A federal budget proposal to forbid insurers from using a contractual service margin as a deductible reserve for tax purposes could impose a one-time tax liability on the industry.
International Financial Reporting Standard 17 (IFRS 17) will “substantially change the financial reporting for Canadian insurers” as of Jan. 1, 2023, the finance department said in the 2022-23 budget document tabled April 7.
But it probably won’t affect that many P&C carriers, experts told Canadian Underwriter.
One key IFRS 17 accounting concept is contractual service margin (CSM).
It aims to try and predict the exact profit the insurer will make over the life of a contract, says Daniel Singer, 2022 conference chair and past president of the Canadian Insurance Accountants Association.
“Budget 2022 proposes legislative amendments to confirm support of the use of IFRS 17 accounting standards for income tax purposes, with the exception of a new reserve known as the contractual service margin, subject to some modifications. Without this exception, profits embedded in the new reserve would be deferred for income tax purposes,” the finance department said in the budget document released April 7.
Short-term policies such as auto insurance “typically won’t be affected that much,” said Paul Vienneau, partner, corporate tax (financial institutions) for KPMG Canada.
It could apply to title or creditor insurance, added Singer. “A strong majority of the current of P&C contracts will not apply.”
Life insurance contracts tend to be multi-year but many P&C policies are renewed annually.
Singer noted most P&C insurers use the premium allocation approach (PAA). And the proposed measure would impact P&C insurers who use the general measurement model (GMM), not PAA.
Some P&C insurers have certain lines of business with a longer tail, Singer said. If an insurer has a contract with a ‘boundary’ of more than one year, the insurer has to compare results between the profit they would get using GMM and the profit they would get using PAA, he added.
If the carrier has a contract longer than a year – and if the difference between the insurance reserves calculated using GMM is materially different than what it would get on the PAA – then the insurer may have to use GMM. If the carrier uses GMM, then contractual service margin is part of the calculation, said Singer.
In 2021, the federal government noted IFRS 17’s CSM would allow insurers to defer the recognition of profits until years following the taxation year in which the economic (income-earning) activities occurred. So the intent with the Budget 2022 proposal is to recognize profits in the year in which the economic activity occurred.
The upshot is insurers would have to pay some income taxes earlier than they otherwise would have, suggested Stephen Frank, president and CEO of the Canadian Life and Health Insurance Association.
“In any business other than insurance, you take profit when you’ve delivered the services. You don’t take the profit as soon as you sign the contract,” Frank said. “If someone buys a cellphone with a three-year plan, the cell phone company has to wait until that contract is finished to book that profit. They don’t book it up front to pay [corporate income] tax on it.”