Under Solvency II, insurers are required to assess the impact of a “1 in 200” shock to their balance sheet own funds to calculate their Solvency Capital Requirement (SCR). If the tax effects of this shock can be taken into account, the SCR may be significantly reduced.
Referred to as the “Loss absorbing capacity of deferred tax” (LACDT), the most common basis on which to recognise such a tax credit in the SCR is a projection of future taxable profits. It is necessary to consider the precise nature of the shock loss and whether it would translate into an immediate tax loss or perhaps a reduction in future profits over time.
The introduction in 2017 of new rules for relieving corporation tax losses, limiting the set off of prior year losses to 50% of current year profits (over a £5m allowance), threatened to make it much more difficult for insurers to recognise LACDT in their SCR. However, these rules are disapplied in the event of a shock loss arising, effectively maintaining the pre-2017 position for SCR purposes only.
Whilst the new flexibility to group relieve prior year tax losses may appear to offer a potential further source of LACDT, the PRA will typically not permit groups to assume any taxable profit capacity other than in the regulated insurance entity.