Industry Impacts of IFRS 17
IFRS 17 is a big change for the life insurance industry. The transition to IFRS 17 continues to monopolize many resources. This transition highly impacts an insurer’s operations. It also affects how executives will manage the business.
Has the transition to IFRS 17 been an opportunity to re-think insurers’ product offering, investment strategy and risk appetite? The Assuris industry consultation sheds light on the question.
Over the last few years, the insurance industry has shifted its focus towards less capital-intensive products such as participating policies, short-term contracts, and investment products. Life insurers’ product offerings can be grouped into three categories:
Products with long-term protection (~retail insurance business)
Products with short-term protection (~group business)
Products without protection (~wealth business)
Sometimes, there is a thin line between offering and not offering an insurance product. Several aspects must be considered, such as client’s needs, the price, the insurer’s profits, and risk appetite. Finding the right balance requires a lot of work, and IFRS 17 will change insurers’ balance sheet, earnings, and capital ratio, which could have an impact on product profitability.
Balance Sheet
At the industry level, we expect a decrease in equity due to changes to liability measurement. The increase in liabilities is mostly driven by lower discount rate and Contractual Service Margin (CSM), which represents the present value of future profit.
At transition, equity is expected to decrease at the industry level due to an increase in best estimate liability and the creation of CSM, which is a liability on the balance sheet. The IFRS 17 balance sheet shows a more conservative equity value because future profits are not immediately recognized. For products with long-term guarantees, the profit will be recognized when the service is provided over the life of the contract.
Assuming the same economics, companies should earn the same profits over the life of the contract. Therefore, lower equity under IFRS 17 implies higher equity growth expectations under IFRS 17 compared to IFRS 4 regime.
In other words, a change in liabilities’ measurement does not change the economics of insurance. Total profits remain the same, but accounting affects the timing of earnings recognition. However, looking at the balance sheet, equity and earnings impact is not the whole story.
The insurer capital ratio is an important variable in the equation. The drop in equity at transition might be viewed negatively from a capital standpoint. However, the capital treatment of the CSM allows insurers to recognize these future profits immediately. The capital treatment of CSM has minimized the negative impact on insurers’ capital ratio.
Corporate Owners’ Dividend Expectations
Corporate owners provide capital in exchange for future dividend payments. The owners are focusing on their return on investment. The insurer’s capacity to free up capital and pay dividends depends on earnings and capital ratio forecast.
What is the implication of IFRS 17 on insurers’ capacity to release capital? We have broken down the insurers’ sources of profits to understand the impact on each component. The last column indicates the IFRS 17 impact on insurers’ capacity to free up capital. “Positive” means that IFRS 17 should be more favourable.
| Earnings | IFRS 4 | IFRS 17 | Impact |
|---|---|---|---|
New business gains |
Some future profits recognized at issue |
No future profits are recognized at issue |
Negative |
Release of reserve margins |
Known as PfADs (economic & insurance margins) |
Risk Adjustment (insurance margins) |
Negative |
Net investment return |
Assets return vs IFRS 4 discount rate |
Assets return vs IFRS 17 discount rate |
Positive |
CSM Release |
N/A |
In force block CSM Run-off |
Positive |
| Earnings | IFRS 4 |
|---|---|
New business gains |
Some future profits recognized at issue |
Release of reserve margins |
Known as PfADs (economic & insurance margins) |
Net investment return |
Assets return vs IFRS 4 discount rate |
CSM Release |
N/A |
| Earnings | IFRS 17 |
|---|---|
New business gains |
No future profits are recognized at issue |
Release of reserve margins |
Risk Adjustment (insurance margins) |
Net investment return |
Assets return vs IFRS 17 discount rate |
CSM Release |
In force block CSM Run-off |
| Earnings | Impact |
|---|---|
New business gains |
Negative |
Release of reserve margins |
Negative |
Net investment return |
Positive |
CSM Release |
Positive |
The table above assumes no experience gains and losses related to actuarial assumptions.
In addition to earnings, the insurers’ ability to release capital also depends on the relationship between available and required capital, which may further limit the ability to pay dividends. The capital regime under IFRS 17 was designed to achieve industry neutrality at transition.
| Capital Release | IFRS 4 | IFRS 17 | Impact |
|---|---|---|---|
Available capital |
IFRS 4 retained earnings |
IFRS 17 retained earnings |
Negative |
PfADs |
Risk Adjustment |
Negative | |
N/A |
CSM |
Positive | |
Required capital |
N/A |
Scalar reduction |
Positive |
| Capital Release | IFRS 4 |
|---|---|
Available capital | IFRS 4 retained earnings |
PfADs | |
N/A | |
Required capital |
N/A |
| Capital Release | IFRS 17 |
|---|---|
Available capital | IFRS 17 retained earnings |
Risk Adjustment | |
CSM | |
Required capital |
Scalar reduction |
| Capital Release | Impact |
|---|---|
Available capital |
Negative |
Negative | |
Positive | |
Required capital |
Positive |
The research indicates that insurers’ capacity to free up capital should not deteriorate at the industry level under the new regime.
It is important to note that the implications of IFRS 17 differ for each insurer. The impacts at the industry level may or may not represents an insurer’s situation. Many factors, such as business mix, investment strategy, and CSM growth, could impact an insurer’s capacity to free up capital.
Volatility
Business owners usually prefer predictable results. Managing earnings and capital volatility is a critical task for the life insurance business. The new regime may or may not generate additional volatility, subject to how insurers will adapt to this new regime.
The insurer’s block of business and investment strategies will affect the volatility of financial results, in particular, because financial guarantees are measured based on a market-consistent approach and the insurer’s assets and liabilities are “de-linked” under IFRS 17. Under IFRS 4, liabilities were valued in reference to the value of the assets supporting those liabilities. This was known as the Canadian Asset Liability Method approach or CALM. Under IFRS 17, liabilities are valued based on the liquidity characteristics of insurance contracts without reference to the actual assets backing those liabilities.
Assets and Liability Management (ALM) practices and hedging will become even more important under IFRS 17. It is an area where we might see different approaches. Some insurers might be comfortable with the level of volatility, and others might prefer to reduce volatility. Modifications to investment strategies such as reduction in Non-Fixed Income (NFI) assets and surplus assets reclassification could be used to mitigate earnings volatility.
In Summary
Overall, our consultation indicates that IFRS 17 implications on insurers’ business models should be minimal as it is defined as an evolutionary process rather than a revolution.
- Products with short-term guarantees and products that do not offer guaranteed protection are minimally impacted by IFRS 17.
- Even though the timing of earnings on life insurance products with long-term guarantees changes under IFRS 17, the implications are not significant enough to jeopardize the offering of these products.
- Business owners’ dividend expectations and product profitability should not change significantly.
- The real volatility of financial results remains to be seen. In any case, insurers have the expertise and tools to adapt to this new reality.
The insurance industry has a lot to manage with the IFRS 17 transition compounded with the financial market volatility we have seen in 2022. Nobody has a crystal ball, and 2023 could be another bumpy year as companies navigate reporting under the new standard. Managing IFRS 17 earnings and capital volatility will again test insurers’ capacity to adapt, but we at Assuris are confident that our industry will successfully rise to this latest challenge as it has so many times in past.
