Meaning and basic concepts of Insurance
General Meaning and Concepts: Insurance means a promise of compensation for specific potential
future losses in exchange for a periodic payment. Insurance is designed to
protect the financial well-being of an individual, company or other entity in
the case of unexpected loss. Some forms of insurance are required by law, while
others are optional. Agreeing to the terms of an insurance policy creates a
contract between the insured (the person, group, or property for which an
insurance policy is issued.) and the insurer (the party to an insurance
arrangement who undertakes to indemnify for losses). In exchange for payments
from the insured (called premiums), the insurer agrees to pay the policy holder
a sum of money upon the occurrence of the specified event.
Insurance Meaning and Concepts Provided by the ITA, 2004
The ITA does not provide a meaning of the word insurance; it is
presumed that the word has the meaning as used in the general sense. However it
gives us a meaning of insurance business as a business of an insurer in
effecting, issuing and carrying out insurance. This meaning is provided by S.3
of the Act.
Categories of insurance business
In
general usage insurance business can be categorized in several groups
including Auto Insurance; Home Insurance; Health Insurance; Accident, Sickness,
and Un-employment Insurance; Property insurance; Liability Insurance; Credit
Insurance; and several others. But the ITA gives us only two categories of
insurance businesses and these are life insurance business and general
insurance business.
Life Insurance Business (S. 59 & S. 3)
Life insurance means insurance to be paid to the beneficiary when
the insured dies. Life insurance provides a monetary benefit to a descendant’s
family or other designated beneficiary, and may specifically provide for income
to an insured person’s family, burial, funeral and other expenses. Life
Insurance policies often allow the option of leaving the proceeds paid to the
beneficiary either in a lump-sum cash payment or an annuity. Annuities provide
a stream of payments and are generally classified as insurance because they are
issued by insurance companies, are regulated as insurance, and require the same
kinds of actuarial and investment management expertise that life insurance requires.
But the ITA refers to life insurance as insurance of any of the
following classes:
Insurance where the specified event is the insured or an associate
of the insured;
Insurance where:-
the specified event is an individual who is the insured or an
associate of the insured sustaining personal injury or becoming incapacitated;
and the insurance agreement is expressed to be in effect for at least
five years or without limit of time and is not terminable by the insurer before
the expiry of five years except in circumstances prescribed by the regulations;
Insurance under which an amount or series of amounts is to become
payable to the insured in the future; and
Re-insurance of insurance referred to under paragraphs (a) to (c).
Life insurance business means a business of an insurer in
effecting, issuing and carrying out life insurance.
Taxation Principles [S. 59(1)]
All activities of a person that are carried in conducting life
insurance business are required to be treated as a business separate from any
other activity of the person and the person’s income or loss for any year of
income shall be calculated separately. That is to say, if you conduct general
insurance business, life insurance business or any other type of business, you
must calculate your income for the general insurance business, the life
insurance business and the other business separately.
Computation of Income from Life Insurance Business
You should not include in your income any premiums you receive as
insurer or re-insurer or any proceeds from reinsurance where you had to pay out
and make a claim of the re-insurance.
You may deduct ordinary business expenses and commissions.
However, you should not deduct expenditure on proceeds you pay out as insurer
or re-insurer, or premiums paid to re-insurers where you take out re-insurance.
Proceeds of an insured person from life insurance issued by a
resident insurer are exempt in the hands of the insured. Proceeds from life
insurance from a non-resident insurer are not exempt and are included in the
investment income of the insured.
General Insurance Business (S. 58 & S. 3)
General insurance business is not defined in the Income Tax Act,
however the Act refers to general insurance business as any insurance business
that is not life insurance business.
Taxation Principles [S. 58(1)]
All activities of a person that are carried in conducting a
general insurance business are required to be treated as a business separate
from any other activity of the person and the person’s income or loss for any
year of income shall be calculated separately. That is to say, if you conduct
general insurance business, life insurance business or any other type of
business, you must calculate your income for the general insurance business,
the life insurance business and the other business separately.
Computation of Income from a General Insurance Business
You include in your income:
- Premiums received as an insurer or re-insurer
- Any proceeds from re-insurance where you had to pay out and make a
claim of the re-insurance
You deduct from your income
- Expenditure on proceeds you pay out as insurer or re-insurer
- Any premiums paid to re-insurers where you take out re-insurance
Otherwise you should calculate your general insurance business
income as any other business.
Principles guiding determination of proceeds from insurance (S.
60)
Proceeds derived from insurance are normally derived in the form
of compensation/indemnification. Taxation principles related to compensation
are provided by S. 31. According to this section, where a person or an
associate of the person derives compensation amounts, the compensation amount
shall be included in calculating income of the person and takes its character
from the amount compensated for.
For instance, XYZ Company insured its stock in warehouse against
theft. On occurrence of the event of theft, XYZ Company will write off stock by
that amount. This will reduce the profit stated by the company. But if the
insurer is satisfied and compensates for the loss, then XYZ Company has to
disclose the amount compensated as part of the realized stock.
But sometimes the insured can obtain a gain from insurance. The
gain is the extent to which proceeds from life insurance paid by an insurer
exceed premiums paid to the insurer with respect to the insurance.
Whenever such a gain happen:-
- In the case where the proceeds are paid by a resident insurer,
they are exempt in the hands of the insured; and
- In the case where the proceeds are paid by a non-resident insurer,
included in calculating the income of the insured.