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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.




  ― 340 ―

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.

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