Life insurers ‘surprised and disappointed’ with Budget 2022 provision

If you sign a multi-year contract that is expected to deliver a profit three, five or 20 years later, should you pay the tax up front?

Canadian life insurers could be faced with this predicament if legislation proposed in Budget 2022 is passed into law, the Canadian Life and Health Insurance Association (CLHIA) suggests.

International Financial Reporting Standard 17 will “substantially change the financial reporting for Canadian insurers” as of Jan. 1, 2023, the Department of Finance said in the 2022-23 budget released April 7.

A key IFRS 17 accounting concept is contractual service margin (CSM).

The basic concept of CSM is to try to predict the exact profit the insurer will make over the life of a contract, said Daniel Singer, past president of the Canadian Insurance Accountants Association and chair of its 2022 conference.

“Budget 2022 proposes legislative amendments to confirm support of the use of IFRS 17 accounting standards for income tax purposes, with the exception of a new reserve known as the contractual service margin, subject to some modifications. Without this exception, profits embedded in the new reserve would be deferred for income tax purposes,” the 2022 budget said.

“We were surprised and disappointed with the direction,” said Stephen Frank, CEO of CLHIA.

In 2021, the federal government noted IFRS 17’s CSM would allow insurers to defer the recognition of profits until years following the taxation year in which income-earning activities occurred. With the Budget 2022 proposal, the Liberals want to recognize profits in the year in which the activity actually occurred.

The upshot is insurers would have to pay some income taxes earlier than they otherwise would have, Frank said, adding that many insurers have contracts that can last 10, 15 or 20 years.

“In any business (other than insurance), you take profit when you’ve delivered the services. You don’t take the profit as soon as you sign the contract. So if someone buys a cellphone with a three-year plan, the cell phone company has to wait until that contract is finished to book that profit. They don’t book it up front to pay [corporate income] tax on it,” Frank said.

Paul Vienneau, partner, corporate tax (financial institutions) with KPMG Canada, gave a hypothetical example of an insurance contract on which the insurer expects to make a profit of $1,000. For a given tax rate, the total tax paid is the same.

“The profits are the profits,” Vienneau said. “So it’s potentially just a question of timing.”

But, as Singer pointed out, “with inflation right now, it’s more expensive if you have to pay [corporate income tax] earlier.”

The federal government estimated the proposed measure will increase federal revenues by $2.35 billion over the next five years.

“That $2.35 billion is the federal portion. There will be provincial tax layering on top of that. It’s likely to be quite significant too,” Frank said. “This [change] will have quite a significant impact for the industry next year.”

The accounting rules insurers have been using is IFRS 4, Vienneau said, adding that the new IFRS 17 standard also changes how insurers measure income from contracts.

“What IFRS 17 does, is says, ‘If you’re going to make profits from this contract, you have to amortize it over the length of the contract.’ So the insurance company basically provides services to the insured for 10 years. So therefore, the income should be earned over that period where the services are rendered by the insurer,” Vienneau said.

The exact impact of the Budget 2022 proposal remains to be seen.

“The legislation is still to come. So once we have the legislation, I think it will be a lot easier to analyze,” Vienneau said.

Experts told Advisor’s Edge that the proposal will mainly affect life insurers, but that property & casualty carriers with multi-year contracts could also be affected.