Which IFRS 17 combined ratio should you use?

While a new key performance indicator (KPI) under IFRS 17 was intended to replicate the well-known combined ratio, this equivalence might not hold true in practice when all components and complexities of a real profit and loss statement (P&L) are included, MSA Research warns in a new report.

The report looked at the net combined ratio (fully discounted), combined insurance service ratio (CISR) and net insurance service ratio (NISR), and when it may be best to use each ratio.

At a high level, the net combined ratio (fully discounted) and other net ratios attempt to replicate the combined ratio under IFRS 4, MSA said in its P&C Quarterly Outlook Report for 2023 Q4. “Some people in the industry have expressed concerns about the new combined ratio used by MSA Research and have proposed alternatives, which has sparked the idea to produce this article,” reads MSA’s Will the Real Combined Ratio Please Stand Up?

Some stakeholders have argued that the net combined ratio (fully discounted) may be too complicated and that a similar approach, leveraging only information available on the new P&L may be preferable, wrote Philippe Grégoire, a consulting actuary from JSCP, with support from another JSCP consulting actuary, Raul Martin, and MSA Research CEO Joel Baker.

Following discussions with stakeholders, CISR was introduced as a new KPI. The CISR is meant to include the net reinsurance expense in the numerator as opposed to allocating its underlying components between the numerator and denominator as is done under the net combined ratio (fully discounted), the article explains. “This measure is not meant to replace the previous ones but rather complement and supplement them.”

Another measure that has been around since the inception of IFRS 17 in 2023 Q1 is NISR. It takes insurance service expense and net expenses from reinsurance contracts held into account, but not general and operating expenses like the CISR does. This measure is anchored around insurance service results; an NISR of 100 indicates an insurance service result of zero.

Pick and choose

MSA notes industry professionals may prefer one ratio over another depending on the circumstances. For example, net combined ratio (fully discounted) replicates IFRS 4 logic and may be appropriate for a more sophisticated audience, but may not be calculated from P&L only. “Likely better from a pricing and reserving point of view as it better communicates the experienced loss ratio,” the article says.

Unlike net combined ratio (fully discounted), CISR can be calculated from P&L only. It’s also simpler to calculate and simpler to communicate, Grégoire writes. “Might be considered better from a financial view since results are expressed as a percentage of the top line, which would be consistent with typical profitability ratios one might see in other industries such as gross profit margin, operating margin and net profit margin.”

The simplest ratio is NISR, but it “misses some inputs,” the article says. It can also be calculated by line of business by province.

“Some argue that an undiscounted COR makes more sense as it better isolates the underwriting activity from capital market movements in assets backing liabilities,” Grégoire writes. “A more appropriate measure, some might say for basing performance-based compensation on.

“The debate is certain to rage on and we at MSA will take the lead from our industry KPI working group with a hope that the industry will coalesce around an agreed-upon COR and that it will indeed stand up!”

The lack of consistency in IFRS 17 related to combined ratios is concerning, Bryan Lillycrop, vice president of financial reporting at Definity and chairman of Insurance Bureau of Canada’s finance standing committee, said during IBC’s recent Financial Affairs Symposium. “It’s interesting, our [new accounting] standard, which is supposed to make us all comparable, has made us less comparable than we’ve ever been in the industry.”

One issue raised during the symposium was whether or not insurers should present discounted or undiscounted rates as part of their combined operating ratio metrics. Some say this can be resolved by companies reporting both discounted and undiscounted rates, and their associated impacts on the combined ratio. The debate was also about how incurred claim losses are reported, which in turn affects the way the combined ratio is presented.

MSA says it welcomes feedback from the industry on the topic. “We expect KPIs and the industry’s preferences to evolve over time, and as such, we may again make refinements in the future.”

Feature image by iStock.com/Ngampol Thongsai