It’s been years since I helped author the ASSA Information Note on Loss Absorbing Capacity of Deferred Taxes (LACDT). Yet I still see fundamental errors and misunderstanding recurring, especially when it comes to ORSA scenarios and LACDT.

Weirdly, for life insurance, despite the complexities of multiple tax funds, it’s usually relatively simple. The large Deferred Tax Liabilities (DTL) that exist in most base and many stressed scenarios mean that LACDT is often just 28% of BSCR+OpsRisk in the base and many scenarios. Easy.

[IFRS17 has entered the chat.] Okay yes, IFRS17 may change some figures for some life insurers. For many, replacing large discretionary margins and zeroisation with a CSM is not all that different. For those with a less conservative tax basis before, life is more interesting.

For non-life insurance though, LACDT is often significantly more complex:

1. Lower capitalisation levels mean post-stress going concern evaluations are more likely to fail and require significantly more attention. Definitely more than zero attention, which is often how much it does receive.
2. DTLs are usually small, and once offset against Deferred Tax Assets (DTA) there’s often not much left. LACDT can then only be recognised if a post-stress DTA can be raised and recovered.
3. Since the SCR stresses are more targeted at one year claims / catastrophes (rather than permanent changes in assumptions as for life insurance), more judgement must be applied to the medium term implications of the stresses. Do claims stay high? Can you re-price, and when, and what is the impact on renewals and new business? What impact does lower business volumes and fixed expenses have on future profits? Can you replace defaulted reinsurance and at what cost? What will reinsurance cost in future anyway?

The most common mistake I see though, is not recalculating DTLs and DTAs in a stressed scenario, and somehow assuming the LACDT is still present.

In severe scenarios, it’s more likely that:

• a DTA should be raised, and
• no LACDT can then be recognised in the stressed scenario.

In a Reverse Stress Test (RST) it may be that not even a DTA can be raised based on the impaired ability to operate and generate future profits.

There is plenty more to unpack here. LACDT can have such a meaningful impact on your SCR cover, your risk appetite, dividend declarations, how comfortable you are on the amount of reinsurance you use, it’s worth spending the time necessary to get it right.