The arrival of IFRS17 was with much anticipation, but a big bang was avoided by a protracted adoption timeframe as complexities associated with data requirements and the actuarial flair of the standard was a source of bewilderment for both experts and commoners.
A couple of years back, one East African risk manager heading a reputable regional life insurer described the standard as an attempt by actuaries to storm into the accounting standards field. This was not an urge to bring the two esteemed professions into a contest but a realisation of the complexities that come with accounting for contracts of various risks – whether it be insurance risk, investment risk or a seamless continuum of hybrid risks - without modelling the behaviour of cashflows associated with the contracts.
The principles to account for such economic benefits correctly across time are germane to accounting matching principles and the intricacies in layering risks and allocating the benefits to contracting parties, and modelling cashflow behaviour are largely the forte of actuaries. Accordingly, inadequacies under IFRS 4, an interim standard on insurance contracts, had to be addressed through a comprehensive range of data intensive models, which provide capable tools for intelligently allocating risk, ushering the introduction of IFRS 17: Insurance Contracts.
Structurally, the impact of IFRS 17 was expected to be mild on short term insurers and more impactful on life insurers. However, recent financial results on first time adoption show limited impacts across the board for the leading insurers. Of note, Santam, the continent’s largest short-term insurer, reported a R100m increase in the net insurance result to R1.8bn in the 2023 financial year relative to IFRS 4 comparatives.
Life insurers were expected to post significant changes, but regional behemoths bucked expectations: Old Mutual Limited and Sanlam Limited reported no significant changes in solvency on first-time adoption due to offsetting changes between equity and liabilities.
Nonetheless, the story is not fully told as the reporting period is still progressing and comparatives are updating with new financial results.
For context, IFRS stands for International Financial Reporting Standards and the process of developing standards is overseen by the International Accounting Standards Board (IASB).
According to the IASB, the objectives of accounting standards are transparency, consistency, accuracy and comparability.
- Why the muted insurance ratings impact from IFRS17?
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These are achieved through setting common rules for presenting financial statements. In this respect, the IASB issues new standards to ensure that financial statements are reliable and relevant to users, who in turn base their financial decisions on these agreed principles, which are rigorously developed and reviewed through public opinions and other internal tests before final adoption. Given that the first-time adoption date for IFRS 17 was 1st January 2023, after a two-year deferment that afforded insurers time to develop proper systems, full year results to 31 December 2023 provide a glimpse into the ex-post impact analysis of the standard.
This is an exciting juncture and as Warren Buffet, relevantly the co-founder of Berkshire Hathaway (13 th largest global insurer by NWP in 2022), said “only when the tide goes out do you discover who has been swimming naked”.
The main gripe with the IFRS 4 stop gap measure and prior standards was lack of comparability of financial statements among insurers depending on the nature of contracts issued: major categories being insurance and investment contracts.
The distortion presented by the mix of insurance and investment contracts is more egregious among life insurers relative to non-life entities, given that they sell insurance products, investment products and hybrid products.
In simple terms, a whole life insurance policy without a surrender value or savings component is an insurance risk product and a pension or deposit administration product without a guaranteed rate is an investment product, while hybrid products like deposit administration with guarantees blend both risks.
The recognition of profit over the life of insurance contracts forms the core of the contention of IFRS 17 with preceding standards through the introduction of the contractual service margin (CSM) - future profits in insurance contracts - to ensure that profit and losses are accounted in the income statement as the service is provided.
In this respect, the CSM will be released gradually over the life of the insurance contract, with loss making products or onerous contracts precipitating an upfront loss in the income statement, thus accelerating the equity decline from poor-quality business.
Suffice it to say that discrepancies in the profitability of insurance contracts in various years from origination, time value of reserves and levels of risk participation among contracting parties, which caused comparability problems among insurers are expected to reduce or at the least be ventilated under IFRS 17.
This is without deep diving into the technical jargon of IFRS17 and multiple approaches under Premium Allocation Approach (PAA) mostly for short term contracts; General Measurement Model (GMM) – core model for long term contracts; and Variable Fee Approach (VFA) – handling contracts with direct participation features through guarantees and profit-sharing arrangements.
These models are a full-on menu for accounting and risk professionals. Nonetheless, the standard is not a fix-it-all to comparability issues as there are many areas for discretion and more amendments are reasonably expected over the future period.
The more prevalent distortion was on life insurers accounting for investment contracts (mostly pension and deposit administration contributions) entirely or in part as gross premiums and inflating the top-line.
Alternatively, conservative life insurers either consolidated the net result of investment business into one line under other income or lumped interest and claims on investment contracts with insurance contracts lines, accounting for the residual balance in other income without distorting revenue reporting.
Conservative insurers also included notes for revenue accounts, which fully disclosed the performance of each product, allowing users to make adjustments and improve comparability.
However, the high level of accounting discretion had repercussions for performance and credit assessments. Using this simple case, the comparison of premium scale among jurisdictions was highly distorted and lack of comparability may continue over the medium term as some markets are hesitant to adopt IFRS17 and elect to use local standards if regulations permit. Furthermore, the discounting of reserves at market consistent levels allows for discretion, either derived using a bottom-up or top-down approach, complicating the discount rate build-up for countries with unstable fixed income securities markets like Zimbabwe.
The impact of IFRS17 on short-term insurers has so far turned out limited, especially in cases where the majority of contracts have boundaries of less than 1 year. However, if a significant portion of the business has long tail contracts where claims are expected over multiple future years or the contract is long term, discounting has a positive impact on the insurer’s net position.
This is due to funds being paid out at lower future value amounts. In subsequent years, movements in interest rates relative to locked rates will introduce losses and gains on the in-force book and impact either profit or equity.
As per Santam’s 2023 financial results, under IFRS 17 the reinsurance cost is risk attaching and spread over the coverage period of the underlying risk compared to the reinsurance contract period under IFRS 4.
Second, the claims incurred liability benefitted from the impact of discounting longer tailed business at market consistent rates. Third, the reclassification of reinstatement premiums as claims rather than a premium reduction increased Santam’s net earned premiums and claims with no net income effect.
Finally, the sales component of binder fees was included in commission under IFRS 17 as opposed to administration costs under IFRS 4 increasing the net commission expense and reducing the operating expense ratio by equivalent amounts. In this respect, the largest short-term insurer in Africa experienced muted impacts of IFRS 17 in line with expectations.
IFRS 17 impacts on life companies were expected to be deeper and far reaching. However, trailblazing major life insurance companies weathered the storm due to years of in-built prudence that accumulated discretionary capital.
Old Mutual Limited group reported an equity reduction of R4.5bn in transition equity, which was offset by a R3.4bn increase in liabilities, largely from a higher CSM recognition. The net total assets movement on the 1 January 2022 opening balance sheet was a comparably small R1.1bn.
Overall, there was no impact on cash or capital generation, ability to invest in new growth areas, ability to pay dividends and solvency position. Similarly, Sanlam Limited reported no significant impacts on the same factors as Old Mutual Limited but pointed to the acceleration of earnings recognition in the income statement due to the deferment of acquisition costs and faster recognition of profit from zeroised liabilities (non-recognition of negative liabilities from profitable contracts).
This was in line with international trends as Zurich based Allianz, which recently entered into a partnership with Sanlam Limited reported no significant changes in profits and incomes but a lower equity figure due to shareholder margin on unrealised gains for direct participating business moving to the CSM. Given that the insurer will use the aggregate of shareholders’ equity and net CSM in leverage calculations, a slightly favourable outcome was realised from the adoption of IFRS17.
Overall, the stability of financial results among leading insurers points to modest changes from the first adoption of IFRS 17 and no material changes in the financial strength of insurance companies. Pleasingly, recent rating outcomes show no changes, with Fitch Ratings affirming Sanlam Life and Santam at national scale financial strength ratings of AAA (zaf) and A.M Best affirming Allianz SE‘s international scale financial strength rating of A+/stable outlook. However, smaller insurers in less regulated environments with minimal in- built prudence could show different financial results and higher susceptibility to rating migration.
The full release of ratings from emerging and frontier risk carriers will show whether there were significant financial reporting shortcomings in less developed jurisdictions that could drive significant changes in financial strength and associated ratings from the first-time adoption of IFRS 17.
