Premium taxes shouldn’t be overlooked as pressure mounts for insurers to protect profit margins.
The UK insurance market in recent years has achieved on average a combined ratio of 95%, meaning that for every £100 of premium income written, the insurer makes an underwriting profit of £5.
If you then consider that the standard rate of insurance premium tax (IPT) in the UK is now 12% and the average rate in Europe is above 15% (the standard rate in Germany is 19%, Netherlands 21% and Italy 21.25%), you can immediately see that rates of premium tax are greater than profit margins.
An insurance company writing £500m of premiums across Europe will have a potential exposure to premium tax of £75m (using a 15% average rate of IPT). If everything is done correctly then the exposure is reduced to zero, however small tax errors can quickly impact underwriting profits.
A tax error of say 10%, or £7.5m equates to 30% of the underwriting profit of that insurer in a single financial year. If the error were to go unchecked for a number of years then the financial impact in the year in which it is uncovered could be substantially more, especially if you factor in interest and penalties. Tax authorities’ statute of limitations vary across Europe with four to six years being the norm.
When performance bonuses, stock options and share prices are all dependant on profits, who would want to be in the shoes of the CFO having to report this tax error to the board?