This week’s article looks at some potential impacts of the new regime on insurance groups.
This is the twentieth in our series of articles looking at some of the detail of the new corporate interest restriction (CIR) rules. Ministers have confirmed that the CIR legislation will be included in a Finance Bill, to be introduced as soon as possible after the summer recess, with the start date continuing to be 1 April 2017. The new rules are intended to replace the existing Worldwide Debt Cap rules from 1 April 2017, from which insurance companies and groups were exempt. By contrast, the new CIR rules will apply to insurance companies and groups. However, special provisions have been included in the CIR rules to address certain issues arising in relation to insurers.
Election to apply an amortised cost basis
Insurance companies typically hold interest bearing instruments to satisfy regulatory capital requirements to match investment asset values with future liabilities. Where debt instruments are accounted for at fair value, any valuation movements will be included in the net tax-interest income or expense for each company. The CIR calculation will thus, almost certainly, be volatile and difficult to predict. Insurance groups had been concerned that financial market volatility would lead to isolated years of net tax-interest expense and restriction despite having a clear long-term net interest income position. To remedy the volatility pitfall, the legislation allows a company to elect to apply an amortised cost accounting treatment - solely for the purposes of calculating its tax-interest for CIR purposes. The election is irrevocable and must be made within twelve months from the end of the accounting period.
While most insurance companies typically chose to account for loan relationships at fair value, they generally have the systems capabilities to model loan relationship accounting on an amortised cost basis. Doing so, however, would have been a significant administrative burden under the normal amortised cost basis prescribed under the relevant accounting standard. This has now been addressed. The draft clauses published on 13 July included a simplification in relation to the derivation of the amount of interest on an amortised cost accounting basis for insurers. Tax-interest (for the purposes of the CIR calculation) will simply be the interest amounts accrued in the company’s records and exclude premiums, discounts, etc. from the accounting credit. In relation to interest originating from collective investments, the tax-interest is the amount that can reasonably be regarded as equating to interest.
These measures ensure that insurance companies’ CIR calculations are relatively unaffected by adverse market value movements on debt instruments and compliance burdens are reduced.
Insurers may acquire interests in non-insurance companies as part of their investment portfolio (in order to receive dividends or sell the shares at a premium at a later date). Although investment income forms part of the trading income of insurance groups, an investment in a non-insurance subsidiary would not form part of the insurance trade for the purposes of CIR.
To avoid interest expenses of non-insurance subsidiaries being sheltered by the interest income from insurance entities, portfolio investments held by insurance companies are not regarded as consolidated subsidiaries for the purposes of calculating the interest restriction, and instead are regarded as forming a separate group.
The position for insurance brokers
The operating model for insurance brokers is generally closer to that of a normal trading company than a traditional insurance company. Brokers are not required to hold the same levels of regulatory capital as insurance companies and typically brokers are heavily geared. As such, the challenges that the proposed interest restriction legislation presents to brokers are similar to those faced by other heavily geared trading companies and groups. We recommend referring to the other articles in the series that touch upon the broader implications of the interest restriction legislation.
The previous articles in this series can be found here.
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