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From 1 January 2023, new requirements set out in the International Financial Reporting Standards (IFRS) on Insurance Contracts and Financial Instruments will change how insurance companies are required to measure and report their performance. From a geographic standpoint, these new reporting standards will have broad global coverage, with some notable exceptions, including the US.1
The accounting standards, set out in IFRS 9 and 17, will affect every sector of the insurance industry and will have a significant impact on long-term contracts, notably for life and health insurance. In particular, the changes will influence how insurers’ investment teams and actuaries manage assets and liabilities and allocate to fixed income, equity and hedging strategies.
Here, in the first of three papers on the new accounting standards, we outline the implications of these changes for managing insurance investment portfolios and balance sheets.
As detailed in Figure 1, IFRS 17 introduces radical changes to the technical provisions relating to how insurance liabilities are measured and reported. These changes will have quantitative as well as qualitative impacts for financial statements.
Measurement: Under the current accounting standard (IFRS 4), in many jurisdictions, technical provisions are valued based on historical data. As such, those valuations are insensitive to changes in risk drivers from one reporting period to another. IFRS 17, in contrast, introduces a direct link between the valuation of technical provisions and risk drivers, notably interest rates. Changes in risk drivers between reporting periods could therefore affect the value of technical provisions and impact the level of emerging profit. As such, this stronger link between the valuation of technical provisions and risk drivers could induce volatility.
Performance: IFRS 17 also modifies how changes in valuations flow through the financial statements, which will affect how profit emergence is displayed as well as key performance indicators, from return metrics to leverage.
Also summarised in Figure 1, IFRS 9, which relates to how insurance companies’ financial assets are valued and displayed, has a number of implications for the measurement and performance of financial investments.
Measurement: Valuations across most asset classes will remain based on fair value, reflecting prices observed in the market or derived from up-to-date market-consistent parameters. However, the valuation of some fixed income assets may become more volatile and skewed to the downside because IFRS 9 introduces ex-ante credit metrics (Expected Credit Losses — ECL) and requires the mark-to-market of asset classes that do not generate predictable cash flows (as measured by the Solely Payments of Principal and Interest test — SPPI).
Performance: For fixed income assets, both the ECL and SPPI tests may increase the volume of changes in valuations that flow through the income statement. For equities, changes in valuations will continue to flow through the income statement or “other comprehensive income” (OCI). However, selling equity securities will not trigger gain or loss recycling through the income statement. Investments in mutual funds and entities with a limited life will typically be treated as puttable instruments; given their structural features, the changes in valuation will flow through the income statement.
In our second paper, we’ll outline the range of approaches insurers should consider to mitigate the impact of the new accounting standards on their shareholders and mutual members.
1A list of the countries covered by the new IFRS requirements is available at: https://www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-jurisdiction/
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