GIM6080 - Technical provisions: accounting periods beginning before 1 January 2000: background

In accident year accounting, paid claims are adjusted by movement on the provision for claims outstanding, (calculated at each year end), to arrive at a figure of incurred claims in the revenue/technical account. The accounts may show a global figure for reported claims and claims incurred but not reported (IBNR) (see GIM6100). The regulatory return forms give these two items separately.

The importance of the outstanding claims amount, and its relationship with the paid claims, will depend on the type of business being carried on by the company. Where most claims are likely to be settled promptly, for example in domestic property business, the outstanding claims may be relatively insignificant. Where major claims are likely to be litigated, or reported late, and in the case of most reinsurance, the tail of outstanding claims may be much larger than the claims paid in the year. This presents difficulties for the insurer in calculating the provision. For periods prior to the introduction of FA00/S107, it also presented the Revenue with the question of the extent to which it could be deducted for tax purposes.

Before the line of tax cases on law and accountancy that emerged in the 1990s (see BIM31080+), the Revenue’s view was that provisions must satisfy the two tests set down by Lord Radcliffe in Owen v Southern Railway of Peru (36TC602). As for other businesses, insurance companies’ provisions were tax deductible to the extent that they were a sufficiently reliable estimate of future liabilities. This remains the Revenue’s view of insurance provisions for accounting periods beginning before 1 January 2001, although the extent to which it could be applied depended on the facts of each particular case. An insurance company must be able to demonstrate that its reserving is reliable and follows best practice in applying actuarial techniques in setting the reserve.

Owen v Southern Railway of Peru also concerned discounting. The company lost its appeal mainly because of its failure to discount provisions that had been made for future superannuation benefits related to current employment. The Revenue did not immediately seek to apply the same reasoning to the reserves of insurance companies, but eventually it adopted the view that the discounting of reserves for outstanding claims was appropriate in certain circumstances, irrespective of the accounting treatment. As the relationship between tax and accountancy developed, the Revenue then began to accept that as the use of undiscounted figures was not contrary to the relevant accounting practice, they could not be set aside for tax purposes. Moreover the extent to which discounting was permissible in accounting was significantly had been significantly reduced by the Insurance Accounts Directive (IAD).

Funded accounting

Prior to 1978 it was thought that the 3 or 4-year bases then used were adequate without the need for outstanding claims provisions. The thinking was that by the time the balance of profit was struck most claims would have been paid. Increasing delays in claims settlement, and the growing significance of claims under liability policies that related to events that only come to light many years after they occurred (such as the onset of an industrial disease) made this assumption unrealistic. From 1978 the Revenue accepted a provision to cover claims that were still outstanding when the balance of profit was struck at the three or four- year point, subject to the arguments set out above.