Article 207 of the Delegated Regulation2015/35/EUstipulates how insurance undertakings should determine Loss Absorbing Capacity of Deferred Taxes (LAC DT). LAC DT may lower insurers' solvency capital requirements, providing they are able to demonstrate that there are sufficient profits available to utilise the deferred taxes given their financial situation after shock.
If the insurance undertaking takes into account LAC DT in its solvency capital requirement, it demonstrates how LAC DT will reduce its solvency capital requirement. This Q&A discusses the aspects that DNB considers when assessing LAC DT if the insurance undertaking substantiates LAC DT by means of future profits.
LAC DT is basically nil, unless insurance undertakings are able to demonstrate that future profits will be available to utilise the deferred taxes. When doing so the insurance undertaking should also consider the impact of the shock loss on its current and future financial situation. This means that the insurance undertaking should at least have the following available:
- a description of its current and future financial situation, taking account of the impact of the shock loss, and
- a description of how the insurance undertaking plans to generate future profits based on this financial situation.
The shock loss equals the sum of Article 207(1) under a, b, and c of the Delegated Regulation 2015/35/EU. The description of the current and future financial situation and an adequate substantiation of future profits are mandatory if an adjustment of the solvency capital requirement by LAC DT is to be allowed.
1. Insurance undertakings should at least include the following aspects in the description of their financial position post shock loss:
- The insurance undertaking determines whether after the occurrence of the shock loss, it still has sufficient eligible own funds at its disposal to continue complying with the solvency capital requirement appropriate to the balance sheet post shock loss. In this, the insurance undertaking should also take into consideration the limits applicable to Tiers 1, 2 and 3 of its own funds.
- If post shock loss, the insurance undertaking would not comply with the solvency capital requirement appropriate to the balance sheet post shock loss, it explains which measures it plans to take to ensure that it will once again meet the solvency capital requirement within the applicable time period required under Solvency II. Here too, the insurance undertaking takes into consideration the limits applicable to Tiers 1, 2 and 3 of its own funds; after implementation of such measures, the insurance undertaking shows that it has sufficient eligible owns funds at its disposal to comply with the solvency capital requirement.
- If the insurancy undertaking includes recapitalisation in its substantiation as a measure to comply with its capital requirement post shock loss, it should factor in that the likelihood of recapitalisation declines as its solvency position decreases.
2. Insurance undertakings should at least include the following aspects in substantiating future profits:
- The impact on future profits of the changed balance sheet post shock loss as well as the impact of all measures taken to comply with the solvency capital requirement post shock loss.
- In doing so, the insurance undertaking also considers the reduced profit potential post shock loss, also if it is not required to take any measures to comply with the solvency capital requirement post shock.
- The insurance undertaking should also consider the impact of possible risk reducing measures on its earnings’ capability.
- Projections of the full balance sheet and aggregate future (taxable) profits. It it is not sufficient to merely submit a list of potential profit sources as there may be other balance sheet items that could have a negative impact on future profits post shock loss.
- Incorporation of the increasing uncertainty in longer-term profit projections.