Insurance firms should take fresh look at transfer pricing plans

THE insurance sector is facing significant impact and a number of operational challenges brought on by the global economic crisis resulting from the Covid-19 pandemic. The key challenge comes from higher claims being made for certain classes of business, which is leading to liquidity and capital constraints for insurance companies.

While it is still hard to estimate the final financial impact on the insurance sector, there is consensus among industry experts and analysts that this could be one of the costliest events, with multiple waves of claims across various insurance products as the pandemic unfolds. Lloyd's of London has forecasted that the sector will suffer losses of US$107 billion in 2020 alone.

The one thing that insurance companies should not overlook is how Covid-19 repercussions on businesses and economies can impact their existing and future related-party pricing arrangements. Based on experiences across certain key markets in South-east Asia, it is clear that tax authorities and regulators adopt certain specific approaches in transfer pricing (TP) - analysing the arm's length nature and monitoring cross-border payments of related-party transactions.

Tax authorities in Indonesia, Malaysia, Singapore and Thailand have historically focused on related-party management service fee payments for insurance groups. Where management service fee payments are concerned, the focus has been on the "need test" to evidence that service recipients actually needed such services, and the tangible evidences to demonstrate the benefits received by service recipients.

With respect to reinsurance transactions, it is not uncommon for tax authorities to question and enquire on the commerciality of such transactions, and challenge the comparable transactions used for TP analysis and adjustments, if any.

In Singapore and Indonesia, though the insurance space has not seen significant action as far as TP audits are concerned, regulators play an important part in managing the capital requirements, controlling cross-border payments and enquiring on the levels of risks that should be borne locally. In recent years, it has become a trend for insurance groups to seek advance pricing agreements with tax authorities to ensure certainty on their TP arrangements.

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TP IMPLICATIONS DUE TO COVID-19

In addition to the existing challenges, the Covid-19 pandemic has brought about potential TP implications, including:

These losses will have a direct impact on related party arrangements in terms of increased scrutiny of management service fee charges, reduced return for asset managers and a need to look at fee splits.

Such loans and surplus guarantees may give rise to additional TP compliance in terms of validating interest rates and revisiting thin capitalisation positions. In addition, large losses across reinsurers may lead to stiff market conditions, resulting in higher rates and commissions for future coverage.

South-east Asian insurers who are looking to increase their intra-group reinsurance cession levels or put in place additional contracts to better manage volatility should maintain adequate documentation to support the commerciality of the arrangements, in particular the reasons the new contracts were introduced or for the changes that have been made to the terms, to ensure that the arrangements are commercially supportable.

Additionally, insurance groups should analyse the impact that the current market conditions may have on the pricing of the ceding and profit commissions for proportional reinsurance and the premium costs in case of non-proportional reinsurance.

The working committee of the Organisation for Economic Co-operation and Development (OECD) has taken up the issues of Covid-19's impact on TP and is currently analysing challenges faced by taxpayers.

Hopefully, we will have some direction from OECD in the coming months that help address some of the challenges faced across industries from impact of Covid-19. Notwithstanding this, it is important that insurance companies adopt a proactive planning approach and take a fresh look at TP arrangements, reprice where necessary and develop robust systems to gather internal and external information on the effects of Covid-19 on the business.