The Central Bank is understood to have finalised its new rules regarding the treatment for solvency purposes of the Italian tax asset held by most companies that sell into the Italian market. While full details are not yet available the new rules will disallow the use of the tax asset to back the minimum solvency margin and technical reserves held in respect of liabilities due within twelve months. This will have a significant impact for at least some of these companies.
The Italian tax asset arises due to the way Italy taxes gains on policies. Essentially policies in Italy are taxed at exit on the gains achieved at a rate that recently increased to 26 per cent (except for a ‘white’ list of investments, mainly government bonds, where gains are taxed at 12.5 per cent). However, because of the delay in getting this tax the Italian authorities some years ago came up with the idea of requiring companies collecting the tax on behalf of policyholders to pay in advance each year an amount which became 35 basis points of total technical reserves. This amount can be offset after five years against the gains tax then due and indeed against any tax then due to the Italian authorities, including corporation and payroll taxes. As further security some Italian parent companies guarantee the refund to their Irish subsidiaries. This means that in most cases the advance tax can be regarded as repayable after five years and hence can be treated as an asset. The CB examined the issue in 2009 and issued guidelines on how the asset should be valued and requiring that it be discounted to reflect the term to recovery.
However, following the increase in the advance tax rate to 45 bps in 2013 (having temporarily increased to 50bps in 2012) and the substantial growth in the tax asset in some companies, especially those that are expanding, the CB decided to revisit the issue again. The main concern seems to be the liquidity of the Asset and its availability in a crisis. For this reason they have now, after some months of deliberation and consultation with industry bodies, decided on putting restrictions on how it may be used in solvency calculations. Some observers expressed surprise that the CB was introducing new Solvency I regulations on the eve of the new Solvency II regime. However, I understand that the new rules will also include some Solvency II type requirements e.g. that Boards consider the liquidity and concentration risk in their FLAORs and Risk Appetite Statements.
As someone with an involvement in the Italian life market, I would be concerned that the new rules may affect the competitiveness of the Irish companies in that market, particularly against Italian and Luxembourg based companies. The Italian market is now the largest segment of the Irish life assurance industry accounting for an estimated €10.2 billion in new premiums in 2013 or 54 per cent of the total cross border market. The new rules will come into effect on 30th September but there may be transitional arrangements for firms affected. It will be interesting to see if companies can come up with arrangements (perhaps through reassurance) to convert their Italian tax assets into a form that can satisfy concerns about liquidity and concentration.
This article appeared in the July 2014 issue of Finance Dublin.