Cracking the IFRS 17 Code: A Game-Changer for Actuaries

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IFRS 17 (International Financial Reporting Standard 17) marks a significant transformation in the way insurance contracts are measured and reported, impacting insurers across the globe. As actuaries play a crucial role in implementing and interpreting this new standard, their insights are invaluable for insurance companies transitioning to IFRS 17. This article explores key actuarial perspectives on IFRS 17 and its implications for the insurance industry.

Understanding IFRS 17

IFRS 17 is a comprehensive new accounting standard for insurance contracts, aimed at increasing transparency and comparability in financial reporting across the global insurance industry. It replaces IFRS 4 and introduces several new concepts and methodologies for measuring and reporting insurance liabilities and profits.

Actuaries have identified three primary measurement models under IFRS 17:

• GMM: General Measurement Model (GMM) is the default model for most insurance contracts. Actuaries note that it requires a more granular approach to calculating insurance liabilities than before, including explicit risk adjustment and contractual service margin (CSM) components.

• Variable Fee Approach (VFA) is a measurement model where policyholders are eligible for return on the underlying pool such as under unit-linked life insurance saving products.

• Premium Allocation Approach (PAA) is a simplified model for short-term insurance contracts.

Actuaries highlight the complexity in determining eligibility for this model and its unique treatment of the unearned part of profit known as Contractual Service Margin (CSM). Actuaries emphasize the importance of determining appropriate discount rates and risk adjustments as well as Loss Component. IFRS 17 requires the use of current market-consistent discount rates. Actuaries are developing methodologies to derive these rates, considering both top-down and bottom-up approaches.

The Risk Adjustment (RA) explicit component represents compensation for bearing uncertainty. Actuaries are exploring various techniques, including cost of capital and confidence level approaches, to quantify this adjustment. Defining contract boundaries and projecting relevant cash flows are critical actuarial tasks under IFRS 17. Actuaries note that this may require reassessment of existing assumptions and models, particularly for long-term contracts with renewal options.

IFRS 17 introduces new requirements for grouping insurance contracts. More granular information can inform product design, pricing, and strategic decisions. IFRS 17 expands the role of actuaries, providing opportunities for skill development and increased collaboration with finance and IT teams. A key feature of IFRS 17, CSM represents the unearned profit embedded in an insurance contract. Actuaries help track the release of this margin over the contract’s duration, reflecting the insurer’s ongoing performance. IFRS 17 requires a quantification of uncertainties associated with future cash flows. This is an area where actuarial judgment is critical, ensuring the risk adjustment aligns with the company's risk appetite and market practices.

Challenges

The adoption of IFRS 17, a new international financial reporting standard for insurance contracts, has posed significant challenges for the insurance industry. The intricacies of the standard, coupled with the need for adjustments in existing systems and processes, have created a high-pressure environment for both insurers and auditors. Some of the challenges that are seen commonly are1:

• Lack of documentation. It’s difficult to see the thinking process behind policy decisions when it hasn’t been documented in the first place for an independent reviewer and when auditing. Given the lack of time and capacity, it’s mostly a choice between doing the actual work or documenting it. This puts the reviewer in a difficult position because they are not able to see how the final outcomes were arrived at.

• Insurers face challenges in validating their methodologies due to the need for a detailed interpretation of IFRS 17 and its application to diverse insurance contracts. The standard requires liabilities for insurance contracts to be calculated using updated estimates of future cash flows, discount rates, and a specific risk adjustment for nonfinancial risk. Applying this accurately demands an in-depth understanding of the standard and its relevance to various products and contractual terms.

• Subledgers, initially built for transaction-level data management, often need extensive modifications to support granular attrition analyses and facilitate controls and analytical reviews of IFRS 17 results. Similarly, ETL processes, which handle data transfers and transformations between systems, can be inflexible and slow to adapt to the iterative workflows and partial data requirements of ad-hoc analyses. This rigidity can impede timely results analysis and adjustments, increasing the risk of delays and errors in financial reporting.

• The implementation of new systems and workflows under IFRS 17 has revealed gaps in insurers' internal controls and governance structures. Responsibilities for processes, risk oversight, and internal auditing are sometimes unclear or inadequately defined. In some cases, internal controls lack sufficient scope to address the complexities introduced by the standard. Ensuring robust ownership and governance is essential to uphold the reliability of financial reporting. Despite these challenges, many insurers focus on achieving quick, incremental improvements across personnel, processes, and technology without making substantial changes to their operating models.

Further Considerations

The standard mandates the use of current market-consistent interest rates to discount liabilities, impacting the valuation of long-term contracts. Actuaries play a crucial role in selecting appropriate discount rates and analyzing their impact on financial results. The actuarial function is at the heart of IFRS 17 compliance, responsible for both technical modeling and strategic financial reporting. Key areas where actuaries add value includes; Actuaries design sophisticated projection models to estimate best-estimate liabilities, CSM, and other future cash flows. These models must capture policyholder behavior, claims development patterns, and economic assumptions, ensuring alignment with IFRS 17's requirements.

The calculation of risk adjustments involves setting confidence levels for different methods such as stochastic modeling and cost-of-capital approaches to quantify uncertainty. Actuaries guide this process by ensuring that the methodology reflects the insurer’s risk profile, complies with regulatory frameworks, and meets stakeholder expectations. IFRS 17 introduces volatility to financial results due to its market-consistent valuation approach. Actuaries conduct scenario testing and sensitivity analyses to assess the impact of changes in assumptions, such as interest rates or mortality rates, on profitability.

Successful IFRS 17 implementation requires large-scale data integration across actuarial, finance, and IT systems. Actuaries collaborate with finance teams to ensure accurate data flows, manage assumptions, and automate reporting processes. The transition to IFRS 17 presents several challenges for insurers, many of which require actuarial expertise to overcome. Measuring CSM, discounting cash flows, and setting risk adjustments are complex processes that require actuarial models with sophisticated algorithms. Developing and validating these models can be time-consuming. Actuaries need to work closely with IT and finance teams to integrate new reporting processes.

The standard demands a more frequent interaction between actuarial and finance departments, which could strain resources and require significant system upgrades. IFRS 17 introduces earnings volatility due to market-consistent discounting. Actuaries must carefully explain these fluctuations to stakeholders, including investors and regulators, to ensure they understand the true drivers of performance. The use of actuarial assumptions, such as discount rates and risk margins, introduces a degree of subjectivity. Transparent communication and documentation are essential to manage scrutiny from auditors and regulators. Actuaries now play a more strategic role by providing insights that shape product pricing, reserving, and capital management decisions. CSM analysis, for instance, offers valuable input into profitability projections and pricing strategies.

Post-implementation

The implementation of IFRS 17 fosters closer collaboration between finance, actuarial, and IT teams. This cross-functional approach strengthens the actuarial function’s role in decision-making. IFRS 17 shifts the focus from merely setting reserves to measuring performance over time. Actuaries contribute by analyzing trends in profit emergence, offering deeper insights into business dynamics. The shift to IFRS 17 requires actuaries to expand their expertise beyond traditional reserving techniques. They must enhance their skills in financial reporting, data analytics, and stakeholder communication to remain relevant in the evolving landscape.

The first year of IFRS 17 adoption has provided valuable insights and detailed data, prompting insurers to reassess and enhance their methodologies. By evaluating their outcomes against those of industry peers, insurers can pinpoint best practices and identify areas for improvement. This involves examining the financial and operational results from the initial reporting period, comparing these with those of competitors, and refining processes to ensure compliance, improve outcomes, and boost precision.

The initial IFRS 17 reporting cycle has brought unexpected findings to the insurance and investment sectors, highlighting significant variations in approaches, assumptions, and results across companies, despite the expectation of uniformity under a single standard.

Post-implementation, insurers are prioritizing cost management as they transition into routine operations. Maintaining the necessary data and computational frameworks involves considerable expenses, especially given the expanded data requirements and intricate calculations mandated by IFRS 17. Key cost-saving opportunities include streamlining data systems, optimizing computational frameworks, and managing related personnel costs efficiently.

Insurers are increasingly leveraging insights from IFRS 17 to guide strategic initiatives. Metrics derived from IFRS 17 are being used to refine forecasting accuracy and shape more effective business strategies. Concurrently, companies are adapting their operations in areas such as asset-liability management, investment strategies, and financial communications to optimize performance.

The sophisticated demands of actuarial modeling and the need for analyzing complex, multi-dimensional data are challenging traditional computational limits. To address these challenges, innovative technologies from computer science are being adopted. These include NoSQL databases for advanced real-time data processing and GPU computing to accelerate stochastic simulations and machine learning applications, enabling insurers to meet the rigorous demands of IFRS 17.

Conclusion

IFRS 17 represents a paradigm shift in insurance accounting, with far-reaching implications for actuarial work. While the standard poses significant implementation challenges, it also offers opportunities for actuaries to enhance their role in financial reporting and strategic decision-making within insurance companies.

As the industry moves towards the IFRS 17 compliance effective date and beyond, which is different as per each country, actuaries will continue to play a crucial role in interpreting the standard, developing methodologies, and translating complex requirements into practical solutions. Their insights will be instrumental in navigating this new era of insurance financial reporting.

IFRS 17 brings both ‘opportunities and challenges’ for the insurance industry, requiring a significant shift in how insurers measure and report their financial results. Actuaries are at the forefront of this transformation, providing technical expertise, strategic insights, and leadership in managing the transition.

The new standard demands greater transparency and introduces complexity into financial reporting, but it also enables insurers to align performance measurement with risk management more effectively. For actuaries, IFRS 17 is more than just compliance it represents an opportunity to elevate their role, expand their skillsets, and shape the future of insurance reporting. In this new era, actuaries must embrace a ‘multi-disciplinary mindset’, combining their traditional expertise with emerging technologies and financial knowledge. Those who succeed in this transition will not only ensure compliance but also position themselves as essential partners in driving business value and long-term sustainability.

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