New taxes in Budget 2022 could dent insurers’ near-term profitability: Fitch

• One-off surcharge tax has limited impact on insurers, given Rs.2.0bn taxable income threshold 
• Social Security Contribution to compress near-term margins before insurers start passing it down to policyholders 
• Unclear whether insurers become liable under elevated VAT on financial services 
• Proposed fee on vehicles meet with accidents could be priced into policies 
• Insurers operate with sound capital buffers to withstand near-term pressures 

Insurance companies could see some near-term pressure on their top lines and thereby their earnings, from the proposed new taxes on the corporates in Budget 2022 but they are unlikely to hurt their capitalisation levels, which strengthened during the pandemic, according to Fitch Ratings. 

Sri Lanka’s insurance companies emerged stronger with growth in their premium incomes, profits and risk-based capital levels during the pandemic, as people sought more life protection necessitated by the heightened health-related concerns sparked by the virus outbreak, last year, decline in motor and medical insurance claims during lockdowns and the regulatory intervention in halting dividends last year, which strengthened the capital levels by way of retention of profits. 

“The Sri Lankan government’s proposal to introduce new one-off as well as recurring taxes on companies will likely constrain the near-term profitability of some insurers,” Fitch Ratings said in a note assessing the impact of the budget on the sector. 

“However, we expect the proposals to have only a limited impact on most insurers’ capital positions because of their sound capital buffers accumulated before and during the COVID-19-led lockdowns in the country,” the rating agency added. 

Budget 2022 proposed to slap companies and individuals with several one-time taxes, with the most contentious one being the 25 percent surcharge tax charged on the profits of the firms and individuals, with a taxable income exceeding Rs.2.0 billion for the financial year ended in 2020/21, 

as the government decided to go after some of the deep pocketed ones to refill its shallow coffers, without burdening the public. 

While there are only two Fitch-rated insurance companies – Sri Lanka Insurance Corporation and potentially National Insurance Trust Fund Board, which could be subject to this tax, as the others rated by Fitch fall below the profit threshold liable for the tax, some insurers, which are part of a group, could fall victim, if the government decides to calculate the tax on the consolidated taxable income. 

Nevertheless, the proposed 2.5 percent Social Security Contribution, which has the style of a turnover tax for firms whose annual turnover exceeds Rs.120 million, could dent the margins of the insurers in the near term before they start gradually passing it down to the policyholders through pricing. 

Meanwhile, Fitch said it remains unclear if the industry would become liable for the Value Added Tax (VAT) on financial services, which was raised by 3 percent to 18 percent, as most insures had previously appealed against the VAT on financial services, citing the VAT Act, which doesn’t specify insurance companies as liable. 

“If imposed, the impact of this tax on near-term profit margins will be more pronounced as companies are not allowed to pass the increase in the VAT to customers,” Fitch added.

Meanwhile, seeking more clarity on the budget proposal to impose a fine in the style of penalty for those who meet with accidents, which can then be reimbursed from the insurance company, the rating agency said this would require changes to the policy terms, as penalty charges or fines are generally excluded from motor insurance policy coverage. 

In any case, it believes the insurers will likely price in this fee as an additional risk in their motor policies.  
While maintaining that the current ban on vehicle imports to remain at least in part over the near term, Fitch expects some influx of vehicles of new motor vehicles into the market, following the government’s decision to release vehicles that are currently held in Customs, due to non-payment of taxes. 

However, Fitch does not expect this to “result in a material recovery in motor insurance policy volumes” and therefore, “most insurers are likely to continue to seek opportunities to diversify their products into non-motor insurance lines”, it added.