Ring-fenced funds under Solvency II: what they are, when they arise and how they change the SCR

RFF in a QRT instruction or a supervisory letter means a ring-fenced fund. This article explains what a ring-fenced fund is under Solvency II, which arrangements create one, and what it does to both the solo SCR and own funds. On the capital side that means a notional SCR per fund and a loss of diversification and on the own funds side, restricted own funds that no longer count in full. RFF Tool calculates the notional SCR for every ring-fenced fund and the remaining part in one run, which is the calculation this article walks through by hand.

What a ring-fenced fund is

Solvency II does not define a ring-fenced fund as a legal structure. It defines it by its effect on own funds. Article 80 of Delegated Regulation (EU) 2015/35 describes own fund items within a ring-fenced fund as items with a reduced capacity to absorb losses on a going concern basis because they lack transferability: they can only cover losses on a defined portion of the contracts, for certain policyholders or beneficiaries, or for particular risks or liabilities. The legal basis is Article 99(b) of Directive 2009/138/EC.

EIOPA’s Guidelines on ring-fenced funds (EIOPA-BoS-14/169) add the practical test. Guideline 1 says the defining characteristic is a restriction on assets in relation to certain liabilities on a going concern basis, which produces restricted own funds. The fund does not need to be managed as a separate unit. The undertaking must simply be able to trace which items the arrangement covers. Guideline 2 lists what generally is not one, among them conventional unit-linked products, reserves that only exist in statutory accounts and the life and non-life split in a composite. A fund is not ring-fenced because it has a name in the ledger. It is ring-fenced because its surplus cannot leave.

Article 80 of Delegated Regulation (EU) 2015/35 frames the own-funds adjustment in terms of restricted own-fund items. However, the RFF assessment is broader and is not limited to items already classified as own funds. EIOPA clarifies in Q&A 3591 that insurance and reinsurance undertakings should assess whether national contribution-based allocation rules constitute ring-fenced funds where they restrict the ability of assets, surplus, future profit emergence or own-fund items attributable to a defined policyholder group to absorb losses elsewhere on a going-concern basis, consistently with the Guidelines on ring-fenced funds.

Where ring-fenced funds come from

Guideline 3 says the restriction can sit in the policy terms, a separate legal arrangement, the undertaking’s own statutes, national law, EU law or a court order. Guideline 4 names the types every undertaking should compare its business against.

The first is the profit participation fund, the with-profits fund in the UK and Irish sense: policyholders have distinct rights, the assets and their returns cannot meet losses outside the fund, and the excess of assets over liabilities kept inside it is restricted own funds. The second is a trust or legally binding arrangement for specified policyholders. The third and fourth are restrictions written into the undertaking’s own statutes or into national law.

The fifth is EU law: Article 4 of Directive (EU) 2016/2341 (the IORP II Directive) lets Member States apply IORP requirements to the occupational retirement provision business of life assurance undertakings. Where they do, the assets and liabilities for that business must be segregated and managed separately. Without Article 304 authorisation under Directive 2009/138/EC, Articles 81 and 217 apply in full. With authorisation, the Article 81 own-funds adjustment remains, but Article 216(2) removes the notional-SCR aggregation requirement and assumes full diversification between the fund and the remaining part.

Matching adjustment portfolios sit in this list today as well, through paragraph 1.15 of Guideline 4. That changes in 2027 with the Delegated Regulation (EU) 2026/269 where they are separated from the general ring-fenced fund rules.

The notional SCR: one calculation per fund

Article 217(1) requires a notional Solvency Capital Requirement for each ring-fenced fund and for the remaining part of the undertaking, calculated as if they were separate undertakings. Guideline 9 spells out what that means for the standard formula: the fund gets its own operational risk charge and its own loss-absorbing capacity adjustments, diversification within the fund is recognised through the normal correlation matrices, and where profit participation exists the charge is net of the future discretionary benefits that can be cut in the shock, capped by Article 217(5) at the benefits held in the fund. This requirement applies under both the standard formula and an internal model. Internal-model undertakings must also evidence how the model reflects material diversification restrictions arising from ring-fenced funds.

Two details trip people up. First, Article 217(6) fixes the scenario: bidirectional shocks such as interest rate up or down are not chosen per fund. The undertaking finds the direction that hurts basic own funds most for the undertaking as a whole (Article 217(7) adds the impacts across all funds and the remaining part) and applies that direction inside every fund. Second, a negative charge in a fund under that scenario is set to zero (Guideline 9(d)), and negative notional SCRs are floored at zero before aggregation (Guideline 12).

Why diversification is lost

Article 217(2) is one sentence: the SCR of the undertaking is the sum of the notional SCRs for each ring-fenced fund and for the remaining part. Article 217(9) closes the door on any offset by requiring the undertaking to assume no diversification of risks between each fund and the remaining part.

Under the standard formula, the BSCR correlation matrix in Annex IV of Directive 2009/138/EC assigns a coefficient of 0.25 between market risk and life underwriting risk. An insurer exposed to both therefore receives diversification credit. Ring-fencing removes that credit between a fund and the remaining part: diversification still applies within each calculation, but not across that boundary. Guideline 17 requires standard-formula undertakings to identify the effect by risk module, and its Technical Annex allows a simplified comparison by direct summation at sub-module or module level.

Restricted own funds: the adjustment to the reconciliation reserve

The second consequence works on the numerator. Article 81(1) requires the undertaking to reduce its excess of assets over liabilities by comparing the restricted own fund items within the fund with the fund’s notional SCR. Whatever exceeds the notional SCR is deducted from the reconciliation reserve, so only own funds up to the notional SCR contribute to covering the undertaking’s SCR and MCR (Guideline 11). If the fund’s own funds are at or below its notional SCR, there is no adjustment.

Article 80(2) excludes future transfers attributable to shareholders from the restricted own funds, since that part of the surplus can leave the fund. Article 81(2) offers a shortcut for immaterial funds: deduct the whole of the restricted own fund items instead of calculating a notional SCR, and fold the fund into the remaining part for the SCR (Guideline 5).

Paragraph 1.5 of the guidelines adds that the notional SCR is not a requirement the fund itself has to meet: a fund short of its notional SCR breaches nothing, provided the undertaking’s own funds as a whole, after the restriction and the Article 82 tiering limits, cover the total SCR.

What changes on 30 January 2027

Recital 53 of Directive (EU) 2025/2, the Solvency II Review directive, says undertakings using the matching adjustment should calculate their SCR with full diversification between the matching portfolio and the rest of the undertaking, unless that portfolio itself forms a ring-fenced fund. Delegated Regulation (EU) 2026/269 removes the references to matching adjustment portfolios from Articles 70, 81, 216, 217 and 234 of Delegated Regulation (EU) 2015/35. Article 81 is retitled “Adjustment for ring-fenced funds”. The amendments apply from 30 January 2027.

EIOPA’s Revised Guidelines on ring-fenced funds delete paragraph 1.15 of Guideline 4 and paragraph 1.6 of the introduction, so matching adjustment portfolios no longer pull Guidelines 6 to 17 with them. Guidelines 6, 7, 11, 15 and 16 are deleted as redundant with the legal text. The Revised Guidelines replace EIOPA-BoS-14/169 from 30 January 2027. From that date, a matching adjustment portfolio is a ring-fenced fund only if it meets the ring-fencing test on its own terms, so a fund register should be reclassified before the first reporting run under the new rules.

Reporting: S.01.03, S.25.01 and the SR templates

S.01.03 is the register. It lists every ring-fenced fund and matching adjustment portfolio, material or not, with a fund number (C0040) that must stay consistent across templates and over time, a name (C0050), the type (C0060), embedded funds (C0070), materiality (C0080) and Article 304 status (C0090).

S.25.01 is where the SCR effect lands for standard formula undertakings. Columns C0030 and C0040 carry the net and gross charge per risk module as if there were no loss of diversification, and column C0050 the allocation of the RFF adjustment. Row R0120/C0100 holds the total adjustment due to RFF/MAP nSCR aggregation, rows R0410 to R0430 the total notional SCRs for the remaining part, the ring-fenced funds and the matching adjustment portfolios, and R0450 the method used for the adjustment.

Each material fund also reports its own SR templates with its fund number in Z0030: SR.02.01 for the balance sheet, SR.12.01 and SR.17.01 for technical provisions, SR.25.01 for the SCR and the SR.26 series for the risk modules. S.23.01 row R0740 shows the own funds deduction. Reserving inside a fund follows the same rules as in the remaining part, so an IBNR estimate for business in a ring-fenced fund is built the same way and then attributed to the fund.

Where this lands in the software

RFF Tool runs the standard formula for every ring-fenced fund and for the remaining part at the same time, so the notional SCRs, the worst case scenario direction for the undertaking as a whole and the adjustment for lost diversification come out of one calculation instead of a spreadsheet per fund. Assets already prepared for the list of assets and the look-through can be split into risk buckets per fund, and the liability importer takes structured internal data on liabilities, funds and exposures and assesses the underwriting risk of each balance sheet in the same pass. The results are mapped to the reporting templates and transferred to QRT Tool with one click, which can populate S.25.01, the SR templates and the register in S.01.03 with consistent fund numbers. A free account is available for the full test and transition period.