Preamble
No. Payments by direct insurers under traditional reinsurance arrangements are accepted as deductible for income tax purposes on the basis that they are an expense incurred in carrying on the business of insurance. The expense is the cost of transferring risks undertaken by the direct insurer in the course of deriving premium income. That is not the circumstances behind financial reinsurance type arrangements.
Reinsurance arrangements which contain significant funding elements, hereinafter referred to generically as 'financial reinsurances', operate through the payment of amounts called 'premiums' but the liability of the reinsurer is generally limited to the amount paid as 'premiums' by the direct insurer to the reinsurer. Where claims do not exceed 'premiums' any excess is returned to the direct insurer as commissions. The commissions are subject to adjustments for costs and charges of the reinsurer.
The amount of underwriting risk of financial reinsurances, if any, is minimal and the transaction is not, in substance, in the nature of the reinsurance of underwriting risks. It is considered that the substance of financial reinsurances is more akin to a 'banking' or 'financial' arrangement than the traditional concept of reinsurance and the transfer of risk.
For income tax purposes, payments of 'premiums' under financial reinsurance arrangements will be treated as loans while 'claims' and 'commissions' paid under the arrangements, to the extent that these payments equal 'premium' payments, will be treated as the repayment of loans. Therefore the existence of a financial reinsurance arrangement will be irrelevant when calculating unearned premiums or outstanding claims provisions. Income derived by a reinsurer from the investment of amounts paid as financial reinsurance 'premiums' will be assessable income of the reinsurer. Any amounts paid to the direct insurer by the reinsurer and which exceed 'premiums' paid under a financial reinsurance arrangement will be deductible to the reinsurer under subsection 51(1) at the time of payment and assessable to the direct insurer under subsection 25(1) as income derived in the course of carrying on a business of insurance.
The approach adopted here in relation to financial reinsurances is consistent with the statement made by the Insurance and Superannuation Commission in its 1991-1992 Annual Report. It was stated in the Report that: "A contract that may contain an element of insurance risk, but which is essentially a financing or funding arrangement, should be accounted for as a loan and will not be accepted as a reinsurance arrangement."
Listed below are some known factors which indicate an arrangement may be a financial reinsurance arrangement to which this Determination will be applied. Each of the factors is indicative only, and the list is not intended to be exhaustive. The critical question is whether or not payments are in fact expenses incurred in carrying on either the business of insurance or the business of reinsurance and are not part of a wider financing arrangement which call for their treatment as capital payments. The following factors are indicative of the type of arrangements to which this determination will apply: • where the amounts payable and/or cover provided under an arrangement are determined on the basis of an interest rate assumption; • where each party to an arrangement is aware of the financial outcome, or range of possible results, at the outset of an arrangement; • the existence of cancellation or commutation clauses which impose substantial penalty or payback conditions on the direct insurer; • where the reinsurer's return is not dependent on the amount of claims arising under an arrangement; and • where the consideration payable by the direct insurer is not reasonable in relation to the amount of insurance risk transferred under an arrangement.