EXPLANATORY STATEMENT
STATUTORY RULES 1990 No. 347
ISSUED BY THE AUTHORITY OF THE TREASURER
These regulations will amend the Income Tax Regulations by inserting a new Part 3A. The regulations contained in new Part 3A describe the basis to be used in determining the risk component of a premium received by a life assurance company in respect of a life assurance policy.
The amending regulations are required as a result of amendments to the Income Tax Assessment Act 1936 (the Act) by the Taxation Laws Amendment Act (No. 5) 1989. Those amendments authorised tax deductions for expenditure incurred on or after 1 January 1990 by a life assurance company in gaining the investment component of certain life insurance premium income.
For the purposes of Division 8 - Life Assurance Companies in Part III of the Act, a premium is treated as consisting of two components, a risk and an investment component. The investment component is defined as the premium remaining after deducting the risk component. The risk component of a premium is to be worked out on the basis specified in new Part 3A of the regulations and varies between different types of policies. The policies covered in the regulations include term insurance and unbundled policies as well as traditional whole of life and endowment assurance policies.
Regulation 1 provides for these amending Regulations to come into effect on 1 January 1990. The Regulations are consistent with subsection 48(2) of the Acts Interpretation Act 1901, which provides that regulations shall not be expressed to take effect from a date before the date of notification in any case where the rights of persons existing at the date of notification would be prejudicially affected, or liabilities would be imposed on any person in respect of anything done or omitted to be done before the date of notification.
Regulation 2 facilitates references to the Income Tax Regulations which, in these amending Regulations, are referred to as the “Principal Regulations”.
Regulation 3 inserts a new Part 3A into the Principal Regulations. Part 3A: RISK COMPONENT: LIFE INSURANCE PREMIUM contains new regulations 14A to 14D and details on the regulations are set out below.
Regulation 14A: Interpretation
Regulation 14A gives to the terms “authorised actuary”, “future premiums”, “life assurance policy” and “risk component” as used in new Part 3A the same meaning as in section 110 of the Act.
Regulation 14B: Risk component: term insurance policy
Regulation 14B specifies the risk component of a premium received in respect of a term insurance policy (paragraph(a)) or a rider or supplementary benefit attached to another policy (paragraph (b)). In both situations, as the premium received is in respect of a sum insured which is payable on death within a specified period, the regulation provides that the risk component is the whole premium. This means that there is no investment component in relation to the premium received for the purposes of the Act.
Regulation 14C: Risk component: unbundled life assurance policy
Regulation 14C applies to a premium received in respect of an unbundled life assurance policy. An unbundled life assurance policy is defined by subregulation 14C(2) as being one that is not a term insurance policy and where the premium received consists of an identified mortality charge and investment contribution. The policy expenses can either be included in the mortality charge and investment contribution or be treated separately.
Paragraph 14C(1)(a) specifies the risk component of a premium received under an unbundled life assurance policy where expenses are not included in the mortality charge, as the mortality charge plus so much of the expenses as determined by the authorised actuary as relating to the mortality charge. Paragraph 14C(1)(b) covers a policy where expenses are included in the mortality charge and provides that the risk component of a premium received under such a policy is the mortality charge component of the premium.
Regulation 14D: Risk component: other life assurance policies
Regulation 14D covers a premium received under a life assurance policy other than a term insurance or unbundled life assurance policy. The policies covered by this regulation will mainly be the traditional whole of life or endowment assurance policies. Subregulation 14D(1). details the 6 Steps necessary for the calculation of the risk component of a premium received.
Step 1 involves ascertaining the calculated liability in respect of the policy. The calculated liability is the “valuation of liability” (as defined in subregulation 14D(4) -see later notes) of the policy adjusted according to the rate of compound interest used in the last actuarial investigation. The table in Step 1 provides the adjustments required depending on the rate of compound interest used. For example, if the rate of compound interest used in the last actuarial investigation was 4% or more the calculated liability would be the same as the valuation of liability. If the rate of compound interest used in the last actuarial investigation was less than 3%, the calculated liability for Step 1 purposes would be 85% of the valuation of liability.
Step 2 determines the sum at risk under a policy by deducting from the sum payable on death under the policy (less any amount reinsured), the calculated liability obtained in Step 1. The components in the sum at risk calculation, i.e., the net sum payable on death under the policy, the calculated liability and hence the valuation of liability, are to be worked out immediately preceding the policy cessation for policies which ceased during the year of income and at the end of the year of income for other policies.
Step 3 is necessary in situations where premiums, such as monthly or fortnightly premiums, are received which relate to a period of less than a year. This step, which involves determining a proportion of the risk obtained from Step 2, is necessary so that the period for which the sum at risk component is calculated is consistent with the period in respect of which the premium is received. By way of example, where 12 monthly premiums are received during an income year, the regulations will operate so that the risk component of each monthly premium received is determined.
Step 4 requires a mortality factor ‘q’ to be obtained from the Australian Insured Lives Mortality Table 1964-1970 (“IA 1964-70”). For a life assurance policy where there is only one life insured, the mortality factor is the probability that a person will die in a year loaded by a factor to allow for expenses. The expense loading is necessary as the sum at risk determined in Step 2 will be net of expenses. The factor is also intended to cover situations where a policy is contingent on one or more lives and is therefore to be obtained by reference to the age or ages of the life or lives insured.
Step 5 then determines the risk component by multiplying the sum at risk (Step 2) or the adjusted sum at risk (Step 3) by the mortality factor obtained in Step 4.
The amount obtained in Step 6 is (subject to subregulation 14D(2)) the risk component of the premium. In particular. Step 6 deals with a premium received under a life assurance policy where the life assurance company has reinsured all or part of the mortality risk under the policy. In this situation, the premium received consists of the reinsurance premium, if any, paid and the premium retained by the company to insure the remaining risk. To the extent that part of the premium received is used to reinsure mortality risk under the policy, it is necessary to add that part of the premium to the amount of risk component obtained in Step 5.
Subregulation 14D(2) applies to premiums which are not contracted to be payable in each year of the policy term. The premiums covered by the regulation would include single premiums, premiums received to pay-up a policy and premiums which are received for a limited part of the policy term such as premiums which cease at age 65 years under a whole of life policy. The amount determined under this subregulation will be added to the amount calculated in subregulation 14D(1) to
obtain the risk component of the premium received. Subregulation 140(1) determines the risk component in a year of income for a premium received in that year. For a premium under this subregulation, it is necessary for the authorised actuary to ascertain an appropriate amount of the extra risk component in the premium in respect of future years of income when the policy is still in force but premiums have ceased.
Subregulation 14D(3) provides that in determining the extra risk component under subregulation 14D(2), the authorised actuary shall have regard to the bases, including the mortality rates, set down in subregulation 14D(1).
Subregulation 14D(4) gives meaning to the abbreviation “IA1964-70” and the term “valuation of liability” as used in subregulation 14D(1).
The abbreviation IA1964-70 stands for the Australian Insured Lives Mortality Table. The table reflects the mortality experience of insured lives for the seven years 1964 to 1970 as published by The Institute of Actuaries of Australia and New Zealand. The table contains the value of ‘q’ referred to in Step 4 of the calculation of the risk component of a premium.
The term “valuation of liability” is defined in respect of a life assurance policy and represents the amount required to meet any future claims which may be expected to be made under the policy. In determining this amount, it is to be assumed that it will accumulate at the rate of interest assumed in the last actuarial investigation (paragraph (a)), and future premiums (other than reinsurance premiums) will also accumulate at that rate (paragraph (b)). The definition is similar to the definition of “valuation of liabilities” in subsection 110(1) of the Act except that it is calculated for a single policy only.
“Future premiums” in relation to a life assurance policy are also defined in subsection 110(1) of the Act and mean such premiums, exclusive of office expenses and other charges, as (according to the rates of interest and mortality assumed in the company’s actuarial investigation) are sufficient to provide for the risk incurred by the company in issuing the policy.