On 25 October 2016, HM Treasury published a consultation paper seeking views on proposed changes to the legal definition of life insurers’ distributable profits under Part 23 of the Companies Act 2006 (CA 2006) following changes introduced by the implementation of the Solvency II Directive on 1 January 2016.

Segregation of life and non-life business

Solvency II requires insurers to segregate life and non-life business. Previously, firms were able to maintain life funds within a ‘long-term fund’. A change in the PRA Rulebook following the introduction of Solvency II meant that the ‘long-term fund’ concept, as referenced by section 843 CA 2006 is no longer used for firms within the scope of Solvency II.

HM Treasury has developed an alternative approach, to ensure that firms only make distributions out of realised profits and drawing on the Solvency II regulatory framework. It is proposed that this new methodology is contained within a new section 843A within Part 23 of the CA 2006. Minor changes are also proposed to sections 830, 843 and 853 of the CA 2006 as a consequence of the introduction of section 843A.

New approach

The general rule is that the amount available for distribution equals accumulated realised profits less accumulated realised losses. HM Treasury states that the first step in its proposed approach is to begin with an insurance firm’s assets and then deduct the firm’s liabilities. The Solvency II framework contains detailed rules on how the assets and liabilities of a life insurer or reinsurer should be identified and valued.

A firm’s assets and liabilities should continue to be identified and valued in accordance with the Solvency II rules, however, there are certain assets which cannot reasonably be considered distributable – these are referred to as ‘relevant deductions’. These relevant deductions relate to regulatory restrictions (eg ring fenced-funds and matching adjustment portfolio surpluses); the inherently non-distributable nature of assets (eg assets represented by the surplus in a defined-benefit pension scheme); and the way realised profits can be determined from the valuation methodologies used in Solvency II (eg in the valuation of undertakings).

As a result, the second step in HM Treasury’s proposed approach is to deduct the value of these assets from the excess of assets over liabilities: the result will be the amount of profit which the firm may distribute to shareholders.

New CA 2006 provisions

In the consultation paper, HM Treasury proposes that this new methodology will be contained within a new section 843A CA 2006 (Distributable profits for long-term insurance business: Solvency II firms). It also proposes making the following minor changes to sections 830, 843 and 853 CA 2006:

  • Section 843A (Distributable profits for long-term insurance business: Solvency II firms). This section of the proposed regulations lays out the new process by which Solvency II firms that undertake long-term insurance business (ie life firms) will calculate their distributable profits. The provisions are intended to capture insurers and reinsurers authorised under Solvency II (including composites). As previously stated, the basic rule for distributable profits in section 830 of the CA 2006 is subject to the new provision for Solvency II firms carrying out long-term business. In line with this, the new rule disapplies the general rule on distributable profits set out in section 830 of the CA 2006.

    Section 834A(4) sets out the new rule, which is that the assets of the insurer or reinsurer are taken and liabilities and then certain other items are deducted – the ‘relevant deductions’. Firms will need to determine whether they can easily distinguish the extent to which profits, losses, assets, liabilities and relevant deductions relate to their life or non-life business. A formula is then used in order to set out this process, this gives ‘the profits of a company which are available for the purpose of making a distribution’ – bypassing any reference to accumulated, realised profits or losses. The general rule stated in section 830 is that the difference between accumulated, realised profits and accumulated, realised losses is the profits available for distribution, when greater than zero. For this reason, within section 843A, section 830 is disapplied. The amount available for distribution is ‘(if greater than zero) given by the formula A-L-D’. This means that if A-L-D (assets-liabilities-relevant deductions) is less than zero, the amount available for distribution is zero.

    The relevant deductions are set out in section 834(5) and broadly include: a gain in value of shares held by the company in a relevant undertaking; an asset representing a surplus in a defined benefit pension scheme; and a surplus in a ‘ring fenced fund’;
  • Section 830 (Distributions to be made only out of profits available for the purpose). HM Treasury proposes amending subsection 3 of this section to make it clear that the general rule that the amount available for distribution equals accumulated realised profits less accumulated realised losses is subject to the new provision for Solvency II firms, as set out in section 843A;
  • Section 843 (Realised profits and losses of long-term insurance business). Section 843 sets out the current rule for companies which are life insurers and reinsurers. HM Treasury notes that there is a small class of insurers to whom Solvency II does not apply and as such, section 843 will need to be maintained for these insurers. HM Treasury proposes to amend subsection 1 of this section to carve out insurers and insurance special purpose vehicles which have been authorised under Solvency II, as these firms will be subject to the new section 843A; and
  • Section 853 (Minor definitions). HM treasury proposes to amend this section to include a new definition of the Solvency II Directive.

HM Treasury invites feedback on specific questions set out in the consultation paper in addition to feedback on all of the draft legislation included in Annex B of the consultation paper before 15 November 2016.