XSE confusion

[bensondros]

I've read a few threads on XSE and XSI but am still very unclear on this topic.

In all of the threads I've read, it says that if a company is XSE, then it can price on gross/gross, since it doesn't pay tax.

I was wondering if this applies only to mutuals?

If a proprietary is XSE, doesn't it still have to pay tax if the minimum profit test bites?

For example, let the min profits = 10
I = 15
E = 7
so I-E = 8
min profits = 10 > 8, and the test bites.

So E will be decreased to 5, and the new I-E = 10

(Note that the company is XSE as E = 2 is carried forward to the next year.)

This I-E will then be taxed at the corporation rate as mentioned in chapter 7, section 5.2.

It seems that XSE has two very different meanings, one as described above, and one where I-E<0 (in which case I understand why the company won't have to pay tax).

 

[Mark Willder]

I've read a few threads on XSE and XSI but am still very unclear on this topic.

In all of the threads I've read, it says that if a company is XSE, then it can price on gross/gross, since it doesn't pay tax.

I was wondering if this applies only to mutuals?

Yes, if a company has more E than I then it can price using gross investment return and gross expenses.

Proprietaries can be XSE and can price gross/gross too.

If a proprietary is XSE, doesn't it still have to pay tax if the minimum profit test bites?

Yes, a proprietary would still need to pay tax on its profits.

For example, let the min profits = 10
I = 15
E = 7
so I-E = 8
min profits = 10 > 8, and the test bites.

So E will be decreased to 5, and the new I-E = 10

(Note that the company is XSE as E = 2 is carried forward to the next year.)

This I-E will then be taxed at the corporation rate as mentioned in chapter 7, section 5.2.

Yes, spot on.

It seems that XSE has two very different meanings, one as described above, and one where I-E<0 (in which case I understand why the company won't have to pay tax).

Yes there are two very different meanings to being XSE. The first is having E bigger than I, and the second is having the minimum profits test bite.

Its confusing to have two types of XSE, but this is the terminolgy used and we're stuck with it. We mention this at the top of page 7 of Chapter 7 for example.

Back to your earlier question on pricing. We have 4 cases:

Mutual with E bigger than I - pays no tax. Prices gross/gross (with no tax on profits).

Mutual with I bigger than E - pays tax on I-E. Prices net/net (with no tax on profits).

Proprietary with E bigger than I - pays tax on profits. Prices gross/gross, but allows for the tax on profits in its profit test.

Proprietary with I bigger than E - pays tax on I-E and is subject to the profits test. Prices net/net and allows for the additional tax on profits in its profits test.

Best wishes

Mark

 

[bensondros]

Thanks for the reply, Mark.

I understand everything up until this part:

Proprietary with I bigger than E - pays tax on I-E and is subject to the profits test. Prices net/net and allows for the additional tax on profits in its profits test.

When pricing net/net in this case, assuming that the current tax rates do not change for the entire term of the contract being priced, what is the tax rate assumed? Is it the PH rate, or the corporation rate, or some weighted average depending on whether the minimum profits test bite?

I am thinking it's something like that:
Say if the min profits test does not bite, so min profit < I-E
then the tax rate assumed is the PH rate, and the additional tax on min profit is added later on?

Say if the min profits test bites, so min profit > I-E
then the tax rate assumed is the corporation rate, and there is no additional tax on profits to be added in its profits testing?

 

[Mark Willder]

I understand everything up until this part:

"Proprietary with I bigger than E - pays tax on I-E and is subject to the profits test. Prices net/net and allows for the additional tax on profits in its profits test."

When pricing net/net in this case, assuming that the current tax rates do not change for the entire term of the contract being priced, what is the tax rate assumed? Is it the PH rate, or the corporation rate, or some weighted average depending on whether the minimum profits test bite?

The I-E calculation is concerned with policyholder tax (as policyholders do not get tax free investment in BLAGAB products).

The profits test is concerned with shareholder tax (as shareholders of insurers should pay tax on profits just like any other company).

Whether we use gross or net investment return and expenses depends on the I-E calculation. So when I is bigger than E, we price net/net using the policyholder rate of tax.

I am thinking it's something like that:
Say if the min profits test does not bite, so min profit < I-E
then the tax rate assumed is the PH rate, and the additional tax on min profit is added later on?

Yes, we net down I and E at the policyholder rate. We then tax the resulting profits for the excess of the corporation rate over the policyholder rate.

Say if the min profits test bites, so min profit > I-E
then the tax rate assumed is the corporation rate, and there is no additional tax on profits to be added in its profits testing?

As the profits test is bigger than the I-E, then we can just tax the profits at the corporation rate and roll up I and E gross. However, this case is very unlikely to hold for more than a year or two. I is greater than E for savings contracts. Savings contracts will pay out more in claims than was received in premiums. So the profit will be less than the I-E calculation over the term of the policy (recall profit = P - C + I - E - increase in reserves). Hence, for pricing purposes, we can ignore the scenarion where I>E and min profit > I-E.

Best wishes

Mark

 

[bensondros]

Thanks Mark! Great explanation.