Tax in Solvency II Ayesha Patel Email: ayesha.patel@uk.pwc.com Tel: 020 7212 1239 June 2014 10 June 2014
Agenda 1 Background 2 The three Pillars 3 Pillar I in detail 4 Survey 5 Summary 6 Questions 2
Background 3
Solvency II Roadmap to 2016 2013 2014 Solvency II Go-Live 2015 2016 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2017 27 Sep: EIOPA s Preparatory Guidelines finalised 13 Nov: Trilogue debate concluded on LTG 25 Nov: European Council published the likely final compromise text of the Omnibus II. BAU activities for Pillar 1, Pillar 2 and Pillar 3 12 Dec: PRA published its Supervisory Statement in response to EIOPA s Preparatory Guide lines 11 Mar: plenary vote on Omnibus II Political and Regulatory activities May 2014: Omnibus II published in Official Journal Member states vote Solvency II into national law before 31 March Supervisors will have power to start granting 2015 internal model approvals from 1 April 2015 Jul Sep: EP+ Council EC draft Adoption of Delegated Acts object Delegated Acts NCAs develop national specific templates. EIOPA consultations and XBRL taxonomy finalised 1 Jan 14: Solvency II Interim Measures effective Systems of governance Forward looking assessment of own risks (FLAOR) based on ORSA principles Draft Regulatory Technical Standards Pre-application for Internal Model Reporting to Supervisors Adoption of Regulatory Technical Standards Deadlines reduce by 2 weeks each year and settle on: Quarterly: 5 weeks after q/e Annual: 14 weeks after y/e Build, implementation and testing phase Dry run on Annual narrative Probable dry run on end 2 Annual narrative and QRT reporting Q3 data and QRT reporting 2015 figures Solo: 18 weeks Pillar 3 SII re-planning: Assess and re-design Solo: 22 weeks Group: 28 weeks Data readiness assessment and cataloguing/ integration for asset dry run/ sourcing (e.g. derivative data) Deploy technology for interim and full reporting covering data warehouse, models, consolidation platforms Solo: 20 weeks Group: 26 weeks 1 Dry run on Q2 Quarterly narrative and QRT data reporting Quarterly narrative and QRT reporting Quarterly narrative and QRT reporting Group: 24 weeks Quarterly narrative and QRT reporting Quarterly narrative and QRT reporting Process alignment: install framework for reconciliations between current reporting basis vs. Solvency II Solo: 8 weeks Group: 14 weeks Last SI reporting Solo: 8 weeks Group: 14 weeks Solo: 7 weeks Group: 13 weeks Solo/Groups: 3 months
The three Pillars 5
The Three Pillars of SII Pillar I Quantitative requirements Calculation of a Solvency Capital Requirement (SCR) Standard formula or internal model Need to ensure insurer able to meet obligations over next 12 months with 99.5% probability Minimum Capital Requirement (MCR) lower level (85%) SCR to be covered by eligible own funds MCR to be covered by basic own funds Pillar II Supervisory review Develop and demonstrate adequate system of governance Appropriate internal organisation and key functions Effective risk management system Prospective risk identification through own risk and solvency assessment (ORSA) Pillar III Disclosure New EEA wide reporting and disclosure requirements (Qualitative Reporting Template - QRT) Private reporting to supervisor (Regular Supervisory Report - RSR) Public reporting (Solvency Financial Condition Report SFCR) 6
Pillar I in detail 7
Proposed framework for Pillar I Ancillary own funds Surplus Basic own funds MCR Solvency Capital Requirement Standard formula or internal model Risk margin Assets covering technical provisions Assets at Market Value (net of other liabilities) Technical Provisions Best estimate liabilities 8
Tax in Pillar I Proposed framework for Pillar I Assets available for SCR/ MCR : net DTA = Tier 3. Tax assets & liabilities valued on IAS 12 basis. DT restated for SII balance sheet values. Basic own funds MCR SCR : loss absorbency of deferred tax Risk margin : SCR based calculation, loss absorbency of deferred tax excluded. Assets covering technical provisions Assets at Market Value (net of other liabilities) Technical Provisions Best estimate liabilities (for life insurers should include tax payments charged to policyholders) 9
Where are the rules? Level 1 directive (2009/138/EC) - gives overall framework / high level principles for Solvency II Level 2 implementing measures - gives detail of the law. Draft Delegated Acts (early 2014) Level 3 guidance consultation by EIOPA Jun 2014 Technical Specification (for preparatory stage) Level 4 enforcement measures PRA Supervisory Statement SS 2/14 10
The basics What do the rules require? Require completion of a base balance sheet on a Solvency II basis Assets & liabilities valued using Solvency II principles. Net position is own funds Base balance sheet is then stressed to calculate the Solvency capital requirement SCR Calculation of the minimum capital requirement MCR Base & stressed balance sheets require Solvency II measure of tax assets & liabilities Key differences from IFRS tax numbers: DT on difference between Tax BS & Solvency II BS IAS 12 vs Solvency II tax rules 11
DT on difference between Tax BS & Solvency II BS Tax balance sheet Solvency II balance sheet Assets 500 Technical provisions (300) Net assets 200 Assets 500 Technical provisions (350) Net assets 150 DTA on additional technical provisions Impact on calculation methodology? Start with IFRS DT & adjust or build up from scratch? Cannot just take tax effect of difference in net assets! 12
Solvency II tax rules - technical standards Rules are broadly similar to IAS 12 The tax base of an asset or liability is as defined in IAS 12 Temporary differences assessed consistently on a single asset/liability basis Take into account the tax regulations specific thereto in the relevant regime In accordance with IAS 12, DT shall not be discounted DT liabilities on subsidiaries etc only if probable will reverse and investor cannot control timing IAS 12 approach to assessing recoverability of DTA s applied Judgements on time horizon of expected DT reversal to be documented, well substantiated & available on request Restrictions on utilisation of tax attributes taken into account (timing & netting) 13
SCR & stress Loss under stress LATP LADT SCR Stresses applied to Solvency II balance sheet to determine SCR modular approach Assets required to cover the worst loss expected to occur in a single year over 200 year period = SCR Assume no management action if instantaneous Mitigating SCR requirement If market losses can be passed onto WP policyholders SCR can be reduced Loss absorbency of technical provisions If tax losses arising from the stress can be relieved (against DTL s or otherwise) SCR can be reduced Loss absorbency of deferred tax But... Where stress gives rise to a net DTA, LADT restricted to the amount of the DTA that could be recognised under Solvency II DT rules! 14
Solvency II rules other areas of interest for tax Technical Provisions Best estimate liabilities include policyholder tax Definition of policyholder tax for these purposes? taxation payments which are charged to policyholders, or which would be required to be made to settle the insurance obligations. Financial liabilities All financial liabilities to be fair valued (eg, current tax) Expected to be the same as current tax per the IFRS balance sheet 15
Other issues Value of tax attributes Net DTA only counts as tier III capital in Own Funds DTA qualifying as tier III capital is capped 1:1 benefit of DTA in SCR calculation Operational Speed of reporting Ensuring consistency of assumptions Group Interaction with other regulatory regimes Granularity of calculations (product, entity, business unit, country) 16
Survey 17
1. Who is primarily responsible for tax in SII in your Group Finance 0% Other 23% Actuarial 31% Tax 46% Slide 18
2. How comfortable are you with your current methodology for calculating tax in SII? Very comfortable 0% Quite comfortable 69% Very uncomfortable 8% Not very comfortable 23% Slide 19
3. Were there any issues in the recent PRA consultation paper which surprised you or are different to your previous understanding? Yes 67% I haven't read it 8% No 25% Slide 20
3. Were there any issues in the recent PRA consultation paper which surprised you or are different to your previous understanding? Statutory accounts unrecognised DTAs why relevant? Risk Margin Stressing noncovered projections: disproportionate & impractical Suggestion that accounting standard treatment is not necessarily the correct answer PRA judgement required Slide 21
4. How do you approach tax in the base balance sheet? 69% 23% Some groups currently considering whether to change this position 8% Bridge from accounts provision (adjust tax balances) Standalone SII tax model Other Slide 22
5. Do you include profits arising on risk margin released in your IAS12 forecasts for DTA recognition purposes? We may need to refine this following the PRA view expressed in the CP Yes 58% They are immaterial to the tax No 42% Slide 23
6. What basis are the projections you use for recognising DTAs in SII? Other 23% Some groups noted that while the starting point for SII tax might be one of these measures, further adjustments are made in the projections. Embedded value SII market consistent models ORSA 0% 8% 15% Business plan 54% Slide 24
7. Do you include items relating to contract boundaries in your IAS 12 profit forecasts? Not currently, but expect to change No 50% Yes 50% They are immaterial to the tax Don t know Slide 25
8. Do you use market consistent or real world assumptions for your SII DTA recovery projections? Other 8% Real world 62% Market Consistent 30% Slide 26
9. Do you include tax when modelling the 1 in 200 stress or do you only fully consider tax in the combined stress? Combined stress 54% Other 8% Modelling 1 in 200 38% Slide 27
Summary 28
Solvency II tax methodology Capital optimisation Design of tax modelling for base balance sheet and stress balance sheet Development of IAS 12 post shock projections Need to create methodology which is resilient to significant change Judgmental aspects Producing projections which are credible based on the insurance company s fact pattern Time horizon of profit projections Can the risk margin effectively be included net? Any risk margin released on liabilities which run off would usually be replaced with risk margin to be provided in respect of new liabilities. Where this is the case, it is not appropriate to include the amount of the current risk margin as an element of future taxable profits in a firm s projections. Source: PRA Supervisory Statement SS2/14 Tax aspects of Solvency II The PRA is publishing this statement now to enable firms to consider the PRA s expectations as part of their planning for SII implementation Source: PRA Supervisory Statement SS2/14 The PRA is now focusing on tax. This potentially material aspect must be actively considered. Alignment of tax risk appetite with other items in Solvency II Tax impacts of changes to the group or capital structure resulting from Solvency II Understanding range of financial outcomes deriving from different tax recognition decisions Solvency II tax approaches may be material in M&A deals Operational considerations Split of accountability between tax and actuarial Need to run calculations regularly Potential need to run calculations outside of the reporting cycle (e.g. part of business planning or M&A) This [PRA s statement] may be particularly important for firms that are developing or amending IT systems affected by deferred tax considerations, whether those developments concern internal models, accounting or other management applications. Source: PRA Supervisory Statement SS2/14
Questions 30
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