Supplementary Explanatory Memorandum and Correction to the Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 3 - General insurance
Outline of chapter
3.1 The amendments to Schedule 2 to the bill ensure that net premium income is effectively spread over the period of risk coverage of a general insurance policy and that the measures in the bill apply to all companies that carry on general insurance activities.
Explanation of amendments
3.2 Amendments 8, 9, 13 and 14 amend the application provisions in Schedule 2 to the bill to clarify that they apply to assessments for the respective income year and all later income years.
3.3 A general insurance policy typically straddles 2 or more income years. Therefore, the premium income needs to be apportioned over the risk period for income tax purposes into the income years in which it is derived.
3.4 Schedule 2 to the bill outlines the basis that must be used by general insurance companies to spread premium income over relevant income years. That is, gross premium income is included in assessable income in the year it is received or receivable. Net premium income that relates to risk exposure in subsequent years is allocated to the unearned premium reserve. The value of the unearned premium reserve at the end of the income year is compared with the value of that reserve at the end of the previous income year:
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- increases in the value of the unearned premium reserve over the income year are allowed as a deduction - this ensures that net premiums that relate to risk exposure in subsequent years is appropriately deferred; and
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- decreases in the value of the unearned premium reserve over the income year are included in assessable income - this ensures that net premiums that relate to risk exposure in the current year are included in assessable income.
3.5 Amendments 10, 11 and 12 remove concerns that have been raised that the provisions in Schedule 2 to the bill do not appropriately spread net premium income if a single, up-front premium is paid in respect of a general insurance policy that covers a period of risk extending over several years. This situation typically arises, for example, in the case of mortgage insurance policies and credit insurance policies. The amendments ensure that, in these circumstances, net premium income is effectively spread over the relevant period of risk.
Example 3.1
Sam borrows money to buy a car and is required by the lender to take out consumer credit insurance. Sam pays a premium of $200 to the Jasper Insurance Company to cover the 5 year term of the loan.
Jasper Insurance incurs $30 in acquisition costs and pays out $50 in relevant reinsurance premiums. Therefore, Jasper Insurance receives net premium income of $120.
The amount of net premium income that Jasper Insurance determines, based on experience in previous years, to relate to risk exposure in subsequent years is allocated to the unearned premium reserve. Therefore, assuming that Jasper Insurance determines the risk exposure in each year of the policy to be same, the value of Jasper Insurances unearned premium reserve and the premium earned each year will be the amount set out in Table 3.1.
Table 3.1 Year 1 2 3 4 5 Value of unearned premium reserve $96 $72 $48 $24 $0 Premium earned $104* $24 $24 $24 $24 * Gross premiums ($200) less increase in the value of the unearned premium reserve ($96). Acquisition costs are deducted from this amount.
3.6 Amendments 15 and 16 add appropriate references to the checklists in the Income Tax Assessment Act 1997 (ITAA 1997) which assist users of the legislation to find specific items of assessable income and allowable deductions.
3.7 The provisions in Schedule 2 to the bill apply to companies that are authorised under the Insurance Act 1973 (Insurance Act) to carry on insurance business (as defined in the Insurance Act). Concerns have been raised that some companies that carry on general insurance business, such as companies that are licensed under the Workers Compensation Act 1987 (NSW), are not required to be authorised under the Insurance Act.
3.8 Therefore, amendment 17 ensures that the measures in Schedule 2 to the bill apply to all companies that carry on general insurance activities.
Application and transitional provisions
3.9 The date of effect for the amendments is outlined in paragraphs 4.65 to 4.72 of the explanatory memorandum to the bill.