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Hawthorn Life Designated Activity Company Solvency and Financial Condition Report: 31.12.2016
Hawthorn Life
Designated Activity Company
Solvency and Financial Condition Report:31.12.2016
Contents
Summary ...........................................................................................................................................1A. Business and Performance........................................................................................................2
A.1. Business...................................................................................................................................2A.2. Underwriting Performance .....................................................................................................3A.3. Investment Performance ........................................................................................................3A.4. Performance of Other Activities ............................................................................................. 4A.5. Any Other Information............................................................................................................4
B. System of Governance ..............................................................................................................5B.1. General Information on the System of Governance ............................................................... 5B.2. Fit and Proper Requirements ..................................................................................................6B.3. Risk Management System including the ORSA .......................................................................7B.4. Internal Control System ..........................................................................................................8B.5. Internal Audit Function ...........................................................................................................9B.6. Actuarial Function ................................................................................................................. 10B.7. Outsourcing........................................................................................................................... 10B.8. Any Other Information..........................................................................................................11
C. Risk Profile.............................................................................................................................. 12C.1. Underwriting Risk.................................................................................................................. 12C.2. Market Risk ........................................................................................................................... 12C.3. Credit Risk ............................................................................................................................. 13C.4. Liquidity Risk ......................................................................................................................... 13C.5. Operational Risk .................................................................................................................... 13C.6. Other Material Risks..............................................................................................................16C.7. Any Other Information..........................................................................................................16
D. Valuation for Solvency Purposes............................................................................................. 19D.1. Assets ....................................................................................................................................19D.2. Technical Provisions ..............................................................................................................20D.3. Other Liabilities ..................................................................................................................... 24D.4. Alternative Methods for Valuation ....................................................................................... 24D.5. Any Other Information..........................................................................................................25
E. Capital Management .............................................................................................................. 26E.1. Own Funds ............................................................................................................................ 26E.2. Solvency Capital Requirement and Minimum Capital Requirement ....................................27E.3. Use of Duration Based Equity Risk Sub-Module in Calculation of SCR .................................29E.4. Differences between the Standard Formula and any Internal Model Used ......................... 29E.5. Non-compliance with the MCR and Non-compliance with the SCR .....................................29E.6. Any Other Information..........................................................................................................30
Appendix A: Annual Quantitative Reporting Templates ................................................................... 31Appendix B: Hawthorn Life Position in Group .................................................................................. 40
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Summary
The European Union regulatory regime for insurance companies, known as Solvency II, came intoforce with effect from the 1st of January 2016. The regime requires new reporting and publicdisclosure arrangements to be put in place by insurers. This document is the first version of theSolvency and Financial Condition Report (SFCR) to be published by Hawthorn Life Designated ActivityCompany (Hawthorn Life).
The Company commenced selling unit linked investment products with optional guarantees on 6thApril 2005. The Company closed to all new business, including top-ups, during May 2009.
The present principal activity of the Company is the management of its existing book of unit-linkedcontracts. Hawthorn Life holds a reinsurance treaty with Berkshire Hathaway Life Insurance Companyof Nebraska (BHLN) which transfers all investment and insurance risks relating to the investmentguarantees to BHLN.
The Company is authorised by the Central Bank of Ireland (CBI) to write Class I, Class III and Class IVlong term life assurance business. Hawthorn Life’s business plan outlines an appetite to engage inreinsurance transactions and acquisitions of inforce blocks of business.
This report covers the business and performance of Hawthorn Life, its system of governance, riskprofile, valuation for solvency purposes and capital management. The ultimate administrative bodythat has responsibility for all of these matters is the Board of Directors (the Board).
Hawthorn Life is required to hold sufficient assets to match its policyholder liabilities at all times and aprimary responsibility of the Board is to ensure that capital is adequate to cover the required solvencyfor the nature and scale of the business, and the expected operational requirements. A number ofmechanisms are in place to evaluate those levels and the outcome of those assessments show thatthe Company’s capital is adequate at this time and for the expected requirements in the future.
There have been no material changes to the Company’s business and performance, system ofgovernance, risk profile, valuation for solvency purposes and capital management over the reportingperiod.
The Company’s financial year runs to the 31st of December each year and it reports its results insterling.
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A. Business and Performance
A.1. Business
Name and Address of Organisation:Hawthorn Life Designated Activity CompanySwords Business CampusSwordsCo. DublinIreland
Supervisory Authority:Central Bank of IrelandInsurance Supervision DivisionSpencer DockNorth Wall QuayDublin 1Ireland
External Auditor:DeloitteChartered Accountants and Statutory Audit FirmHardwicke HouseHatch StreetDublin 2Ireland
Group:The immediate parent undertaking and controlling party of Hawthorn Life is Columbia InsuranceCompany incorporated in the United States of America. The ultimate parent undertaking andcontrolling party is Berkshire Hathaway Inc. registered in the United States of America.
See Appendix B for the Company’s position in the legal structure of the group.
Prior to 2013 the Company was known as Hartford Life Limited and was a wholly owned subsidiary ofThe Hartford Financial Services Group Inc. The sale of the Company to Berkshire Hathaway wascompleted in December 2013.
Line of Business:The Company commenced selling unit linked investment products with optional guarantees on 6thApril 2005. The Company closed to all new business, including top-ups, during May 2009.
The present principal activity of the Company is the management of its existing book of unit linkedcontracts. Hawthorn Life has entered into a reinsurance treaty with Berkshire Hathaway LifeInsurance Company of Nebraska (BHLN), which transfers all investment and insurance risks relating tothe investment guarantees to BHLN.
The Company is authorised by the Central Bank of Ireland (CBI) to write Class I, Class III and Class IVlong term life assurance business. Hawthorn Life’s business plan outlines an appetite to engage inreinsurance transactions and acquisitions of inforce blocks of business.
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Business or Other Events:No significant business event, or other event, has materially impacted the undertaking within thereporting period.
A.2. Underwriting Performance
The company had a positive underwriting performance in 2016 with the majority of the £18.9m gaindue to the performance of its shareholder investments. These investments contributed £15.9m withthe balance due to the return on unit linked assets.
Table 1 outlines the underwriting performance for 2016.
Table 1: Profit and Loss Account: Technical Account for the period ended 31.12.20162016 2015
GBP £m GBP £mTechnical Account: Life Insurance BusinessGross Premiums Written - -Outward Reinsurance Premiums (4.2) (4.6)Investment Income 122.2 16.0Claims Paid (92.3) (119.3)Change in Life Assurance Provision (1.3) 6.5Other Technical Provisions 5.3 107.4Net Operating Expenses (7.9) (8.9)Tax Attributable to Life Assurance Business (2.2) 1.3Deferred Tax on Life Assurance Funds (0.7) -Balance 18.9 (1.6)
Table 2 details insurance and reinsurance premiums written during the year:
Table 2: Insurance and Reinsurance Premiums2016
GBP £m2015
GBP £mEarned PremiumsGross Premiums Written – Single - -
Reinsurance PremiumsOutwards Reinsurance Premiums (4.2) (4.6)
Total (4.2) (4.6)
A.3. Investment Performance
Table 3 outlines the investment income by asset type earned during the year.
Table 3: Investment Income by Asset Type2016
GBP £m2015
GBP £mUnit Linked Funds and Collectives 106.3 32.9Equity Shares 0.8 (16.4)Debt Securities 15.0 (0.5)Deposits 0.1 0.0
Total 122.2 16.0
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Unit Linked Funds & Collectives2016 investment income from unit linked funds and collectives includes market gains of £92.7marising mainly from:
Positive performance in the fixed income sector; Strong U.K. equity performance; and, The strengthening of the U.S. dollar, euro and yen relative to sterling.
Income received net of tax through policyholder and shareholder collectives was £13.6m.
EquitiesThe Company received equity dividend income of £0.8m.
Debt SecuritiesDebt security investment income arose from:
Increased market value due to falling interest rates of £10.1m; The strengthening of euro against sterling contributed £3.0m; and, Coupons of £1.9m.
DepositsIncome from shareholder deposits was £0.1m
A.4. Performance of Other Activities
Hawthorn Life has a lease on its premises at Swords Business Campus, Co. Dublin, Ireland. TheCompany does not have any other operating or any finance leases. There are no additional activitiesperformed by the company other than those included in this document.
A.5. Any Other Information
Hawthorn Life’s principal performance indicators in 2016 are as follows:
Table 4: Hawthorn Life Principal Performance Indicators2016
GBP £m2015
GBP £mPolicyholder Assets Under Management 815.9 820.4Net profit/(loss) for the Financial Year 18.9 (1.6)Net Operating Expenses 7.9 8.9Gross Claims 92.4 119.4Number of Policies in Force 8.8 9.5% Lapses 7% 9%
Policyholder assets under management fell by 1% in 2016. Lapse rates of 7% were in line withCompany expectations. Net operating expenses fell reflecting lower maintenance expenses.
The Company does not hold securitised assets.
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B. System of Governance
B.1. General Information on the System of Governance
The Board of Directors manages the business and affairs of the Company and is comprised of:
2 independent non-executive directorso Colm Fagano Brendan McCarthy;
3 group non-executive directorso Stephen McArthur (Chair)o Stephen Michaelo Jonathan Collins; and,
1 executive director / Chief Executive Officer (CEO)o Alastair Murray.
The Board is primarily responsible for:
Effective, prudent and ethical oversight; Setting and overseeing business strategy; and, Overseeing the implementation of strategy.
The role, responsibilities and procedures of the Board, including membership criteria and votingrights, are set out in an annually reviewed and approved terms of reference. The Board delegatesauthorities and responsibilities to the CEO who is responsible for the day to day management ofHawthorn Life.
The Board has constituted an audit committee, the only sub-committee of the Board. The Companyhas obtained derogation from the CBI with respect to the requirement to have a separate riskcommittee, with the Board discharging these responsibilities. The audit committee reports to theBoard on its activities three times a year. Its primary function is to assist the Board with its oversightrole with respect to:
The integrity of financial statements and information provided to shareholders and others; The Company’s compliance with financial regulatory requirements; The adequacy and effectiveness of the internal control environment implemented and
maintained by management; and, The qualifications, independence and performance of the external auditors who are
accountable to the audit committee, the Board and the Company’s shareholders.
The roles, responsibilities and procedures of the audit committee, including membership criteria andvoting rights, are set out in a Board approved terms of reference which are reviewed and approvedannually.
Hawthorn Life has established the following key control functions: risk; actuarial; compliance; andinternal audit. These functions are responsible for providing oversight of and challenge to thebusiness and for providing assurance to the Board.
Hawthorn Life’s staffing requirements, including the staffing requirements of the four key functions,are determined by the Board, who are responsible to ensure each key function is resourcedadequately to discharge their responsibilities taking into account the nature, scale and complexity ofthe Company’s business and affairs.
Each heads of key function is of sufficient seniority to be able to exercise critical review of theCompany’s business. The heads of the risk, actuarial, and compliance functions each have a directreporting line to the Board and report quarterly on their activities. The risk, actuarial, and compliance
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functions have business responsibilities, though are able to discharge control function responsibilitieswith operational independence. The internal audit function is independent from business operationsand reports to the audit committee.
There have been no material changes in the Company’s system of governance over the reportingperiod.
B.1.1. Remuneration
Hawthorn Life has adopted a number of key principles with regards to employee remuneration:
Remuneration is linked to long term objectives and performance; Hawthorn Life’s Remuneration Policy should not challenge policyholder’s interests; Remuneration awards must not threaten the ability to maintain an adequate capital base;
and, Remuneration for service providers must not encourage risk taking that is excessive in view
of the risk management strategy.
Group Non-Executive Directors (GNEDs) are paid directly by affiliate companies within the BerkshireHathaway Group to align Company objectives with shareholder interests. Hawthorn Life does notmake any payments of salary or bonus to its GNEDs. Independent Non-Executive Directors (INEDs)are compensated by fixed fee payments paid quarterly in arrears. The objective of this fixed form ofremuneration is to ensure that independent assessments conducted by the INEDs areuncompromised by remuneration incentives.
The remuneration of the CEO and all other employees consists of a fixed base salary and an annualaward. Annual awards are at management discretion and are paid to all employees who are deemedto have successfully contributed to the overall business objectives.
No Board member or other employee has any entitlement to shares or share options. There is nosupplementary pension or early retirement schemes for the members of the Board or other keyfunction holders. There were no material transactions during the reporting period with shareholders,with persons who exercise a significant influence on the Company, or with members of the Board ofDirectors.
B.2. Fit and Proper Requirements
Members of the Board, senior management and the heads of key functions are required to possesssufficient skills and experience and meet the standards of fitness and probity set out in HawthornLife’s Fit and Proper Policy.
Where a position involves a technical or formal qualification, the individual must possess the relevantuniversity degree, technical qualification or be admitted to practice with the recognised professionalbody. Where there is no technical or formal qualification required for a position, the individual mustdisplay a minimum level of experience to satisfy that they are capable of discharging the relevantresponsibilities.
On an annual basis all pre-approved control function holders are required to sign an annualdeclaration confirming that they continue to meet the standards of fitness and probity as prescribedby the CBI and confirm their obligation to notify the Company immediately if there is any deviation intheir compliance.
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B.3. Risk Management System including the ORSA
Hawthorn Life’s risk management system has been developed to enable the Board and managementunderstand and manage the Company risk profile over the short, medium and long term.
The risk management system includes the following key elements:
A clearly defined risk management strategy which is consistent with business strategy; A defined risk appetite and overall risk tolerance limits; Written policies to:
o Implement risk management strategy;o Facilitate control mechanisms;o Take into account the nature, scope and time horizon of the Company and the
associated risks; The connection between the Own Risk and Solvency Assessment (ORSA), regulatory capital
requirements and risk tolerance limits; Risk management responsibilities including the responsibilities of the risk function; Stress and scenario testing; The approach to underwriting and reserving risk, reinsurance and other risk mitigation
techniques, asset liability management, investment risk management, liquidity riskmanagement and strategic and reputational risk management; and,
The identification, measurement, management, monitoring and reporting of risks on bothand individual and aggregate level.
Hawthorn Life’s risk management strategy is to:
Ensure that the Board and senior leadership team take into account the informationreported as part of the risk management system in the decision making process;
Optimise the balance of risk and return by embedding effective, well integrated riskmanagement in the business;
Operate continuous risk management, covering all relevant risk categories, with due regardto the Risk Appetite Statement; and,
Promote an appropriate risk culture at all levels of the business.
B.3.1. Chief Risk Officer and Risk Function
The Board has appointed a Chief Risk Officer (CRO) who reports directly to the Board and hasresponsibility for managing the risk function and monitoring the effectiveness of the risk managementsystem.
The risk function is responsible for:
Facilitation of the setting of the risk appetite by the Board; Providing comprehensive and timely information on the Company’s material risks which
enable the Board to understand the overall risk profile of the organisation; Evaluating whether any internal investment limits are appropriate in view of the Company’s
obligation to meet its liabilities, by ensuring a number of appropriate stress tests are carriedout on a regular basis;
Reporting to the Board on risks that have been identified as potentially material; Reporting on other specific areas of risks on its own initiative and following requests from
the Board; Maintaining an aggregated view on the risk profile of the undertaking which includes
identifying and assessing emerging risks and suggesting ways to deal with themappropriately;
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Regularly evaluating the design and effectiveness of the risk management system andreporting its findings to the Board, stating any shortcomings identified and givingrecommendations as to how the deficiencies could be remedied;
Coordinating each ORSA; Coordinating risk management activities across the Company and ensuring the
implementation of each risk policy; Analysing, assessing and documenting the effectiveness of reinsurance, including monitoring
the strength of reinsurance counterparties; Documenting the identification and assessment of risks; and, Maintaining a risk register.
B.3.2. Own Risk and Solvency Assessment
Through the ORSA process Hawthorn Life ensures that adequate and robust processes exist to assess,monitor and measure its risks and overall solvency needs, ensuring that the output from theassessment forms an important part of decision making processes.
The assessment aims to ensure that the Board is aware of all material risks the Company faces and toenable the Board to make appropriate strategic decisions, regardless of whether risks are captured bythe Solvency Capital Requirement (SCR) calculation or whether they are quantifiable. The ORSAprocess reports on the adequacy of capital and risk sensitivities that are used in shaping strategy andrisk appetite.
As part of the ORSA process the Board is responsible for:
Ensuring that each ORSA assessment is appropriately designed and implemented; Taking an active part in the ORSA assessment, including steering how the assessment is to be
performed and challenging the results; Challenging the identification and assessment of risks; Giving instruction on management actions to be taken if certain risks were to materialise; Challenging the assumptions behind the calculation of the (SCR); and, Approving the ORSA policy.
Hawthorn Life’s assessment of overall solvency needs includes an analysis of the sensitivity of theCompany to changes in risk profile, including the influence of reinsurance arrangements,diversification effects and any other risk mitigation techniques.
The Board take into account the insights gained from the ORSA and wider risk management system inapproving long and short term capital planning, whilst considering business and risk strategies.Capital planning includes alternatives to ensure that capital requirements can be met even underunexpectedly adverse circumstances.
B.4. Internal Control System
Hawthorn Life’s internal control system considers four distinct areas:
The control environmento Includes policies and practices for appropriate ethical behaviour and compliance
with relevant legislation; Control activities
o Includes approvals, authorisations, verifications, reconciliations, managementreviews, and other appropriate measures;
Information and communicationo Includes encouraging the reporting of negative news and permitting the cutting
across of reporting lines where the situation calls for such action; and,
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Monitoring and reportingo Includes monitoring mechanisms to detect deficiencies.
The internal control system is designed to ensure:
Company’s compliance with applicable laws, regulations and administrative provisions; Effectiveness and efficiency of the Company's operations in light of its objectives; and, Reliability of financial and non-financial information.
B.4.1. Compliance Function
Part of the internal control system is a compliance function which is responsible for:
Providing reasonable assurance to the Board on material compliance with relevant laws andregulation;
Assessing possible impacts of changes in the legal environment; and, Identifying and managing compliance risk.
At a day to day business level, the compliance function:
Maintaining a Compliance Policy and Compliance Plan; Co-ordinating compliance reviews, testing and training; Embedding procedures and policies to ensure compliance with laws, regulations and codes of
conduct; Reporting on compliance issues; Acting as an adviser on compliance related matters; and, Promoting a culture of compliance throughout the business.
B.5. Internal Audit Function
The independence of the internal audit function and its objectivity from the activities it reviews isachieved through:
Organisational statuso Separation from other administrative and operational departmentso Internally outsourced;
Objectivity of functiono Receiving its mandate directly from the audit committee with authorisation to
perform its roles and responsibilities on its own initiative; and, Reporting line
o Reporting to the audit committee, not to Company management.
Additional controls to safeguard the independence of the internal audit function include:
Independent from the audit committee in all aspects except for the approval of the annualinternal audit plan;
In performing, evaluating and reporting on audits the function is not subject to anyinstructions from the audit committee that would impair its independence and impartiality;
Internal audit does not undertake any additional roles within the Company; and, Where a conflict of interest arises or is identified during the course of investigation, the
auditor in question is obliged to report such conflict to the audit committee.
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B.6. Actuarial Function
The Head of Actuarial Function (HoAF) has responsibility for the tasks carried out by the actuarialfunction. The principal responsibilities of the actuarial function relate to the reliability and accuracyof technical provisions, including ensuring appropriate data and assumptions and methodologies.
The HoAF is required to provide sufficient information in order for the Board to adequately challengethe key assumptions, expert judgements and results relating to experience analysis and theassumption setting process. The HoAF is required to provide an annual actuarial opinion on thetechnical provisions to the CBI and an annual report to the Board to support the actuarial opinion.
The HoAF is expected to provide opinions on the underwriting policy, the adequacy of the reinsurancearrangements and contribute to the effective implementation of the risk management system(including providing an opinion to the Board in respect of each ORSA process).
As the owner of the actuarial model used to calculate the technical provisions the actuarial function isresponsible for the calculation of the Solvency Capital Requirement (SCR) and Minimum CapitalRequirement (MCR) and to work closely with the risk function in the producing the projections andstressed scenarios used in the ORSA. The HoAF provides an extra layer of independence andoversight of these processes.
The activities of the actuarial function are split between those involved in preparing output and/oranalysis, performed by the Head of Actuarial Operations and the actuarial team, and those activitiesperformed by the HoAF who provides oversight and validation. Segregation of duties within theactuarial function is implemented using a two line sign-off process when calculating technicalprovisions and solvency capital requirements.
B.7. Outsourcing
The Company has implemented an Outsourcing Policy designed to ensure that any outsourcingagreement entered into with respect of important or critical functions will not:
Materially impair the quality of the system of governance; Unduly increase operational risk; Impair the ability of regulatory supervisors (i.e. the CBI for prudential matters and the
Financial Conduct Authority / Prudential Regulatory Authority for issues connected with“general good” requirements in the UK) to monitor compliance with obligations; or,
Undermine continuous and satisfactory service to policyholders.
In the context of the closed book of business the following relationships are presently deemed to beoutsourced critical or important functions:
Policy administration services provided by IFDS Percana International Managed ServicesLimited (Ireland based);
Taxation and payment administration services provided by Equiniti (UK based); Fund administration services provided by Capita Life and Pensions Services (Ireland) Limited
(Ireland based); and, Internal audit services provided by Resolute Management Limited (UK based) a Berkshire
Hathaway Group company.
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B.8. Any Other Information
B.8.1. Assessment of Adequacy of System of Governance
Hawthorn Life’s system of governance provides for the sound and prudent management of theCompany and has been designed to meet all regulatory requirements arising under the Solvency IIDirective and the Corporate Governance Code for Credit Institutions and Insurance Undertakings.
Management undertakes a cyclical review of the system of governance every three years and reportsto the Board on its findings. The most recent review was reported to the Board in 2015, whodetermined that the system of governance was satisfactory.
There is no other material information regarding the Company’s system of governance.
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C. Risk Profile
Hawthorn Life uses the Solvency II standard formula to calculate its capital requirements, using fourstandard risk modules relating to:
Life Underwriting Risk; Market Risk; Counterparty Default Risk, and; Operational Risk.
The Company uses standard formula correlation matrices to aggregate capital requirements.
Regarding its reinsurance partner, Hawthorn Life actively monitors:
Its exposure to BHLN; BHLN‘s financial strength and key financial information; The effectiveness of the reinsurance arrangement.
Hawthorn Life does not use any special purpose vehicle constructs.
In this section Hawthorn Life’s material risks (all risks over £1m SCR) are primarily discussed net of thereinsurance treaty with BHLN (see section E.2 for a breakdown of SCR by risk).
C.1. Life Underwriting Risk
Life underwriting risk is defined as the risk of loss, or of adverse change in the value of insuranceliabilities resulting from changes in the level, trend or volatility of (among other things) mortalityrates, expenses incurred in servicing insurance contracts, rates of policy lapses or from uncertainty ofpricing and reserving assumptions related to extreme or irregular events.
Expense RiskHawthorn Life is exposed to the risk of increasing expenses and expense inflation. Expense risk canalso result from the impact of high levels of lapses on fee income (where overhead expenses may notbe quickly reduced to a suitably lower level). The Company recognises that as the business runs off,the ratio of fixed expenses relative to variable expenses will continue to increase, with a misalignmentbetween relatively fixed expenses and variable fee income. The Company has partially mitigated thisexpense risk by entering into an outsourcing agreement with IFDS Percana (IFDS) on the basis ofvariable (i.e. per policy) expenses.
Lapse RiskPolicyholder lapses could have a significant impact on Hawthorn Life’s balance sheet as changes tolapse rates result in changes to future levels of fee income and future levels of expenses.
C.2. Market Risk
Market risk arises from the level or volatility of market prices of financial instruments.
Equity RiskEquity risk arises from the level or volatility of market prices for equities, with exposure to equity riskarising in respect of all assets and liabilities whose value is sensitive to changes in equity prices.Hawthorn Life is exposed to equity risk from underlying policyholder investment in equity funds, as
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decreasing equity values will reduce fee income.
Currency RiskHawthorn Life’s local currency for reporting is sterling, so exposure to currencies other than sterlingcreates a currency risk. This arises in a number of areas, for example:
Shareholder assets denominated in euro; Underlying policyholder funds invested in assets not denominated in sterling; and, Expenses being partly denominated in euro while charge income, used to pay the expenses,
is denominated in sterling.
Interest Rate RiskInterest rate risk, the risk of a change in value caused by a deviation of the actual interest rates fromthe expected interest rates, is inherent in the projections by Hawthorn Life as interest rateassumptions are used in projecting investment returns and discounting liabilities. Hawthorn Life isalso exposed to interest rate risk through bond values, as changes in the level of interest rates willimpact their market price.
Credit Spread RiskCredit spread risk is defined as the risk of a change in value due to a deviation of the actual marketprice of credit risk from the expected price of credit risk. Hawthorn Life is exposed to this risk in twomain areas:
A shareholder owned portfolio of corporate debt; and, Policyholders having a proportion of assets invested in corporate bonds.
C.3. Credit Risk
Credit risk reflects the possible losses due to the unexpected default, or deterioration in the creditstanding, of counterparties. The scope of credit risk includes risk mitigating contracts (e.g.reinsurance arrangements), securitisations and derivatives, and receivables from intermediaries.
Hawthorn Life’s counterparty exposures are:
Exposure to UK and EU governments through holding sovereign debt; Exposure to BHLN through the reinsurance arrangement; Exposure to banks through cash deposits; and, Exposure to other debtors.
C.4. Liquidity Risk
Liquidity risk is the risk that the Company is unable to realise investments and other assets in order tosettle its financial obligations as they fall due. Hawthorn Life has liquidity exposure in relation topolicyholder payments, reinsurance claims and single large ad-hoc expenses. Recognising the presentasset profile and the liquidity controls in place, liquidity risk is not considered significant at present.
C.5. Operational Risk
Operational risk is defined as the risk of loss arising from inadequate or failed internal processes, frompersonnel and systems, or from external events. Specific risks of note along with their main mitigantsare listed below.
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Outsourcing RiskHawthorn Life recognises that it is significantly exposed to outsourcing risk. Much of Hawthorn Life’soperational risk has been mitigated through outsourcing of policyholder administration, pensionpayments, information technology and fund administration, where the outsourcing partners haveaccepted financial liability for operational errors that occur within these outsourced services.Hawthorn Life has in place effective legal protection, along with rigorous contingency planning andmonitoring, to further mitigate this risk.
Claims RiskHawthorn Life has outsourced its policyholder administration to a regulated insurance intermediary,IFDS, which implements agreed processes on the administration of all types of policyholdertransactions. Hawthorn Life has robust governance in place to ensure that the outsourcing partner isadhering to agreed processes.
Anti-Money Laundering / Counter-Terrorist FinancingThe Company maintains an Anti-Money Laundering (AML) and Counter Terrorist Financing (CTF)Handbook which sets out policies and procedures on how the Company prevents and detectspotential money laundering and terrorist financing. IFDS conducts AML and CTF checks on behalf ofHawthorn Life in the provision of outsourced policy administration services. Hawthorn Life iscommitted to ensuring that the risk of money laundering and terrorist financing is minimised throughcompliance with all applicable AML and CTF legislation.
Fraud RiskHawthorn Life maintains an Anti-Fraud and Anti-Bribery Policy which sets out appropriate governanceover how the Company prevents and detects fraudulent activity within its business. The Companypromotes legal and ethical organisational behaviour by assigning responsibility for reporting actual orsuspected fraudulent activity and providing guidelines to conduct investigations in respect of reportedfraudulent activity.
Human Resource RiskHuman resource risk related to potential losses due to drain or loss of personnel, deterioration ofmorale, inadequate development of human resources, inappropriate working schedule, inappropriateworking and safety environment, inequality or inequity in human resource management ordiscriminatory conduct. The Legal and Compliance function is responsible for managing theCompany’s human resources responsibilities, maintaining related policies and procedures andensuring compliance with applicable legislation.
Unit Pricing RiskUnit pricing risk is an operational risk associated with the potential loss, financial and reputational,arising from the misstatement of daily unit prices. This risk is mitigated in two main ways:
Outsourcing of the unit pricing function to a third party industry expert Capital Life andPensions Services Ireland (CLPSI) who use an industry recognised unit pricing system; and,
A unit pricing governance structure within the Company’s investment control framework,which includes the internal Policyholder Investment Forum and unit pricing and investmentpolicies.
Financial Reporting RiskFinancial reporting risk is the risk of material misstatement of financial reports. Hawthorn Life hasimplemented a financial control framework and Public Disclosure and Supervisory Reporting Policy.To mitigate financial reporting risk the Company employs accounting personnel that are adequately
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qualified and trained with job responsibilities commensurate with their expertise and experience.This is further supplemented by the use of external expertise as provided by:
National Indemnity Company (NICO) in respect of accounting for shareholder investments; External consultants for the production of relevant tax returns; Outsourcing of fund administration accounting to IFDS; and, Outsourcing of fund accounting to CLPSI.
Financial statements are also subject to review by the Board, audit committee, internal audit andexternal audit.
Legal Environment RiskThis is the risk that insurance and reinsurance undertakings are unable to adapt their risk profile inresponse to sudden or unexpected changes in the legal environment, such as an unforeseen change inthe legal retirement age. The legal and compliance function, supported by all other functions andexternal advisors where necessary, are responsible for monitoring the legal and regulatoryenvironment in which the Company conducts business.
Cybersecurity RiskCybersecurity risk refers to the effect of hostile threats exploiting vulnerabilities in informationsystems with the intent to cause harm to the organisation and limit the ability to achieve objectives.Through 2016 Hawthorn Life have reviewed and formalised its approach to cybersecurity, alignedwith wider Berkshire Hathaway group requirements, through hardware and software reviews andupgrades, and the approval of the Hawthorn Life Information Security (inc. Cybersecurity) Policy. In2017 the Company will review the CBI’s Cross Industry Guidance in Respect of InformationTechnology and Cybersecurity Risks and close any material gaps that the analysis uncovers.
Governance RiskThe Company’s system of governance provides for sound and prudent management. The system ofgovernance meets all regulatory requirements and is proportionate to the nature, scale andcomplexity of the business. It includes:
Clear organisational structures; Clear reporting lines; Clear expression of the roles and responsibilities of each tier of management; A risk management system and internal control system appropriate to the nature, scale and
complexity of the business; and, Documented policies on key requirements, aligned with each other and business strategy,
which are approved by the Board on at least an annual basis.
Conduct RiskConduct risk refers to the risk the firm poses to its customers through its direct interaction with them.The Company services its existing book of policies within the parameters of its products terms andconditions and ensures it has a reliable system to administer the book of business including anappropriate change control process. Hawthorn Life also has documented policies and procedureswhich govern the administration of all types of policyholder transactions and has outsourced itspolicyholder administration to a regulated insurance intermediary which trains its staff in order toensure compliance with applicable policies and procedures.
In order to monitor conduct risk the Company monitors and reviews customer complaints and errorson a monthly basis, as well as performing quarterly service reviews in order to review the nature of
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direct interaction with policyholders. Incoming and outgoing communications with customers(phone, mail and email) are also reviewed.
C.6. Other Material Risks
Reputational RiskReputational risk is the risk that adverse publicity regarding business practices and associations,whether accurate or not, will cause a loss of confidence in the integrity of the institution. The Boardand senior management ensure that all significant decisions are viewed through the prism ofreputation management, and that decisions will not bring unduly adverse reputational consequencesto the Company, its ultimate parent Berkshire Hathaway, or any other stakeholders.
Contagion RiskContagion risk is where an insurance or reinsurance undertaking could be exposed to the risk that anadverse event or situation will spread from one undertaking to another. For example an insuranceundertaking could be exposed to the financial weakness of other group entities affected by, forinstance, market, reputation or operational risk. Hawthorn Life have multiple mitigants for contagionrisk through: having multiple counterparties engaged in multiple lines of business; throughreinsurance (BHLN); a surety bond guaranteeing the reinsurer’s obligations (NICO); and a capitalmaintenance agreement and claims-payment guarantee (CIC).
Strategic / Business Model RiskStrategic risk is a function of the incompatibility between two or more of the following components:the Company’s strategic goals; the business strategies developed; the resources deployed to achievethese goals; the quality of implementation; and the economic situation of the markets theundertaking operates in. A related risk, business model risk, refers to the risk of the current andprospective impact on the Company’s earnings or capital arising from adverse business decisions,improper implementation of decisions, or lack of responsiveness to industry changes.
Hawthorn Life identifies, assesses and monitors actual or potential exposure to material strategic risksand the interconnectedness between these risks and other material risks, with any perceivedsignificant threats to the Company’s stated objectives raised and discussed at Board level. Significantchanges to Hawthorn Life’s business model are evaluated by senior management, with a businesscase (establishing the associated costs, benefits and risks) brought to the Board and the CBI forapproval prior to any significant new venture. The Company Risk Appetite Statement is consequentlyupdated as appropriate.
Emerging RisksThe identification and monitoring of emerging risks occurs within Hawthorn Life through the riskfunction supported by the internal Risk and Finance Forum, Policyholder Investment Forum andOperations Forum.
C.7. Any Other Information
C.7.1. Assets and the Prudent Person Principle
Hawthorn Life only invests in assets and instruments whose risks the Company can properly identify,measure, monitor, manage, control, report, and appropriately take into account in the assessment ofits overall solvency needs (part of the ORSA process). All assets are invested in such a manner as toensure the security, quality, liquidity and profitability of the portfolio as a whole.
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Assets held to cover technical provisions are invested in a manner appropriate to the nature andduration of the insurance and reinsurance liabilities. These assets are invested in the best interest ofall policyholders and beneficiaries.
Over the period in question of this report, Hawthorn Life did not:
Complete any non-routine investment activity; Purchase or hold any assets not admitted for trading on a regulated financial market; Enter into or hold any derivative contracts; or, Hold or transact in securitised instruments.
Hawthorn Life:
Does not solely rely on third party information to make decisions on its shareholder andpolicyholder assets;
Has in place a set of key risk indicators in line with its investment risk management policy andbusiness strategy;
Takes into account the risks associated with the investments without relying only on the riskbeing adequately captured by the capital requirements;
Regularly reviews and monitors the security, quality, liquidity and profitability of theportfolio as a whole by considering at least:
o Any liability constraint, including policyholders’ guarantees, and any disclosed policyon future discretionary benefits and, where relevant, policyholders’ reasonableexpectations;
o The level and nature of risks that an undertaking is willing to accept;o The level of diversification of the portfolio as a whole;o The characteristics of the assets;o Events that could potentially change the characteristics of the investments,
including any guarantees, or affect the value of the assets; and,o Issues relating to the localisation and availability of the assets.
Hawthorn Life describes in its Investment Policy how it identifies and manages any conflict of interestthat arises regarding investments and documents the actions taken to manage such conflicts. TheCompany ensures that its investments of unit-linked contracts are selected in the best interest ofpolicyholders and beneficiaries taking into account any disclosed policy objectives. In the case of unitlinked business Hawthorn Life takes into account and manages the constraints related to unitlinked contracts, in particular liquidity and any contractual or legal transferability constraints.
C.7.2. Risk Concentrations and Risk Mitigation
Hawthorn Life recognises that it is exposed solely to unit-linked products with optional guaranteesthat were sold into the UK. Hawthorn Life’s substantial free assets allow it to accept riskconcentration within the shareholder asset portfolio, though at 31.12.2016 there were no materialrisk concentrations in this regard.
The Company currently reinsures 100% of the guarantees on its existing run-off business to BHLN.Hawthorn Life continually monitors the effectiveness of risk mitigation and provides the ActuarialOpinion on Reinsurance report to the Board.
C.7.3. Stress Testing and Scenario Analysis
The Company carries out a proportional stress testing and scenario analysis exercise on at least anannual basis as part of its ORSA process, and also:
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Prior to a material shareholder dividend payment; Prior to a material change in investment strategy; and, During periods of rapidly changing financial markets.
As part of the 2016 ORSA process Hawthorn Life stressed the 30.06.2016 balance sheet for numerousindividual risks, chosen to reflect the Company’s present and potential future risk profile.
The Company incorporated elements of the 2016 European Insurance and Occupational PensionsAuthority (EIOPA) risk stresses within its range of stress tests (these stresses were designed by EIOPAin conjunction with the ESRB (European Systemic Risk Board) to evaluate the potential for systemicrisk that may be posed by financial institutions to increase in situations of stress. The “low-for-longscenario” focuses on a prolonged low interest rate environment while the “double-hit scenario”combines a low interest rate curve and a market stress).
The most recent ORSA has confirmed the Company had sufficient financial resources to:
Continually comply with regulatory capital requirements; Continually comply with technical provisions; Meet its risk appetite over the short and medium term; Withstand a wide range of stresses; and, Withstand a number of severe scenarios.
C.7.4. Other Material Information
Hawthorn Life has no exposure arising from off-balance sheet positions nor has transferred any risk tospecial purpose vehicles.
There is no other material information regarding the risk profile of Hawthorn Life.
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D. Valuation for Solvency Purposes
D.1. Assets
Assets are recognised in conformity with International Accounting Standards (IAS) and FRS102/103.Where there is a clash between IAS and valuation principles as set out in Article 75 of Directive2009/138/EC the company uses the Article 75 valuation method.
This states that:
“Assets shall be valued at the amount for which they could be exchanged betweenknowledgeable willing parties in an arm’s length transaction”.
Hawthorn Life values all assets based on the assumption that it will pursue its business as a goingconcern. The Company values each of its assets separately, with each asset recognising all accruedincome and expenses. All investments are held in assets where there is an active price in an activemarket.
Hawthorn Life does not currently use any alternative valuation methods for its assets. Where aninvestment is non-routine in nature the Company will choose a suitable valuation methodology that isin conformance with relevant standards. These valuation approaches may then be subject toindependent review and oversight by the Board.
There are no material differences in the valuation bases, methods and assumptions used in thevaluation for solvency purposes and those used for valuation purposes within the financialstatements.
See Table 5 for detail of Hawthorn Life’s assets at 31.12.2016
Table 5: Hawthorn Life Assets at 31.12.201631.12.2016
GBP £mGovernment Bonds 377.5Corporate Bonds 33.6Collective Investments Undertakings 3.2Assets Held for Index-Linked and Unit-Linked Funds 818.1Reinsurance Recoverables from: Life Index-Linked and Unit-Linked 95.5Insurance and Intermediaries Receivables 0.3Reinsurance Receivables 8.6Receivables (Trade, not Insurance) 0.7Cash and Cash Equivalents 34.7Property, Plant and Equipment held for Own Use 0.2
Please note the following explanations:
Government and Corporate Bondso Debt securities including corporate and government bonds are valued at fair value
using the current market price as quoted in an active market; Collective Investment Undertakings
o Collective investment undertakings are unit linked funds held to match HawthornLife’s obligations to allocate loyalty bonus units to policyholders. These are valuedat current market value;
Assets held for Index-Linked and Unit-Linked Fundso Assets held for unit-linked funds are invested into a range of authorised unit trusts
and Open Ended Investment Companies (OEICs);o Assets invested in unit trusts are valued at the bid price and those invested in OEICs
are valued using the single price issued daily;
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o Hawthorn Life values its holding in each fund separately. The valuation of theseassets includes the recognition of all accrued income and expenses in respect ofthese assets.
Reinsurance Recoverables from: Life Index-Linked and Unit-Linkedo Hawthorn Life uses a valuation method that is consistent with the valuation
approach set out in Article 75 of Directive 2009/138/EC; Insurance and Intermediaries Receivables
o Receivables related to policyholder investment management fees; Reinsurance Receivables
o Amounts which are receivable from BHLN under the reinsurance treaty; Receivables (Trade, not Insurance)
o All income and expenditure is recognised on an accrual basis i.e. the non-casheffects of transactions and other events are reflected, as far as possible, in thefinancial statements for the accounting period in which they occur;
o This includes all other receivables not classified as insurance and intermediaryrelated.
Cash and Cash Equivalentso Monetary assets are held at current market value; and,
Property, Plant and Equipment held for Own Useo Tangible fixed assets are stated at cost or valuation net of depreciation and any
provision for impairment.
D.1.1. Deferred Tax
The Company did not recognise a deferred tax asset as at 31st December 2016. Deferred tax assetsare recognised to the extent that they are regarded to be recoverable in the short to medium term.
D.2. Technical Provisions
D.2.1. Value of Technical Provisions
Table 6 shows the value of technical provisions, including the amount of the best estimate of liabilitiesand the risk margin for Hawthorn Life’s business.
Table 6: Hawthorn Life Technical Provisions 31.12.2016GBP £m
Variable Annuity 933.9Annuity Reserve 1.9Best Estimate Liability 935.8
Risk Margin 12.3Technical Provisions 948.2
D.2.2. Methods Used to Calculate Technical Provisions
Stochastic Simulation ApproachThe key risks affecting the cash-flows associated with Hawthorn Life’s product guarantees are lowinterest rates and a fall in equity markets. Where contracts have attaching financial guarantees andcontractual options, a fall in equity markets may reduce the value of the unit fund, which would resultin the corresponding guarantee becoming more valuable. Due to the nature of these guaranteesthere is not a symmetrical decrease in guarantee value following an increase in unit values.
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As a result, in order to adequately reflect the risks affecting the cash-flows associated with theseguarantees and options, it is necessary to simulate the levels of the unit funds under a large numberof scenarios. Hawthorn Life then calculates the present value of cash-flows under each scenario,using scenario specific discount rates. The related reserves are then calculated as the average of thepresent values calculated across each scenario.
Hawthorn Life allows for dynamic policyholder behaviour in the calculation of the present value ofcash-flows (e.g. the likelihood of policyholders lapsing will be affected by the ‘moneyness’ of theirguarantees and their withdrawal status).
Deterministic ApproachThe key risks affecting the cash-flows associated with Hawthorn Life’s immediate annuities areexpected to be a fall in interest rates and a fall in mortality rates. The key risks affecting HawthornLife’s expenses are expected to be as follows:
An increase in the amount of expenses; Currency movements; and, A fall in interest rates.
Hawthorn Life calculates the best estimate in respect of annuities and expenses using a deterministicapproach where the Company derives best estimate assumptions and calculates the present value ofcash-flows based on these assumptions.
D.2.3. Bases and Main Assumptions used for Technical Provisions
Main AssumptionsThe main assumptions influencing the level of technical provisions include:
Risk free rateso Used to determine future fund growth and discount rates. These are set in line with
sterling and euro swap rates at the valuation date and are checked quarterly againstthe risk free rates published by EIOPA;
Expenseso Expense assumptions are updated annually in line with the most recent operational
plan and are projected forward allowing for inflation and assuming that theCompany is open to new business;
Foreign exchange rateso The euro to sterling rate is used to convert the euro expense reserve to sterling at
the valuation date; Lapse rates
o Lapse rates are updated annually in line with the lapse experience of the business;and,
Longevity assumptions including mortality improvementso Longevity assumptions are reviewed annually in line with the mortality experience
of the business. Where insufficient experience is available Hawthorn Life reviewsthe mortality basis used by other annuity providers.
D.2.4. Level of Uncertainty within Technical Provisions
There are no material sources of uncertainty in the calculation of the technical provisions. Cashflowprojections take account of uncertainties in the cashflows as follows:
Timing, frequency and severity of insured events
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o Allowance for fluctuations in the timing and severity of claims is made throughassumptions, including dynamic policyholder behaviour assumptions, which arereviewed and updated at least annually in line with the actual experience of thebusiness;
Claim amounts, claims inflation, settlement and payment periodo Allowance for uncertainty associated with claims through stochastic simulations of
unit funds over a large number of scenarios; Amount of expenses
o Expense assumptions are set in line with the most recent operating plan and arereviewed at least annually;
Expected future developmentso Legal, social and economic developments are monitored on an on-going basis with
allowance for these factors made as appropriate; Policyholder behaviour
o Cash-flow projections allow for dynamic policyholder behaviour whereby lapse andwithdrawal decisions are based on policy moneyness levels. These assumptions arebenchmarked against actual experience at least annually;
Path dependencyo The cash-flows associated with bonds and pensions are path-dependent (e.g.
guarantee level, lapse rate and withdrawal status depend on the evolution of theunit fund). Allowance for path-dependence is made through stochastic simulationsof unit funds over a large number of scenarios; and,
Dependencies between causes of uncertaintyo Allowance for the dependencies between causes of uncertainty through the use of
dynamic policyholder behaviour assumptions.
Regarding data quality the following are considered:
Fitness for purpose; Consistency over time; Timeliness; Adequacy of information technology systems; and, Availability of individual policy data and of historical data.
No material uncertainties or limitations have been found in the data.
D.2.5. Simplifications
Hawthorn Life uses a simplified method to project individual SCRs at future time periods within thecalculation of the risk margin. In order to project each of the SCRs, the Company calculates theproportion of the SCR at time zero attributable to each of the components of the best estimateliability (policy reserves, guarantee reserves, expense reserves) and then assumes that this proportionremains constant over time. The SCR is then projected in line with the change in these reserves overtime. Table 7 illustrates this using sample figures.
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Table 7: Projection of individual SCRs
Time 0 Time 0 Time 5 Time 5£m £m £m £m
Components of SCR Reserve SCR % Change Reserve SCR Stress
Policy Reserves -40 -4 -10% -20 -2Guarantee Reserves 100 20 20% 80 -16Expense Reserves 60 3 5% 40 2
Best Estimate Liability 120 100SCR 19 16
The values of the reserves at future time periods are taken directly from Hawthorn Life’s cash-flowprojection models and are projected using risk neutral returns. Once the individual SCRs at futuretime periods have been estimated they are aggregated using the standard formula correlation matrixto allow for the effects of diversification.
No other material simplifications are applied in the calculation of technical provisions.
D.2.6. Recoverables from Reinsurance Contracts
The Company holds a reinsurance treaty with BHLN. Collateralised assets are held on the HawthornLife balance sheet as protection against BHLN default.
D.2.7. Material Changes in Assumptions
In the period 31.12.2015 to 31.12.2016 Hawthorn Life made the following material changes toassumptions used to calculate the technical provisions:
Mortalityo Hawthorn Life updated the mortality improvement tables from the UK Institute and
Faculty of Actuaries Continuous Mortality Improvement (CMI) 2014 tables to theCMI 2015 tables;
Lapse rateso Updated in line with experience leading to a decrease in long term bond lapse rates,
a decrease in pension lapse rates when in drawdown, and an increase in pensionlapse rates when not in drawdown;
Withdrawal take up rateso Updated in line with experience leading to an increase in the time assumed before
bond and pension policyholder commence withdrawals and an increase in the ageat which pension withdrawals are assumed to occur;
Taxo A reserve was set up to allow for ‘income minus expenditure’ tax on the modified
coinsurance assets;
Expenseso Expenses were updated in line with the most recent operating plan and expense
allocations. The method used to project expenses was updated to assume thecompany is open to new business in line with the business plan and Solvency IIrequirements.
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D.2.8. Other Information Relating to Technical Provisions
Hawthorn Life:
Uses the same basis, methods and main assumptions in its valuation for solvency purposesand the valuation in financial statements;
Does not apply the matching adjustment; Does not apply the volatility adjustment; Does not apply the transitional risk-free interest rate-term structure; and, Does not apply the transitional deduction to technical provisions.
D.3. Other Liabilities
Hawthorn Life values all other liabilities based on the assumption that it will pursue its business as agoing concern. Liabilities are valued at the amount for which they could be transferred, or settled,between knowledgeable willing parties in an arm’s length transaction.
The Company recognises its other liabilities in conformity with International Accounting Standards(IAS) and FRS102/103. Where there is a clash between IAS and valuation principles as set out in Article75 of Directive 2009/138/EC the company uses the Article 75 valuation method. All expenditure isrecognised on an accrual basis (i.e. the non-cash effects of transactions and other events arereflected, as far as possible, in the financial statements for the accounting period in which they occur,and not for example, in the period in which any cash involved is received or paid).
There are no material differences in the valuation bases, methods and assumptions used in thevaluation for solvency purposes and those used for valuation purposes within the financialstatements.
The amounts receivable or payable in respect of these items are included in the balance sheet untilthey are settled. These liabilities are held at current value. Included in these liabilities are:
Deposits from reinsurers held under the reinsurance treaty; Deferred tax liabilities are arising on capital gains tax on unit linked funds; Insurance and intermediaries payables are liabilities arising out of insurance operations,
including amounts payable to policyholders; and, Payables (trade, not insurance) are liabilities not related to policy expenses.
Table 8: Other Liabilities31.12.2016
GBP £mDeposits from Reinsurers 95.5Deferred Tax Liabilities 0.7Insurance and Intermediaries Payables 10.8Payables (Trade, not Insurance) 1.2
D.4. Alternative Methods for Valuation
The Company does not apply any alternative methods of valuation in the calculation of any assets orliabilities.
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D.5. Any Other Information
There is no other material information regarding the valuation of assets and liabilities for solvencypurposes.
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E. Capital Management
The Company’s capital consists of share capital and retained earnings. The entire capital is consideredto be unrestricted ‘Tier 1’ basic own funds for Solvency II purposes. There is currently no intentionthat the Company will issue other forms of capital, however should it subsequently do so, HawthornLife will ensure before issuance that the terms and conditions of any new own funds item is clear andunambiguous, they meet the appropriate Solvency II requirements and are classified correctly.
A Company objective is to efficiently utilise excess capital held, whether by returning it to its parent orachieving a higher return through investment. At the time of approval of this report, there is no setschedule for dividend payment over the three year business planning period. The most recent ORSAassumed that surplus capital would be used to support new business in accordance with the businessplan, rather than returning it to the shareholder.
Hawthorn Life will maintain an appropriate buffer over SCR as per its Risk Appetite Statement whilemaintaining a Capital Management Policy and a Capital Management Plan. There have been nomaterial changes on capital management objectives, policies and processes over the reporting period.
E.1. Own Funds
The Company’s own funds are composed of ordinary share capital of £0.9m and by reconciliationreserves (comprised wholly of retained earnings) amounting to £315.3m. There are no ancillary ownfunds and own funds items are not subject to transitional arrangements.
Table 9: Own FundsTotal 31.12.2016 Total 31.12.2015
GBP £m GBP £mOrdinary Share Capital (Gross of Own Shares) 0.9 0.9Reconciliation Reserve 315.3 296.2Total Basic Own Funds 316.2 297.1
E.1.1. Amount of Eligible Own Funds
All own funds are eligible to cover both solvency and minimum capital requirements and there are noproposed dividends.
E.1.2. Ratio of Eligible Own Funds to SCR / MCR
The company is well capitalised with an SCR coverage of 800% and an MCR coverage of 3199%.
Table 10: Ratio of Eligible Own Funds to SCR / MCR2016 2015
GBP £m GBP £mSCR 39.5 46.8MCR 9.9 11.7Ratio of Eligible Own Funds to SCR 800% 634%Ratio of Eligible Own Funds to MCR 3199% 2538%
E.1.3. Excess of Assets over Liabilities versus Equity as per Financial Statements
As a result of a change in accounting policy for the financial statements in 2016 there is no differencebetween the equity as shown in the financial statements and the excess of assets over the liabilities ascalculated for solvency purposes.
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E.1.4. Other Information
Hawthorn Life has:
Not taken advantage of any transitional arrangements; No items of ancillary own funds; No items deducted from own funds; and, No restrictions affecting the availability and transferability of own funds within the Company.
E.2. Solvency Capital Requirement and Minimum Capital Requirement
E.2.1. Solvency Capital Requirement Split by Risk Module
Table 11 shows the components of the SCR at 31st December 2016. The Company calculates its SCRusing the Solvency II standard formula.
Table 11: SCR 31.12.201631.12.2016
GBP £mEquity Risk 18.8Foreign Exchange Risk 3.4Interest Rate Risk 2.4Concentration Risk 0.3Credit Spread Risk 2.8Market Risk Diversification -5.4MARKET RISK 22.3
Expense Risk 11.8Lapse Risk 16.2Mortality / Longevity / Life Catastrophe Risks 0.5Life Underwriting Diversification -4.0LIFE UNDERWRITING RISK 24.5
Cash at Banks 0.8Reinsurer 1.0Debtors 0.2Counterparty Diversification -0.3COUNTERPARTY DEFAULT RISK 1.6
Risk Module Diversification -10.9
OPERATIONAL RISK 2.0
TOTAL SOLVENCY CAPITAL REQUIREMENT 39.5
E.2.2. Simplified Calculations
Hawthorn Life uses the simplified calculation of the capital requirement for life catastrophe risk. TheCompany’s cash-flow projection model does not allow for additive increases to be applied to mortalityrates for the first twelve months of the projection.
Hawthorn Life’s business is not sensitive to mortality risk (the mortality risk SCR is £0.3m) and giventhat the life catastrophe risk is £0.1m (using the simplified calculation) the use of the simplifiedmethod is deemed appropriate under the principle of proportionality.
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E.2.3. Minimum Capital Requirement Inputs
Table 12 shows the inputs used to calculate the Minimum Capital Requirement (MCR).
Table 12: Inputs to MCR£m
Obligations with Profit Participation - Guaranteed Benefits 0.0Obligations with Profit Participation - Future Discretionary Benefits 0.0Index-linked and Unit-linked Insurance Obligations 933.9Other Life (re)Insurance and Health (re)Insurance Obligations 1.9Total Capital at Risk for all Life (re)Insurance Obligations 43.5Linear MCR 6.6
Solvency Capital Requirement 39.5MCR Cap 17.8MCR Floor 9.9
Combined MCR 9.9Absolute Floor of the MCR 3.2Minimum Capital Requirement 9.9
E.2.4. Material Changes to SCR and MCR
Table 13 shows the change in the SCR and MCR over the 12 months to 31.12.2016.
Table 13: Changes to SCR and MCR over 201631.12.2016 31.12.2015 Change
GBP £m GBP £m GBP £mEquity Risk 18.8 24.4 (5.6)Foreign Exchange Risk 3.4 4.5 (1.1)Interest Rate Risk 2.4 7.9 (5.5)Concentration Risk 0.3 15.9 (15.6)Credit Spread Risk 2.8 3.5 (0.7)Market Risk Diversification (5.4) (22.2) 16.9MARKET RISK 22.3 33.9 (11.6)
Expense Risk 11.8 10.1 1.7Lapse Risk 16.2 13.7 2.5Mortality / Longevity / Life Catastrophe Risks 0.5 0.4 0.1Life Underwriting Diversification (4.0) (3.4) (0.6)LIFE UNDERWRITING RISK 24.5 20.8 3.7
Cash at Banks 0.8 0.5 0.3Reinsurer 1.0 1.0 (0.1)Debtors 0.2 0.7 (0.6)Counterparty Diversification (0.3) (0.4) 0.1COUNTERPARTY DEFAULT RISK 1.6 1.9 (0.3)
Risk Module Diversification (10.9) (12.0) 1.1
OPERATIONAL RISK 2.0 2.2 (0.2)
TOTAL SOLVENCY CAPITAL REQUIREMENT 39.5 46.8 (7.3)
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The SCR decreased by £7.3m over the period. The material movements are due to changes to theshareholder asset portfolio and assumptions updates, as explained below:
Market risk decreased by £11.6m due to:o Equity risk decreased by £5.6m as a result of the sale of equities held by the
Company. This was partially offset by an increase in equity risk due to increasedexpected future income from policies increasing the loss on a fall in equity values.Expected future income increased due to good market performance and lowerinterest rates, combined with a reduction in lapse assumptions;
o Currency risk decreased by £1.1m as a result of a decrease in shareholder eurodenominated bonds held;
o Interest rate risk decreased by £5.5m, the majority of this change was as a result ofreducing the duration of shareholder bond assets;
o Concentration risk decreased by £15.6m as a result of the sale of Hawthorn Life’ssingle UK equity investment holding;
o Credit Spread risk decreased by £0.7m as a result of a £7.5m reduction inshareholder corporate bond holdings.
Life underwriting risk increased by £3.7m due to:o Life expense risk increased by £1.7m as a result of an increase in the base expense
reserve following lower discount rates;o Lapse risk increased by £2.5m as a result of the increase in the expected future
income from policies, increasing the loss on lapse.
Counterparty default risk decreased by £0.3m due to:o Cash default risk increased by £0.3m as a result of an increase in cash holdings;o Debtor default risk decreased by £0.6m as a result of a decrease in amounts owed
to Hawthorn Life.
Hawthorn Life’s ‘Linear MCR’ is below the ‘MCR Floor’ of 25% of the SCR. This was also the case at theend of December 2015. Therefore the change in the MCR is due to the change in the SCR.
E.3. Use of Duration Based Equity Risk Sub-Module in Calculation of SCR
Hawthorn Life does not apply the duration-based equity risk sub-module.
E.4. Differences between the Standard Formula and any Internal Model Used
The company uses the Solvency II standard formula and does not use an internal model.
E.5. Non-compliance with the MCR and Non-compliance with the SCR
There has been no instance of non-compliance with either the SCR or the MCR.
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E.6. Any Other Information
Regarding the calculation of solvency requirements:
The company has not taken advantage of any transitional measures; The Company does not apply undertaking specific parameters in the calculation of the SCR;
and, The Company is not required to apply a capital add-on or required to use any particular
undertaking specific parameters in the calculation of the SCR.
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Appendix A: Annual Quantitative Reporting Templates
All figures are in £m’s
S.02.01.02 – Balance Sheet
Assets
Goodwill
Deferred acquisition costs
Intangible assets
Deferred tax assets
Pension benefit surplus
Property, plant & equipment held for own use 0.2
Investments (other than assets held for index-linked and unit-linked contracts) 414.3
Property (other than for own use) -
Holdings in related undertakings, including participations -
Equities -
Equities - listed -
Equities - unlisted -
Bonds 411.1
Government Bonds 377.5
Corporate Bonds 33.6
Structured notes -
Collateralised securities -
Collective Investments Undertakings 3.2
DerivativesDeposits other than cash equivalents -
Other investments -
Assets held for index-linked and unit-linked contracts 818.1
Loans and mortgages -
Loans on policies -
Loans and mortgages to individualsOther loans and mortgages
Reinsurance recoverables from: 95.5
Non-life and health similar to non-life -
Non-life excluding healthHealth similar to non-life
Life and health similar to life, excluding index-linked and unit-linked -
Health similar to life -
Life excluding health and index-linked and unit-linked -
Life index-linked and unit-linked 95.5
Deposits to cedants -
Insurance and intermediaries receivables 0.3
Reinsurance receivables 8.6
Receivables (trade, not insurance) 0.7
Own shares (held directly) -
Amounts due in respect of own fund items or initial fund called up but not yet paid in -
Cash and cash equivalents 34.7
Any other assets, not elsewhere shown
Total assets 1,372.6
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S.02.01.02 – Balance Sheet (Continued)
Liabilities
Technical provisions - non-life -
Technical provisions - non-life (excluding health) -
TP calculated as a whole
Best Estimate
Risk margin
Technical provisions - health (similar to non-life) -
TP calculated as a whole
Best Estimate
Risk margin
Technical provisions - life (excluding index-linked and unit-linked) 1.9
Technical provisions - health (similar to life) -
TP calculated as a whole -
Best Estimate -
Risk margin -
Technical provisions - life (excluding health and index-linked and unit-linked) 1.9
TP calculated as a whole -
Best Estimate 1.9
Risk margin -
Technical provisions - index-linked and unit-linked 946.2
TP calculated as a whole -
Best Estimate 933.9
Risk margin 12.3
Other technical provisions
Contingent liabilities
Provisions other than technical provisions
Pension benefit obligations
Deposits from reinsurers 95.5
Deferred tax liabilities 0.7
Derivatives
Debts owed to credit institutions -
Financial liabilities other than debts owed to credit institutions -
Insurance & intermediaries payables 10.8
Reinsurance payables
Payables (trade, not insurance) 1.2
Subordinated liabilities -
Subordinated liabilities not in BOF
Subordinated liabilities in BOF -
Any other liabilities, not elsewhere shown
Total liabilities 1,056.4
Excess of assets over liabilities 316.2
33
S.05.01.02 – Premiums, Claims and Expenses by Line of Business
Life Line of Business for: life insuranceobligations
TotalIndex-linked and unit-
linked insuranceOther lifeinsurance
Premiums writtenGross 0.0Reinsurers' share 4.2 4.2Net -4.2 -4.2 -4.2Premiums earnedGross 0.0Reinsurers' share 0.0Net 0.0 0.0 0.0Claims incurredGross 92.3 0.1 92.4Reinsurers' share 0.1 0.0 0.1Net 92.2 0.1 92.3Changes in other technical provisionsGross 14.2 0.1 14.3Reinsurers' share 18.3 0.0 18.3Net -4.1 0.1 -4.0Expenses incurred 7.9 0.0 7.9Other expensesTotal expenses 7.9
34
S.05.02.01 – Premiums, Claims and Expenses by Country
LifeHome
Country
Top 5 countries (by amount of gross premiumswritten) - life obligations Total Top 5
and homecountryGB
Premiums writtenGross 0.0Reinsurers' share 0.1 4.1 4.2Net -0.1 -4.1 0.0 0.0 0.0 0.0 -4.2Premiums earnedGross 0.0Reinsurers' share 0.0Net 0.0 0.0 0.0 0.0 0.0 0.0 0.0Claims incurredGross 2.0 90.3 92.4Reinsurers' share 0.0 0.1 0.1Net 2.0 90.3 0.0 0.0 0.0 0.0 92.3Changes in other technicalprovisionsGross 5.0 9.3 14.3Reinsurers' share 0.3 18.0 18.3Net 4.7 -8.7 0.0 0.0 0.0 0.0 -4.0
Expenses incurred 1.9 6.0 7.9Other expensesTotal expenses 7.9
35
S.12.01.02 – Life and Health SLT Technical Provisions
Index-linked and unit-linkedinsurance Other life insurance Total
(Life otherthan healthinsurance,incl Unit-linked)
Contractswithoutoptions
andguarantees
Contractswith
options orguarantees
Contractswithoutoptions
andguarantees
Contractswith
options orguarantees
Technical provisionscalculated as a whole 0.0
Total Recoverables fromreinsurance/SPV andFinite Re after theadjustment for expectedlosses due to counterpartydefault associated to TPcalculated as a whole
0.0
Technical provisionscalculated as a sum of BEand RM
Best estimateGross Best Estimate 50.9 883.0 1.9 935.8
Total Recoverables fromreinsurance/SPV and Finite Reafter the adjustment forexpected losses due tocounterparty default
0.0 95.5 95.5
Best estimate minusrecoverables fromreinsurance/SPV andFinite Re
50.9 787.5 1.9 0.0 840.3
Risk margin 12.3 12.3
Amount of thetransitional on TechnicalProvisionsTechnical Provisionscalculated as a whole 0.0
Best estimate 0.0Risk margin 0.0
Technical provisions -total 946.2 1.9 948.2
36
S.23.01.01 – Own Funds
Basic own funds before deduction for participations inother financial sector as foreseen in article 68 ofDelegated Regulation 2015/35
TotalTier 1
unrestricted
Tier 1restricted
Tier2 Tier 3
Ordinary share capital (gross of own shares) 0.9 0.9 0.0Share premium account related to ordinary share capital 0.0 0.0 0.0Initial funds, members' contributions or the equivalentbasic own-fund item for mutual and mutual-typeundertakings
0.0 0.0 0.0
Subordinated mutual member accounts 0.0 0.0 0.0 0.0Surplus funds 0.0 0.0Preference shares 0.0 0.0 0.0 0.0Share premium account related to preference shares 0.0 0.0 0.0 0.0Reconciliation reserve 315.3 315.3Subordinated liabilities 0.0 0.0 0.0 0.0An amount equal to the value of net deferred tax assets 0.0 0.0Other own fund items approved by the supervisoryauthority as basic own funds not specified above 0.0 0.0 0.0 0.0 0.0
Own funds from the financial statements that shouldnot be represented by the reconciliation reserve and donot meet the criteria to be classified as Solvency II ownfundsOwn funds from the financial statements that should notbe represented by the reconciliation reserve and do notmeet the criteria to be classified as Solvency II own funds
0.0 < Note: this deduction nowincluded in R0290/C0020
DeductionsDeductions for participations in financial and creditinstitutions 0.0
Total basic own funds after deductions 316.2 316.2 0.0 0.0 0.0
Ancillary own fundsUnpaid and uncalled ordinary share capital callable ondemand 0.0
Unpaid and uncalled initial funds, members'contributions or the equivalent basic own fund item formutual and mutual - type undertakings, callable ondemand
0.0
Unpaid and uncalled preference shares callable ondemand 0.0
A legally binding commitment to subscribe and pay forsubordinated liabilities on demand 0.0
Letters of credit and guarantees under Article 96(2) of theDirective 2009/138/EC 0.0
Letters of credit and guarantees other than under Article96(2) of the Directive 2009/138/EC 0.0
Supplementary members calls under first subparagraphof Article 96(3) of the Directive 2009/138/EC 0.0
Supplementary members calls - other than under firstsubparagraph of Article 96(3) of the Directive2009/138/EC
0.0
Other ancillary own funds 0.0Total ancillary own funds 0.0 0.0 0.0
37
S.23.01.01 – Own Funds (Continued)
Available and eligible own fundsTotal available own funds to meet the SCR 316.2 316.2 0.0 0.0 0.0Total available own funds to meet the MCR 316.2 316.2 0.0 0.0Total eligible own funds to meet the SCR 316.2 316.2 0.0 0.0 0.0Total eligible own funds to meet the MCR 316.2 316.2 0.0 0.0
SCR 39.5MCR 9.9Ratio of Eligible own funds to SCR 799.83%Ratio of Eligible own funds to MCR 3199.30%
Reconciliation reserveExcess of assets over liabilities 316.2Own shares (held directly and indirectly) 0.0Foreseeable dividends, distributions and chargesOther basic own fund items 0.9Adjustment for restricted own fund items in respect ofmatching adjustment portfolios and ring fenced funds 0.0
Reconciliation reserve 315.3
Expected profitsExpected profits included in future premiums (EPIFP) - LifebusinessExpected profits included in future premiums (EPIFP) - Non-life businessTotal Expected profits included in future premiums (EPIFP) 0.0
38
S.25.01.21 – Solvency Capital Requirement - for undertakings on Standard Formula
Net solvencycapital
requirement
Gross solvencycapital
requirement
Market risk 22.3 22.3Counterparty default risk 1.6 1.6Life underwriting risk 24.5 24.5Health underwriting riskNon-life underwriting risk 0.0Diversification -10.9 -10.9
Intangible asset risk 0.0
Basic Solvency Capital Requirement 37.5 37.5
Calculation of Solvency Capital RequirementOperational risk 2.0Loss-absorbing capacity of technical provisions 0.0Loss-absorbing capacity of deferred taxesCapital requirement for business operated in accordance with Art. 4 ofDirective 2003/41/ECSolvency Capital Requirement excluding capital add-on 39.5Capital add-ons already setSolvency capital requirement 39.5
Other information on SCRCapital requirement for duration-based equity risk sub-moduleTotal amount of Notional Solvency Capital Requirements for remainingpartTotal amount of Notional Solvency Capital Requirements for ringfenced fundsTotal amount of Notional Solvency Capital Requirements for matchingadjustment portfoliosDiversification effects due to RFF nSCR aggregation for article 304
39
S.28.01.01 – MCR: Only Life or Only Non-Life Insurance or Reinsurance Activity
Linear formula component for life insurance and reinsurance obligationsMCRL Result 6.6
Net (ofreinsurance/SPV)
best estimateand TP
calculated as awhole
Net (ofreinsurance/SPV)
total capital atrisk
Obligations with profit participation - guaranteed benefits 0.00Obligations with profit participation - future discretionarybenefits 0.00
Index-linked and unit-linked insurance obligations 933.9Other life (re)insurance and health (re)insuranceobligations 1.9
Total capital at risk for all life (re)insurance obligations 43.5
Overall MCR calculationLinear MCR 6.6SCR 39.5MCR cap 17.8MCR floor 9.9Combined MCR 9.9Absolute floor of the MCR 3.2
Minimum Capital Requirement 9.9
40
Appendix B: Hawthorn Life Position in Group
Figure 1: Hawthorn Life DAC Position in the Legal Structure of Group (Relevant Companies)
