CMP Chapter 24, page 15 “Implicitly looking at projecting the necessary amount of policyholders’ funds needed to meet liabilities rather than shareholders’ funds” 1) What does this mean? 2) How does this explain that the “rate for netting down is not influenced by corporation tax rate”? CMP Chapter 24, question 24.7 For overseas business pricing, “investment return and expense are gross while profit is net” 3) Why? Thanks !
Hi: Page 15: this is about how the "I" and "E" included in the pricing calculation should be netted down. The paragraph is saying that they should both be netted down in this situation (i.e. I>E, proprietary) at the policyholder tax rate rather than at the corporation tax rate. Remember from the earlier chapters on taxation of life insurance companies that the taxable amount in the BLAGAB fund of a proprietary company is split into a policyholder share and a shareholder share. The paragraph here is saying that the "I" and "E" are parts of the policyholder share. On their own, they do not comprise shareholder profit, and so are not taxed at the corporation tax rate. They are part of the accumulation of funds used to pay the claims to the policyholder, and so are within the policyholder share - and hence netted down at the policyholder tax rate. You might find a revision of Chapter 7 helpful. Q24.7: As indicated in Section 1.1 of Chapter 6, overseas life assurance business falls within the non-BLAGAB fund. Therefore it is not taxed on "I-E" but on profit. Hence "I" and "E" can be included gross in the pricing calculation, but the overall profit would be taxed i.e. net. Hope that helps to make this clearer.
Hi Lindsay, I am also having some confusion with Page 15 quoted above. Based on my study of chapter 7 I have seen that "I-E" includes both a policyholder share and a shareholder share.. I dont understand why we can just apply a policyholder tax rate to I-E? Surely we need to apply a P/H rate to the PH share and the SH share at the shareholder rate? This has lead to confusion for me in Chapter 8 where we allow for taxation in unit pricing. In that chapter for blagab funds we again tax "I-E" meaning that the shareholders units are having both the P/H and S/H amount of tax deducted?? I am clearly missing something here but struggling to see what this is
Hi - this is a really tricky area so don't worry if you are finding it confusing. Yes, I-E is broken down into a policyholder share and a shareholder share, with each being taxed at a different rate. The shareholder share reflects the profit being made on the business. The remainder effectively represents the gain that the policyholders have achieved on their policies. As an example, let's consider unit-linked business. The investment return earned on the assets held in unit funds will increase the liabilities as well as the value of the assets. Hence it will not appear in the 'profit' calculation: the increase in assets and increase in liabilities will cancel out. So we can consider it as being within the policyholder share. And that makes sense: the gain achieved by the policyholder on their policy will principally reflect the investment return earned on the unit fund. Therefore, in Chapter 8 (where it talks about unit pricing) the deferred tax adjustments made in relation to unrealised gains in the unit funds will be based on the policyholder tax rate. In Chapter 23 (Product design and pricing) page 15, where we are looking at the tax rate that would be applied to I (net of E) when pricing the product, we again need to consider the investment returns that will accrue to the policyholder under their policy (as this is fundamentally what we will be projecting in the profit testing model or pricing calculation). Hence we use the policyholder tax rate. To reflect that element which falls to the shareholder, ie the profit, the company would normally ensure that the profit determined by the profit testing model is netted down at the corporation tax rate before comparing it with its (post-tax) profit criterion. Does that make a little more sense?
Hi Lindsay, Thanks so much for the reply. I think I am following you here. So is it the case that when a full company's BLAGAB fund is taxed, we tax "I - E" which includes a s/h and p/h component. However, we we look exclusively at the "unit fund" contribution to the total BLAGAB fund, any "I-E" is actually totally for a policyholders benefit in this instance (Kind of almost like a mutual?). I think a big part of my confusion comes from certain areas in chapter seven where the term "investment income and gains" seems to be used interchangeably to relate to "I" and also to the "Policyholder holder investment return (C - P)". The latter here appears to be called policyholder investment return in uk legislation. I was confusing this with "I" (the total company investment income and gains)
Yes - that sounds right: I think you've cracked it! And yes, the terminology used in the Core Reading can be bemusing in places. But as long as you have understood the basic principles, you should be fine. I would also caution against reading the underling actual tax legislation, as that is likely only to provide further confusion!
Great Lindsay - really appreciate the help. Can I also check 2 other small things with you 1. one part of chapter 8 compares the tax charges we make to unit funds compared to the liability to the tax authorities. In this instance it says how we make no account for “E”. I presume again in this instance we are comparing the tax charge to the unit fund vs the actual tax charge “in respect of the unit fund”. I.e we are not comparing vs the companies total tax bill otherwise we would be missing the shareholder tax component? 2. For a standard non linked product. Do we include the investment return on reserves or reserves + solvency capital when we are modelling the cash flows for pricing ?
Yes: this means comparing the tax charges taken out of the unit fund using this deferred tax liability approach (which only considers I and ignores E) with that element of the overall actual tax bill that would relate to that unit fund (which would be based on I-E).
This will depend on the company. Some will allow for the cost of holding solvency capital requirements, others might not.
