United Kingdom

Details

  • Industry: Financial Services, Solvency II
  • Type: Business and industry issue
  • Date: 17/12/2012

The tax opportunity hiding in Solvency II 

There is a lot said about Solvency II and uncertainty - not least on when it will be implemented. Rules have yet to be finalised on several important technical areas that will have material implications for some insurers.


There is, however, a technical area which is applicable to virtually all insurers, is under-debated, has little or no relevant guidance, where regulators potentially lack understanding, but with the potential to reduce capital required by a quarter or more in some jurisdictions. That area is tax.


While this article refers to Solvency II, the same considerations arise for other measures of required capital calculated on an economic basis. For example, given the delay in Solvency II, some insurers are considering whether the work they have done can be applied to the UK’s individual capital assessment (ICA), or the “ICA+” regime which may be a staging post between the ICA and Solvency II.

 

Key points:

  • The most recent technical specifications from EIOPA require tax to be accounted for using IFRS rules. IAS 12 permits the anticipation of future profits that are not on the balance sheet to value deferred tax assets on tax losses. This gives insurers flexibility but also gives uncertainty in respect of how the regulator will view the taxable profits anticipated.
  • The significance and ease with which these items of profit can be estimated will vary from company to company. A considerable range of positions can be taken depending on an insurer's risk appetite and chosen time horizon.
  • Tax modelling needs to have regard to the differences in tax regimes across jurisdictions; but often approximation and simplifications can be justified. For many, the business challenge is evidential, not tax technical.
    Regulators are naturally sceptical of tax adjustments as the value of tax losses is intangible and may not be realised easily. Each firm will need to argue their position individually with their supervisor in the absence of published practical guidance and advice.
    Those responsible for managing a company's capital position should question how tax is being used to reduce the SCR.

 

Conclusion

 

For some companies, tax represents a huge untapped opportunity to reduce the Solvency II (or ICA+) SCR.  For others that have recognised tax benefits but have done inadequate work to support them, there is risk of challenge.

 

The companies that are best placed to manage the tax adjustment to their capital effectively will be those that appreciate that the tax adjustment is not primarily a tax technical matter.  Identifying credible sources of “probable” future profits, assessing the quality of supporting evidence and validating the result are not tax questions. 

 

These companies will have developed metrics and other management information which allow stakeholders to understand the extent to which potential tax adjustments are recognised, including the nature and quality of the evidence supporting each slice.   Boards need to evaluate the risks and rewards associated with different stances.  Tax professionals have a crucial contributory role in informing the debate and in producing supporting analysis, but they should not be left to manage this alone.  

 

What should companies do next?

 

This is a summary of an article on tax within Solvency II, which was first published on 11 December on the InsuranceERM online journal.

 

To see the full article please visit the InsuranceERM website (subscription required).  

 

Alternatively an email copy of the article can be requested from Simon Tomlinson at KPMG.


If you would like to discuss matters raised above please contact Gordon Gray, Simon Tomlinson or your usual KPMG contact.

 

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Contacts

Gordon Gray

Gordon Gray

Senior Manager, FS Tax

 

0131 527 6796

email Gordon

 

Simon Tomlinson

Simon Tomlinson

Manager, FS Tax

 

0117 905 4012

email Simon