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Traditional profitability metrics such as loss and expense ratios may change significantly under International Financial Reporting Standards (IFRS) 17, particularly for reinsurers, said rating agency AM Best.
In a new report, “IFRS 17 - Economic View Adds Complexity to Reinsurers' Financial Statements”, released ahead of the Monte Carlo Rendez-Vous de Septembre in two weeks, the rating agency said the ongoing shift in financial reporting to IFRS 17 was now fully underway, which represented “a significant accounting change that has necessitated segmentation of performance analysis in the reinsurance market”.
In its report AM Best said that under IFRS 17, reinsurers have seen a greater impact on combined ratios than the direct market has. “The impact on profitability is further dampened by a lower investment result than previously”. This, they said, was due to the investment expense from unwinding the discounting.
"We believe insurers will reduce volatility in their profitability by switching
the recognition of assets from FVPL to FVOCI."
IFRS became effective on January 1, 2023, although some European and Asian insurers will adopt it over a period of three years.
Countries including South Korea have made some headway in adopting it. In a July report, rival rating agency Fitch Ratings report that the country was expecting to see market volatility following some changes related to IFRS 17 adoption.
The changes to recognise financial instruments using fair value through profit and loss (FVPL) could lead to an increase in volatility in investment returns, although stable underwriting performance may offset this, Fitch said. “We believe insurers will try to reduce volatility in their profitability by switching the recognition of assets from FVPL to fair value through other comprehensive income (FVOCI)”, it said.
In June, Christopher Wright, Group Treasurer, Legal & General, told Insurance Investor, that the sector has also been managing the transition to IFRS17 and IFRS9, which “is ultimately an uneconomic reporting change”.
“However, what it does present, from a hedging perspective, are opportunities around how insurers can better manage hedging across different bases, and in particular increase the focus on hedging for the most economically and capital efficient outcomes,” he said.
Elsewhere in the world, Angie Cantillon, VP – Investments and Corporate Treasury, from Canadian Wawanesa Insurance, told Insurance Investor in March that the IFRS 17 changes were driving her organisation to look at different investment strategies. “Over the last couple of years, we've been looking at privates, especially with the shift to IFRS 17, which was significant for us,” she said. “With these changes, unrealised gains and losses are now above the line. Previously, it was all in comprehensive income, so market volatility of publicly traded securities had less of an impact on a company’s profitability.”
“The move from IFRS 4 to IFRS 17 is a significant change for those in
the insurance industry adopting the new accounting standard."
The report specified that IFRS 17 has started during a “one of the hardest reinsurance markets in decades” and that its much-discussed effects are likely to come to fruition at a time when reinsurers are carefully watching balances already.
“The move from IFRS 4 to IFRS 17 is a significant change for those in the insurance industry adopting the new accounting standard,” said the report. “Although the transition brings about changes to metrics for all types of re/insurers, it is a far more radical change for life and composite re/insurers.”
This is because it allowed a “more meaningful” accurate representation of earnings.
Some of the key considerations for reinsurers to look out for as part of this new model include IFRS 17 requiring discounting of future cash flow for all insurance contracts, including non-life, and establishing a “risk adjustment” portion of the reserve, says AM Best, which would differ “significantly from the rules established in US GAAP accounting”.
“In many cases, this discounting has led to significantly lower loss reserves and, as a result, has driven equity positions up and leverage ratios down.
Another new area of the IFRS 17 is the contractual service margin (CSM), which represents the present value of unearned profit on a contract expected to be earned as insurance services provided. It is set up as a liability on the balance sheets.
Then there is the Variable Fee Approach (VFA) method of IFRS 17 - which is a modification of the general model for insurance contracts with direct participation features, where the policyholders share in the profits and losses of the insurance company
AM Best said this will affect investment’s at insurers because it will allow them to pass the insurer’s share of the investment result through the CSM, instead of a taking “what can be a volatile item directly to the income statement.”
The report said that even through discounting liabilities is meant “to support reinsurers’ asset-liability matching (ALM) more adequately, which in the past wasn’t aligned due to assets being carried at fair value and liabilities at amortised.
These changes could significantly change investment teams at insurers strategies as well as treasury and accounting measures, which are becoming increasingly intertwined and with more places adopting IFRS 17 there is likely to be more interest in it.
