How insurers map today’s businesses to the 18 classes of insurance

By  Elliot Shulver, Manager of IPT Compliance, Sovos 

First, a primer to set the scene. There are 18 classes of insurance for non-life insurance and these were introduced by the EU in 1973.

Applicable to all Member States, these classes cover everything from goods in transit, legal expenses, and credit. Insurance policies must be assigned to one of these classes, each with its own clauses and tax filing requirements.

The 18 classes exist to provide clear definitions for each type of insurance and the appropriate tax as well as ease cross-border business and risk management. Through the classes, insurers and underwriters can correctly calculate the correct tax owed and to which Member State.

Even with these defined categories, knowing how to classify the risk accurately can prove complicated, especially as every country sets its own rules for each class and the corresponding tax rate.

Should there be more than 18 classes of insurance?

An issue is that although the 18 classes appear comprehensive, in recent years a wealth of new risks have emerged since their last update and it’s not always immediately obvious as to which category a risk should be filed under.

In many cases, the insurer or underwriter is responsible for classifying the risk to ensure the correct taxes are paid to the correct jurisdiction – this is known as determining the location of risk. This becomes increasingly complicated when a policy applies to multiple assets in multiple locations as depending on the class in question, taxes could be due to different Member States.

Incorrect tax remediation can significantly cost a company, and there have been high profile EU court cases when taxes have not been paid in the correct jurisdiction. It is therefore important that the correct class is applied to each risk to avoid investigation by the European Commission.

Although this is by no means an exhaustive list, below are some examples of newer products and how insurers and tax auditors are attempting to categorise these new offerings.

Cyber insurance

A recent survey revealed that 46% of UK businesses have suffered cyber security breaches in the last twelve months (Gov.uk). With the banking and finance industries holding highly sensitive customer data and GDPR enforcing significant fines for data breaches, cyber insurance is becoming an increasingly prevalent policy.

Depending on the level of coverage, cyber insurance can include coverage for any direct financial costs from an event, the cost of data recovery, reputational damage, and legal fees for GDPR fines. Cyber insurance is not explicitly included under any of the 18 classes and isn’t currently written into any legislation. Due to the range of coverage, it can fit under more than one category, making it particularly difficult to manage from a tax perspective.

Financial interest clause

The financial interest clause is most often used by companies that operate across multiple countries, and it is a clause that is inserted into a global policy.

For example, this policy may cover properties all over the world and as such, local taxes would most likely be due. To avoid this, the financial interest clause insures the balance sheet of the policyholder instead of the properties themselves, which means taxes are only due in the policyholder’s jurisdiction.

This clause is most likely to come under category 16, miscellaneous financial losses but as there is no hard and fast rule, it’s a case by case basis.

Index linked products

Index linking ensures properties are not under-insured by calculating the difference between the rebuild value and the sum insured. The rebuild value is the cost of the total value to rebuild the property if it were lost and the sum insured takes into account inflation during an insurance year, in addition to the rebuild value.

Policy indexing eliminates having to re-value the property every year as the sum insured takes into account the variables of the rebuild cost (e.g. the changing costs of materials). However, it’s important the policy has the correct rebuild value when it is taken out to ensure the index is accurate.

Depending on the property and the ownership, this insurance can come under a few different classes.

Assigning and filing tax correctly

Assigning the correct class to each product is complicated to say the least.

Eventually the insurance industry will catch-up with these newer risks, but it’s likely to take some time as process, systems and legal frameworks are put into place.

Incorrect tax filing can cause significant financial and reputational loss so it’s important that insurers and tax auditors are aware of the latest classification updates, in each jurisdiction, to prevent under or over filing.

In the financial industry more than most, compliance to the latest regulations is paramount and a hefty tax fine is unwelcome.

Offering these newer products is essential to match customer demands, but it’s vital that when responding quickly to add these new products to a portfolio that the correct tax is not overlooked nor mis-assigned.