In this blog post we consider some aspects of IFRS17 that are relevant to actuaries working in general insurance.
IFRS17 is set to shake-up insurance accounting with the aim of providing transparent financial information about insurance contracts. At the heart of the standard is the assessment of insurance contract liabilities which will require input from actuaries.
Some particular aspects of the standard that are of interest to general insurance actuaries include:
- The calculation of the liability for incurred claims (expired risk).
- The calculation of the liability for remaining coverage (unexpired risk).
- Determining which group a contract belongs to.
- Reinsurance contracts held.
- Reporting and disclosures.
Let’s consider each one in turn.
1. Calculation of the liability for incurred claims (expired risk)
The current basis for GAAP reserves calculated by actuarial teams is quite different to that required by IFRS 17. Solvency II technical provisions are much closer to IFRS 17, and tend to be produced after GAAP reserves by way of a waterfall of steps from GAAP to Solvency II. Adjustments include allowances for discounting, expenses, contract boundaries, risk margin and events not in data.
Actuarial calculations that were an add-on in the Solvency II world, will now need to be embedded into regular reserving processes
While the calculation of the incurred claims liabilities may have similarities with the calculation of technical provisions and can draw on the processes used under Solvency II, there are some nuances to get to grips with. Some of these nuances will be easily handled but others will require more effort. Furthermore, actuarial calculations that were an add-on in the Solvency II world, will now need to be embedded into regular reserving processes.
One issue that is likely to present a challenge for many insurers is the discount rate. Not only is there a different approach to determining the discount rate but rates at both initial recognition and the current reporting date are required in each valuation exercise. This will necessitate operational changes to systems as well as changes to actuarial calculations.
With regards to the risk adjustment, the need for separate gross and reinsurance risk adjustments as well as granularity in the risk adjustment, will present challenges.
The requirement for reserves to consider the full range of possible outcomes may cause some actuaries to revisit the issue of aligning stochastic with deterministic reserving.
2. Calculation of the liability for remaining coverage (unexpired risk)
The initial reaction to IFRS17 was that most general insurers could, and should be able to, use the Premium Allocation Approach (PAA), a simplification aiming to reduce implementation costs for insurers while retaining useful information for users of financial statements.
The market now seems less sure. Some insurers have already assessed their business and found that not all of it is eligible for the optional PAA simplification. Moreover, consideration is now being made of the benefits of PAA against the drawbacks of having two calculation methods.
If the PAA cannot be used, or the insurer chooses not to use it, the General Measurement Method (GMM) is the default. This will require actuarial input and is a change compared to GAAP, where actuarial involvement in the unexpired premium reserve is minimal.
3. Determining which group a contract belongs to
IFRS17 requires contracts to be aggregated into groups based on their date of issue and expected profitability with loss-making (“onerous”) contracts grouped separately from profitable ones. Contracts that are onerous from day one and those that have the potential to become onerous are grouped separately.
Grouping will be easily achieved in some instances but for other portfolios, where there is heterogeneity in pricing approach, risk profile or uncertainty, it will be more difficult. Furthermore, due to the inclusion of expenses in the assessment for onerousness, rather than the traditional test for additional unexpired risk reserve, the trigger point is much closer. It is very possible that further actuarial analysis will be required to justify the grouping to auditors. Sensitivity analysis around some assumptions may also be required to support any such grouping.
Some lines of business may be considered sufficiently heterogenous that analysis at much greater granularity than current reserve classes will be required. For example, in many London Market lines expected profitability and risk profile of primary layers versus excess layers can be very different. Would these need to be separated?
We expect the issue of grouping to be discussed further by actuaries as it raises numerous questions including:
- Will our groups for reserving exercises be different to our current grouping?
- What implications will this have for consistency between pricing and reserving work?
- How should we handle the risk adjustment in determining onerousness?
- Will existing reserving methodologies remain appropriate if groups are much smaller?
- If reserving is currently on an accident year basis, does this need to change?
4. Reinsurance contracts held
IFRS17 generally requires the accounting of reinsurance contracts held to be consistent with that of the underlying insurance contracts with profit or loss from reinsurance recognised over the reinsurance coverage period. However, there are some technical differences and some practical challenges to overcome.
Since the GMM is applied with certain modifications it is likely to fall within the remit of actuaries. Challenges that we have already discussed such as the risk adjustment and grouping will also apply to reinsurance. Additional complications arise because the grouping of reinsurance contracts may not mirror the groups of the underlying insurance contracts and there could be a further mismatch if the PAA approach is used for the underlying contracts but not for the reinsurance contracts held, or vice versa.
5. Reporting and disclosures
Since the liabilities under IFRS17 are likely to be different to those under GAAP and Solvency II, actuaries will have to think how best to communicate those differences to senior management. With add-ons from Solvency II becoming embedded into IFRS17, thought will need to be given to the governance structure of the process. In some companies, the Solvency II figures are the responsibility of the risk team, rather than the finance team, and so actuaries may need to provide training to ensure that those responsible for signing-off on the figures are able to do so.
Explanation will also need to be provided to aid understanding of the differences in figures from one reporting date to the next. One of the key elements of IFRS17 is that it is based on updated information and so elements such as discount rates and cash flows will need to be updated at each reporting date with changes flowing through to the P&L. Since there is no Solvency II P&L as such, this type of information will be new and will require careful communication.
Other changes such as modification of a contract or transfer of contracts due to acquisition may also need actuarial input with regards to both assessment and explanation.
Actuaries will have to think how best to communicate differences to senior management
Many years of thought have gone into IFRS17 so it is to be expected that some considerable effort will be required to implement it successfully. The market is still considering the implications of the standard and actuaries will continue to debate some of the detail through 2018 and beyond. A collaborative approach between IT, finance, actuarial and auditors will be needed and if actuaries are involved in the process from the start, then it can only make the process run smoother come January 2021.
Gemma Gregson is a senior consultant at Insight Risk Consulting and Buu Truong is the Managing Director of Insight Risk Consulting.
This blog is based on our current (November 2017) understanding of IFRS17 and experience of the UK general insurance market. It is intended for general interest purposes only.