ths rule be continued. However, this latter rule has its shortcomings: being based on the time at which premium is charged rather than the period of risk, it cannot be wholly accurate in all cases. Hence, as more exact methods of calculating the unearned premium are developed, they should be accepted by the Commissioner. In recommending continuance of the exclusion of unearned premiums from assessable income, the Committee is not seeking to treat the income of a general insurance company in a specially favourable way. It is concerned only with establishing a fair basis for calculating taxable income.

Claims Incurred but not Reported

20.9. Insurance companies are liable to meet claims arising from losses of the insured during the income year but not notified during that year. At the end of each year companies estimate claims which occurred during the year but likely to be made after the end of the year. Understandably, the delay in notifying claims varies according to the class of insurance business. With workers’ compensation and third-party insurance business, for instance, there may be a considerable time-lag between the occurrence of the injury, the manifestation of the symptom and of the extent of the injury suffered, and settlement of the claim. It is thus extremely difficult to calculate this provision accurately. The insurance industry as well as the Insurance Commissioner have been concerned with developing statistical techniques to enable the calculation of claims incurred but not reported to be made with greater precision.

20.10. Claims incurred but not reported have not until recently been submitted as deductions for income tax purposes. However, R.A.C.V. Insurance Pty. Ltd., in its return for the year ended 28 February 1971, sought a deduction in respect of claims reported after 1 March 1971 for accidents that had occurred during the financial year. In the assessment, the amount claimed was disallowed and the matter eventually became the subject of an appeal to the Supreme Court of Victoria.note A decision in favour of the company was given by Menhennitt, J. in June 1974 and by consent an appeal by the Commissioner was dismissed. While by the facts of the case the decision is limited to motor-car insurance and third-party insurance, the Commissioner has accepted the decision as applying to all general insurance companies. The decision is not expected to give rise to practical difficulties for the Commissioner and will undoubtedly be welcomed by the insurance industry.

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Catastrophe Fund

20.11 It has been put to the Committee in submissions that insurance companies should be allowed to deduct from taxable income additions to provisions built up to meet an exceptional aggregation of claims arising from a catastrophe. The maintenance of a high solvency margin, it is argued, would be facilitated by such deductions and the provisions would be available for emergency purposes, payments from the provisions not of course being allowable deductions.

20.12. While substantial provisions to meet unusual claims are desirable in any business, the Committee does not favour special treatment in this regard for insurance companies. The uncertainty of the basis of such provisions would cause serious administrative difficulties in deciding to what extent the amounts claimed should be allowed as deductions.

Reinsurance with Non-residents

20.13. It is not uncommon for resident insurance companies to reinsure certain risks with non-resident companies, and section 148 of the Act contains special provisions for taxing such non-residents. Amendments to the section have been sought in submissions to the Committee.

20.14. To bring the income of a non-resident reinsurer to tax in respect of premiums pertaining to insurance of property situated in Australia or of events that can happen only in Australia is an extremely complicated matter. Before 1938 the Australian insurer was assessable to tax as agent for each ex-Australian reinsurer on the profit derived by the reinsurer. The profit so derived was deemed to be 20 per cent of the premiums received by the reinsurer, unless the actual profit or loss made by the reinsurer could be established to the satisfaction of the Commissioner.

20.15. Under pressure from the insurance industry, this basis was abandoned in 1938. Thereafter, premiums paid to non-resident reinsurers and recoveries from the latter were excluded from the assessments of local insurers and the full profit or loss arising from the risk insured was included in the assessment of the local insurer.

20.16. It was found that in most cases the insurer was able to recoup from the non-resident reinsurer the tax attributable to the reinsurance in question; but some local companies were at a disadvantage when they could not make satisfactory arrangements to recoup.

20.17. To meet the disadvantages facing local companies, the Act was amended in 1947 to allow the Australian insurer either to bring to account in his own return the profit or loss derived by the reinsurer or else to return 10 per cent of the premium paid to the reinsurer as taxable income and pay tax on that amount as agent for the reinsurer.

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20.18. Representations to have the figure of 10 per cent reduced have not been successful, the Commissioner being satisfied that, over a period, 10 per cent is not excessive. A submission to the Committee that overseas reinsurers be allowed to submit income tax returns for reinsurances ceded by Australian companies would lead to the unsatisfactory complications previously outlined, and to double taxation unless the Australian insurer elected not to bear the tax on the reinsurer's profits or losses.

20.19. Section 148 (3) of the Act refers to ‘ten per centum of the sum of the gross amounts of the premiums paid or credited by him … to non-residents’. The Committee understands that the Commissioner is interpreting this as not precluding the deduction from gross premiums of returned premiums and rebates for the purposes of calculating deemed profits on premiums. This interpretation will go some way to reduce deemed profit of local insurers on reinsurance business, and the Commissioner ought to notify the insurance industry of his current interpretation.