The Ledger

To IFRS 17 and Beyond

July 13, 2022
Posted by Brian Heale
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This article was previously published in The Digital CFO Magazine.

Most Insurers are now nearing the end of their IFRS 17 solution implementation and are loading their opening balances. Once complete, they can start analysing their initial results and assessing the impact of the Standard on their business and reinsurance arrangements. This shift in focus will usher in the next challenge for Insurers impacted by IFRS 17, namely, how an Insurer can formulate optimal IFRS 17 results based on the scenarios and accounting judgements applied.

This is of critical importance as IFRS 17 will have an impact on virtually all aspects of the business, from profit to dividends to reinsurance optimisation and through to KPIs. Equally, the Rating Agencies are awaiting the publication of the first IFRS 17 results in early 2023 to analyse and compare across the insurance market. To add another layer of complexity, they will also expect to see the key KPIs on both an IFRS 17 and IFRS 4 basis, at least for a few years!

Currently, there is no market consensus on what the new KPIs should be. It’s likely many existing KPIs will still be utilised but adjusted for IFRS 17 while new IFRS 17 specific KPIs will be added and evolve over time. Metrics will, of course, differ between Life, P&C, and Reinsurers.

So, what does this mean for Insurers gearing up for the first year of reporting under the new standard? The next 6-12 months will undoubtedly involve simulation and forecasting to understand the impacts on key metrics under a variety of scenarios with the aim of producing favorable and explainable results to the market.

Below, is a brief summary of the key metrics that are the most relevant for Life Insurers. A detailed analysis is beyond the scope of this article, but greater detail is provided in our White Paper entitled A detailed look at Insurance industry KPIs in a post-IFRS 17 world. 

Life KPIs

Below is a summarised analysis of the existing metrics that will be affected by IFRS 17 and the new KPIs that are emerging for Life Insurers.

Adjusted Operating Profit (AOP) adjusted by EBIT Various adjustments are likely to be required and will be more complex under IFRS 17. The Standard may smooth out an Insurer’s AOP, but other factors need to be considered. For example, do you exclude mismatches? Do you take out short-term market movements caused by market fluctuations and economic variances? This will be down to interpretation.
Value of New Business (VNB) This will remain an important metric for Life Insurers. VNB is a measure of the economic value of profits, which will change under IFRS 17, and is expected to emerge from new business, net of the cost of supporting capital. Some Insurers also use VNB Margin as a metric that is indicative of profit margins in an Insurers’ book of business. Equally, SII VNB will continue to be a KPI and compared to IFRS 17 VNB.
Embedded Value (EV) This is a core insurance metric and a measure of the economic value of the shareholder capital in the business and the profits expected to emerge from the business currently in force.
Insurance Contract Revenue This is a new measure that differs considerably from the current equivalent of Gross Written Premium (GWP). ICR provides information about the amount of service provided in the relevant year. Depending on the expected duration of the contracts, the scale of the differences can be significant, particularly for long-term contracts.
Contractual Services Margin (CSM) and Risk Adjustment (RA) These are designed to provide more uniform profit metrics and are major new KPIs introduced under IFRS 17. Cohort profitability and the associated narrative will be a pivotal contributor to improved transparency under IFRS 17. For Management Information (MI) purposes, Insurers will want to know the contribution to current profitability, in the form of CSM amortisation, from both current and historic cohorts. Reconciliation of the CSM and the Analysis of Change of the CSM over time will become increasingly important to analysts.
CSM + Net Asset Value (NAV) This looks to become a major balance sheet/profit metric moving forward as it also aligns with an own funds perspective under SII. Looking at the two together helps to understand balance sheet metrics such as gearing. The CSM and its release over time will become a key profit metric. One of the main challenges here is the CSM metric varies between books valued on a GMM versus VFA basis and there is no CSM for PAA/Investment business.
Return on Equity (RoE) This typically represents net income attributable to shareholders, divided by the average shareholders’ equity, excluding unrealized gains/losses on bonds, net of shadow accounting at the beginning of the period and at the end of the period. It is another performance indicator for Insurers and will continue to be calculated and adjusted for IFRS 17 – primarily in relation to the CSM.

General Insurers

P&C Insurers currently disclose fairly limited information relating to profitability and KPIs are primarily based on loss ratios on an aggregated basis, including prior period business. This changes under IFRS 17 and Insurers will have to adjust accordingly.

Combined Operating Ratio (COR) This remains a key metric for P&C Insurers, although the underlying inputs will change because of IFRS 17. For example, long-term claims now must be discounted, and the risk adjustment added. Additionally, Insurers have the choice of calculating CoR on a Net/Net or Net/Gross basis. From a P&C perspective, the market seems to be moving towards a net-of-reinsurance result (Net/Gross) ratio. For P&C Insurers using the PAA measurement model, excluding onerous contracts, there is no requirement to disclose the ultimate expected profitability on new business, and doing so would require an additional calculation.
Gross Underwriting Gross Underwriting results are included under IFRS 17 and are an integral part of CoR which also needs adjusting to take into account attributable costs (e.g., claims handling) and non-attributable costs. The Standard permits interpretation in this regard so different interpretations will be made by insurers. This may result in a reduction in CoR but underlying expenses will be broadly the same.
Loss Ratio The Loss Ratio is another existing P&C metric that does not readily translate under IFRS 17. Under IFRS 17, line items are derived by various adjustments – for the variance in cash flows or for time value of money for example. However, the losses incurred will stay the same regardless of the accounting regime considered. Discounting those losses and the ICR from inception means that results are subject to the sensitivity of the discount rates and the coverage units.
Gross Written Premium (GWP) P&C Insurers use Gross Written Premium as a key KPI, and this will remain a KPI. Many Insurers also currently disclose Annualised Premium Equivalent (APE) or Present Value of New Business Premiums (PVNBP), as KPIs, which provide a view of the volumes generated over the period. For the next few years, these metrics are likely to continue to be disclosed, although reconciled with ICR.

Reinsurance

Perhaps the biggest challenge IFRS 17 introduces is around measuring reinsurance treaties which in turn has a material impact on an Insurer’s Balance Sheet both at transition and at future reporting periods. Additionally, many Insurers use reinsurance not only to mitigate risk but also to potentially arbitrage for profit. Future profit emergence also impacts dividends, shareholder equity, and rating agencies’ expectations.

Current practice is to use a mirroring approach, essentially matching reinsurance contract revenue, costs, assets, and liabilities to the underlying insurance contracts. IFRS 17 makes this approach redundant, requires reinsurance treaties to be measured separately, and introduces the concept of the reinsurance CSM that must be calculated and amortised over the reinsurance coverage. This requires a separate measurement of the impact of direct and reinsurance treaties on the recognition of reinsurance recoveries in respect of any underlying onerous contracts. IFRS 4 allows the impact of onerous losses for expected recoveries to be factored in for direct contracts held, resulting in a netting out effect. IFRS 17 includes specific requirements for determining the reinsurance recoveries associated with underlying onerous contracts – the Loss Recovery Component (LRC) for reinsurance on new business. This new component may also be considered a KPI by some insurers.

Currently, few Insurers report specific reinsurance KPIs, but this will change under IFRS 17. Separation of reinsurance in the P&L means the performance of an Insurer’s reinsurance portfolio will be more visible. For example, the netting of ceding commissions which shows the numbers net of these gross-ups. Ceding commissions and profit commissions typically lower net claims ratios when using the Net/Net approach more significantly under IFRS 17 than under IFRS 4 or local GAAP reporting.

The post-IFRS 17 world

The market and analysts will carefully examine and dissect the first sets of IFRS 17 reports to hit the press. They can then assess the impact of the accounting changes on an Insurer’s business. Analysis between the IFRS 17 and IFRS 4 numbers will have to be undertaken to understand the differences and many will look to calculate their KPIs under both regimes for the foreseeable future. IFRS 17 is more granular and therefore understanding the impacts on KPIs at different levels of aggregation will be critical. This analysis, while vital for the market, will also be important for internal management and shareholder education. A lucid explanation of the deltas will also be important.

Whilst January 2023 will be the technical end for IFRS 17 projects, Insurers will likely spend the following few years refining IFRS 17 results and compare with those of their peers. So, in some respects, the work has only just begun!

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This blog post was written by:

Brian Heale
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