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 halves of a solvency ratio. On the capital side that means a notional SCR per fund and a loss of diversification; on the own funds side, restricted own funds that no longer count in full. A worked example shows both effects, followed by what changes on 30 January 2027 and which templates carry the figures. 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, applied since 1 April 2015) 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.

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 comes from EU law. Occupational pension business written under Article 4 of Directive 2003/41/EC (the IORP Directive) must be ring-fenced, and where the undertaking holds no authorisation under Article 304 of Directive 2009/138/EC, Articles 81 and 217 apply in full. With an Article 304 authorisation the own funds adjustment still applies, but Article 216(2) exempts the fund from the sum-of-notional-SCRs rule and the SCR assumes full diversification between the fund and the rest of the undertaking.

Matching adjustment portfolios sit in this list today as well, through paragraph 1.15 of Guideline 4. That changes in 2027.

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.

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.

The standard formula SCR normally rewards a mixed balance sheet: market risk and life underwriting risk are aggregated with a correlation of 0.25, so a company running both carries less capital than the two charges added together. Ring-fencing removes that credit at the boundary of the fund: the correlations still apply inside each part, but not between them. Guideline 17 requires standard formula undertakings to identify that effect when reporting the SCR by risk module, and its Technical Annex allows a simplified comparison figure 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.

A worked example with round numbers

Take a life insurer with one material with-profits fund and a remaining part. Only two risk modules are used, market risk and life underwriting risk, correlated at 0.25 as in Annex IV of the Directive. Operational risk, loss-absorbing capacity and deferred taxes are left out, and the scenario direction is already the worst case for the undertaking as a whole. Amounts are in millions, rounded to the nearest whole number.

The fund has a market risk charge of 27 and a life underwriting charge of 8. Its notional basic SCR is the square root of 27 squared plus 8 squared plus 2 times 0.25 times 27 times 8, which rounds to 30. The remaining part has market risk 12 and life underwriting risk 66, which aggregates to 70. Under Article 217(2) the SCR of the undertaking is 30 plus 70, so 100.

Now the comparison figure. Adding the module charges across the two parts before aggregation, as in Simplification 2 of the guidelines, gives market risk 39 and life underwriting risk 74. Aggregated with the same correlation, the SCR as if there was no loss of diversification is 92. The adjustment due to RFF nSCR aggregation is 100 minus 92, which is 8. That 8 is reported in S.25.01 at R0120/C0100 and allocated across the risk modules in column C0050.

Then the own funds. The fund holds an excess of assets over liabilities of 50, none of it a future transfer to shareholders, so restricted own funds are 50. Its notional SCR is 30, so 20 of restricted own funds exceed it. Article 81(1) deducts 20 from the reconciliation reserve; in S.23.01 the figure appears at R0740. The remaining part holds own funds of 100. Total basic own funds before the adjustment were 150; after it they are 130.

The solvency ratio is 130 divided by 100, so 130 percent. Had the same balance sheet been one undertaking with no restriction, the ratio would have been 150 divided by 92, about 163 percent. The gap is the price of a fund whose surplus cannot leave and whose risks cannot offset the risks next door.

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. Commission Delegated Regulation (EU) 2026/269, published on 18 February 2026, 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, published on 15 July 2026, 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 also apply from 30 January 2027. From then on 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 populates 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.