Solvency Capital and Reported Profits

[Studystuff]

Hi,


I was hoping someone may able to clear up some confusion I’ve ran into.


In CP1/SP2 we learned about pricing/profit tests in which we projected cash flows associated with a contract. Within this we included the need to establish supervisory reserves (not accounting reserves) and SCR. This makes sense to me as it is a proper cash flow associated with a contract and hence will delay profit emergence.


However, studying the taxation chapters of SA2 got me thinking about how we determine our reported profit figures for published accounts and for how we calculation of tax. Ive picked up in SA2 that aloud accounting profit is calculated using the accounting basis which will not have relevance to SCRs. So profit is just change in assets - liabilities (which don’t include scrs). Does this mean that there is an inconsistency between the accounting profits an insurance company reports and the actual profits an insurer makes in a period ?


for example. Imagine at time zero a company has Assets = 100 (on both SII and accounting basis)

Liabs/technical provisions = 50 (on both SII and accounting basis)

SCR = 50


at time 1

Assets = 100

Liabs = 30

SCR = 70 (imagine this increased cause of changes in standard formula)


This company would have generated 20 in “profit” in its published accounts.. however this needs to be held against solvency capital. Could this put pressure on insurers to give dividends even though it’s not possible as they need to be held against the SCR ?


This has been causing me great confusion so I would really appreciate some help! Thank you

 

[Studystuff]

And connected to the above. Is there essentially a difference between reported profit and an insurers actual profit? (Taking actual profit as what we project during profit tests)

 

[VishalKumar]

Hi,
I have the following understanding re this, but someone could validate the same.
Adjusted net worth (ANW)= free surplus (FS)+ SCR, ANW belongs to the shareholders account. So if there is a increase in SCR than it will give a hit to shareholders. FS is something transfer fully to Shareholders at the end as a dividend and FS doesn’t have any regulatory bindings.
Value of Inforce (VIF) = present value of future profits( PVFP) - Cost of capital(CoC) - TVOG; now decrease in BEL will increase the PVFP component and hence also the VIF. This will be transferred to Shareholders as and when they are realised.
This way we see that both the decrease in BEL or increase in SCR will impact the Shareholders.

 

[Em Francis]

Hi
This is going beyond what you would need to know for SA2....

However, you are right, there is no IFRS 17 equivalent to the SCR. However, there is the CSM which restricts profit being released to the P&L, which doesn't exist within the SII balance sheet. And like the SCR runs off over time.

So in your example below, at time zero there would be a CSM of '50' (ignoring acquisition costs which are another example of this profit deferral) which (similar to the SCR) would be expected to be released over time. So at time one you may expect a profit release going into the P&L. However, there have been assumption changes which may actually increase the CSM further (which it has done for the SCR) which would defer this time one profit release.

However, be careful not to compare SCR and CSM directly as they have different objectives. And remember the Regulator is interested in the SII BS and the shareholder will be informed of this within the IFRS statements. There is a note in the accounts on 'Risk and capital management' which shows a breakdown of the total regulatory capital, ie share premium, retained earnings etc and a note to say that 'the company is required by the regulator to hold an excess of its assets over its insurance contract liabilities calculated on a regulatory basis to ensure that the company is able to meet its obligations over the next 12 months at a 99.5% confidence level....'


Hope this helps.

Hi,


I was hoping someone may able to clear up some confusion I’ve ran into.


In CP1/SP2 we learned about pricing/profit tests in which we projected cash flows associated with a contract. Within this we included the need to establish supervisory reserves (not accounting reserves) and SCR. This makes sense to me as it is a proper cash flow associated with a contract and hence will delay profit emergence.


However, studying the taxation chapters of SA2 got me thinking about how we determine our reported profit figures for published accounts and for how we calculation of tax. Ive picked up in SA2 that aloud accounting profit is calculated using the accounting basis which will not have relevance to SCRs. So profit is just change in assets - liabilities (which don’t include scrs). Does this mean that there is an inconsistency between the accounting profits an insurance company reports and the actual profits an insurer makes in a period ?


for example. Imagine at time zero a company has Assets = 100 (on both SII and accounting basis)

Liabs/technical provisions = 50 (on both SII and accounting basis)

SCR = 50


at time 1

Assets = 100

Liabs = 30

SCR = 70 (imagine this increased cause of changes in standard formula)


This company would have generated 20 in “profit” in its published accounts.. however this needs to be held against solvency capital. Could this put pressure on insurers to give dividends even though it’s not possible as they need to be held against the SCR ?


This has been causing me great confusion so I would really appreciate some help! Thank you

 

[Studystuff]

Cheers Em Francis!

It sounds like the CSM could get us closer to the numbers being closer. However in general, is it fair to say that the “accounting profit” doesn’t actually equal the the true profit that can be released to shareholders, Due to the existence of the SCRs? However I do now see due the the CSR the difference between these two amounts shouldn’t be as big as I believed

 

[Em Francis]

Cheers Em Francis!

It sounds like the CSM could get us closer to the numbers being closer. However in general, is it fair to say that the “accounting profit” doesn’t actually equal the the true profit that can be released to shareholders, Due to the existence of the SCRs? However I do now see due the the CSR the difference between these two amounts shouldn’t be as big as I believed

I think the following might help:

Remember that the Balance Sheet is a snap shot in time whereas the P&L looks at the profit over the year.
Also, the CSM is calculated at inception per product group as day one profit, whereas the SCR is on the total balance sheet.

The CSM sits on the Balance sheet and released over time as and when insurance services are provided (under insurance revenue), to the P&L. Shareholders will be interested in this release. However the Regulator will be interested in the build up of this revenue as retained earnings which, along with other reserves and ordinary share capital, sub debt, sit on the Balance Sheet as part of the company's capital. The total CSM will not be part of this capital.

In answer to your question: 'is it fair to say that the “accounting profit” doesn’t actually equal the the true profit that can be released to shareholders, due to the existence of the SCRs?"
The SCR will not have an impact on the profit release to the P&L and will only have an impact on the dividend release due to the regulatory requirement. However for most companies this is a small part of total retained earnings.
As I have mentioned above shareholders will be made aware, in the notes to the accounts, that there is this regulatory requirement that the capital needs to be enough to cover the Solvency II requirements.