Unbundling on Insurance Contracts for Accounting and Tax Purposes - One Common Solution for Two Problems

Abstract

Insurance contracts often - or even regularly - contain both an insurance component and a so-called deposit component, i.e., they combine insurance coverage with a certain kind of saving process. Due to this feature insurance contracts are difficult to report on in financial statements and difficult tax. The IASB's recent Discussion Paper Preliminary Views on Insurance Contracts (which has also been made part of a FASB's Invitation to Comment) requires an insurer to unbundle those components under certain conditions, since the failure to unbundle could lead to the complete omission of material contractual rights and obligations from the balance sheet. In this regard, unbundling refers to accounting for the deposit component separately from the insurance component as if they were independent contracts. However, the Discussion Paper does not contain any relevant guidelines on how the process of unbundling shall be carried out. Therefore, the proposed regulations pose severe applicability problems. For tax purposes, a workable method of unbundling insurance contracts has eluded tax authorities for decades. However, taxing life assurance premiums containing large deposit components with VAT as a whole would not be appropriate since that would not fit into the VAT system. Therefore, the insurance component and the deposit component have to be separated in order to be able to treat them individually. This principal design innovation is the way of distinction of different deposit components and their classification into different types. Dividing them into implicit and explicit deposit components delivers the theoretically correct results for unbundling of insurance contracts both for accounting and tax purposes.