Actuarial Notes

Future Income Tax Asset

The Future Income Tax Asset (the CIA's asset for Future Income Taxes related to policy liabilities, shown on the P&C-1 as deferred tax assets) arose, under pre-IFRS 17 Canadian practice, because the tax deduction for a P&C insurer's claim liabilities is smaller than the claim liabilities it carries. Part XIV of the Income Tax Regulations allows 95\% of the lesser of the reported reserve and the claim liability. The asset is the tax prepaid on that difference, and the Appointed Actuary estimated the effect of discounting it. The calculation is off the current syllabus: IFRS 17 leaves income taxes, other than those chargeable to the policyholder, out of the insurance liability.

\text{Effect} = \big[\text{RR} - 0.95\min(\text{RR},\ \text{CL})\big] \times t \times (1 - \text{PVF})

\text{PVF} = \frac{\text{Discounted estimate excl. PfADs} + \text{PfAD}_{\text{IR}}}{\text{Undiscounted estimate}}

  • The symbols. The definitions follow the CIA's 2005 educational note, Consideration of Future Income Taxes in the Valuation of Policy Liabilities, which cites Regulation 1408 for the first two:
    • \text{RR}, the reported reserve, is the net claim liabilities carried in the balance sheet.
    • \text{CL}, the claim liability, is the net claim liabilities under accepted actuarial practice, meaning discounted and including the explicit PfADs.
    • Both are net of reinsurance recoverable and of salvage and subrogation recoverable.
    • t is the future income tax rate.
    • \text{PVF} reflects the time value of money at the selected rate of return net of the investment-return margin, which is why the investment-return PfAD, \text{PfAD}_{\text{IR}}, sits in its numerator. The ratio above is the note's approximation from the actuary's estimates; given a payout pattern instead, discount it at the rate less that MfAD.
  • The first two factors are the asset itself: the carried reserve less the deductible amount, times the tax rate. This is the "future tax temporary difference", a prepayment of tax. The last factor turns the asset into the effect of discounting it. The income-statement effect is the change in that balance-sheet effect from one year to the next.
  • Usually immaterial, and the note said so. It anticipated that "in most cases the effect of discounting the asset for Future Income Taxes would not be material". The formula was offered as a reasonable approximation for checking that assumption. Its worked example came to 0.10\% of the actuary's estimate. The effect grows with the discount rate, the length of the payout and any excess of the reported reserve over the claim liability, reaching about 1\% in the note's most extreme case. Where it is material, the note has the actuary reflect it in the estimate of the policy liabilities. Materiality turns on whether the error would change a user's conclusion or course of action.
  • Scope. The note covers the part of the asset tied to claim liabilities. A part tied to premium liabilities is handled the same way, and future tax items unrelated to policy liabilities fall outside the actuary's valuation.
  • Where candidates lost marks, per the examiner's reports:
    • Leaving the interest-rate PfAD out of the PVF numerator.
    • Skipping the \min.
    • Using gross figures. The unpaid claims on page 20.20 of the Annual Return are gross, so the net reported reserve is that amount less reinsurance and salvage and subrogation recoverables.
    • Using 1 - t instead of t.
    • Defining the asset as arising when the tax deduction exceeds the carried liability.
  • What replaced it. IFRS 17, in force in Canada from January 1, 2023, excludes income taxes from the fulfilment cash flows, apart from those specifically chargeable to the policyholder. The former CIA standards required consideration of all future income taxes. The tax rule itself survives: section 1400(3) of the Income Tax Regulations, rewritten in IFRS 17 terms, still applies a factor of 0.95 to the liability for incurred claims other than structured settlements.

When the Reported Reserve Exceeds the Actuary's Estimate The Appointed Actuary's net claim estimates ($000s) are:

Item Amount
Undiscounted estimate 250,000
Discounted estimate excluding PfADs 232,000
PfAD – investment return rate 1,600
PfAD – claims development 17,400
PfAD – reinsurance recovery 1,000

The reported reserve is 262{,}000 and the future income tax rate is 26\%. Calculate the estimated effect of discounting the asset for future income taxes, as an amount and as a percentage of the claim liability.

Answer

\begin{align*}
\text{CL} &= 232{,}000 + 1{,}600 + 17{,}400 + 1{,}000 \\
&= 252{,}000 \\
\text{PVF} &= \frac{232{,}000 + 1{,}600}{250{,}000} \\
&= 0.9344
\end{align*}

The claim liability is below the reported reserve, so the \min picks 252{,}000:

\begin{align*}
\text{Effect} &= (262{,}000 - 0.95 \times 252{,}000)(0.26)(1 - 0.9344) \\
&= (22{,}600)(0.26)(0.0656) \\
&= 385.5
\end{align*}

That is 385.5 / 252{,}000 = 0.15\% of the claim liability.

Why the excess matters. Had the insurer carried exactly the actuary's 252{,}000, the bracket would be 0.05 \times 252{,}000 = 12{,}600 and the effect 214.9, or 0.09\%. The deduction stops at 95\% of the claim liability, so every dollar carried above the actuary's estimate is non-deductible and enlarges the asset.

Working from the Annual Return Page 20.20 of an insurer's Annual Return shows unpaid claims and adjustment expenses of 90{,}000 ($000s). Page 20.10 shows 24{,}000 recoverable from reinsurers on unpaid claims and 1{,}500 of salvage and subrogation recoverable. The actuary's net claim liability, discounted with PfADs, is 62{,}800.

The net unpaid claims pay out 55\%, 30\% and 15\% over the next three years, at mid-year. The discount rate is 4\% with an investment-return MfAD of 0.5\%, and the future income tax rate is 27\%. Calculate the estimated effect of discounting the asset for future income taxes.

Answer Net the reported reserve down, since page 20.20 is gross:

\begin{align*}
\text{RR} &= 90{,}000 - 24{,}000 - 1{,}500 \\
&= 64{,}500
\end{align*}

Present value factor, at the discount rate net of the MfAD, 3.5\%:

\begin{align*}
\text{PVF} &= 0.55(1.035)^{-0.5} + 0.30(1.035)^{-1.5} + 0.15(1.035)^{-2.5} \\
&= 0.5406 + 0.2849 + 0.1376 \\
&= 0.9632
\end{align*}

Effect, with \min(64{,}500,\ 62{,}800) = 62{,}800:

\begin{align*}
\text{Effect} &= (64{,}500 - 0.95 \times 62{,}800)(0.27)(1 - 0.9632) \\
&= (4{,}840)(0.27)(0.0368) \\
&= 48.1
\end{align*}

That is under 0.1\% of the claim liability: a short payout and a low discount rate leave little to discount, the note's typical immaterial case.