The amendments first and foremost aim at refraining insurers from being overly optimistic in setting their assumptions when projecting future taxable profits after an exceptional loss scenario.
Indeed, the new text now explicitly states that new business sales projected for the purposes of the insurer’s business planning after an exceptional loss cannot be more favourable than those used for the business planning on a “going concern” basis.
Additionally, the rates of return on the insurer’s investments following an exceptional loss should be assumed to be equal to the implicit returns of the forward rates derived from the relevant shocked risk-free interest rate term structure obtained after that loss, unless the insurer is able to provide credible evidence of likely returns in excess of those implicit returns for the valuation and utilisation of deferred tax assets.
Both of the aforementioned new requirements are not expected to bring significant changes to the way insurers currently project their future taxable profits, but may contribute to confirming their choices when they have chosen to take a prudent approach.
The amendments also include new provisions in relation to the governance around the setting of assumptions after an exceptional loss. Notably, the involvement of the relevant key functions in selecting and assessing methods and assumptions to demonstrate the amount and recoverability of the loss-absorbing capacity of deferred taxes is now a requirement, as well as a description of how the outcome of that assessment is reported to the Board.
The new text also states that the assessment of the underlying assumptions applied for the projection of future taxable profit and an explanation of any concerns about those assumptions, should be carried out in each case by either the actuarial function or the risk management function.
These new Pillar II requirements are now expected to be incorporated in the risk management policy.
Although these new governance requirements are not impacting the amount of LACDT directly, it is thought by many stakeholders that they are quite restrictive as insurers should be able to define themselves the governance that best suits their organisation.
The amendments also aim at increasing transparency in relation to how the adjustment for LACDT is calculated and its relative importance in the insurer’s Own Funds. As part of the SFCR, insurers will now have to disclose the following in relation to the LACDT:
- the amount with which the SCR has been adjusted for the loss-absorbing capacity of deferred taxes, and a description of the deferred tax liabilities, carry-back and probable future taxable profit used to demonstrate likely utilisation
- where the amount of deferred tax assets is material, a description of the underlying assumptions used for the projection of probable future taxable profit after an exceptional loss.