LAM15330 - Excess expenses, losses and deficits:  Loss reform: shock losses: solvency loss CTA2010/S269ZO and shock loss threshold when company has ring-fenced funds

Where a company has ‘relevant ring-fenced funds’ (RFF), which in the UK will generally mean with-profit funds, Basic own funds (BOF) (see LAM15310) cover both the policyholders’ and shareholders’ share of the surplus of the fund. (CTA10/S269ZP references the definition in the Solvency II regulations.)

Specific rules recognise that different structures of with-profits funds and differing levels of financial strength within them need to be reflected in the calculations of the solvency loss and shock loss threshold. For example, a surplus in one RFF fund may not be available to offset a weaker solvency capital requirement (SCR) position in another fund. The weaker fund may be supported by shareholder funds.

Calculating solvency loss CTA10/S269ZO

Where the insurer has Relevant RFFs the solvency loss is:

  • Adjusted BOF at the end of the 12-month period less
  • Adjusted BOF at the beginning of the 12-month period.

Closing BOF must be calculated on the assumption that the period is a solvency shock period and therefore the loss restriction rules will not apply.

The calculation of the adjusted opening and closing BOF is:

  • total entity BOF (see LAM15310) less
  • ‘surplus’ for each separate Relevant RFF

The ‘surplus’ for each Relevant RFF is the amount of BOF attributable to policyholders. The surplus is zero if there is a deficit. There may be shareholder support arrangements in place in this case. The effect of the rules is that Relevant RFF BOF will be included to the extent that it is in excess of policyholder funds plus future shareholder transfers. In practice this is likely to mean only where BOF is regarded as shareholder BOF (i.e. it represents future shareholder transfers or BOF that arises as a result of conditional support arrangements).

The company’s with-profits actuary must certify that items in the fund arise from conditional support arrangements under CTA10/269ZN(3) and CTA10/269ZO(10)(b) for these to be recognised. Conditional shareholder support arrangements could include, for example, a loan whose repayment is contingent on the emergence of surplus put in place to ensure the SCR is met.

The method of calculation of the solvency loss must fairly represent the method by which the company calculates its SCR. Any variations in BOF which would not be taken into account in the calculation of a company’s SCR (e.g. payment of dividends or issue of capital) are disregarded.

Calculating the shock loss threshold CTA10/S269ZN

Step 1

Calculate the company’s solvency capital requirement (SCR) at the beginning of the period. In that calculation any adjustment for the loss-absorbing capacity of deferred taxes (as defined within the Solvency II directive) is calculated and applied on the assumption that the period is a solvency shock period in relation to the company and therefore loss restriction rules will not apply. The resulting amount is the company’s ‘adjusted SCR’.

Step 2

Calculate the deductible amount for each RFF of the company. The deductible amount for a RFF is the lesser of A and B, where–

  1. A is the amount of BOF within that fund at the beginning of the period (or zero, if greater);

  2. B is the notional SCR for that fund at the beginning of that period.

In calculating A no account is to be taken of the value of future transfers attributable to shareholders and an item within the fund is to be disregarded if the company’s with-profits actuary provides a written opinion confirming that the condition in the legislation (CTA10/S269ZN(4) in relation to conditional support arrangements (see above) apply.

These adjustments act to exclude elements of BOF in which the shareholder has an interest resulting in amount A representing the policyholders’ share of BOF.

Step 3

Deduct the total of the amounts found under step 2 from the company’s adjusted SCR.

This step identifies the amount of the company’s SCR supported by shareholder BOF (i.e. the part of the SCR that is not supported by the policyholder BOF in with-profit funds).

Step 4

Multiply the amount found under step 3 by 90%.

The result is the company’s shock loss threshold for the period.