More ways IFRS 17 can make for wonky reporting

In the face of IFRS 17 reporting requirements, insurers should prioritize stabilizing and managing their balance sheets, noted a panellist during a recent Canadian Insurance Accountants Association (CIAA) webinar.

They also should strive to ensure the company’s assets and liabilities complement each other.

“Asset/liability mismatch could potentially cause a bigger impact than it would have before IFRS 17,” said Fiona So, director actuarial services at RSM Canada. “And so if you had any mismatch before, you could be more mismatched now.”

The same is true for foreign exchange risk margin, which covers loss from changing currency exchange rates, but only on assets and not on claims.

As an example of increased foreign exchange risk, So noted some insurers have cross-border business claims that must be paid in U.S. dollars. That foreign exchange risk must be managed.

“Sometimes, these insurers will [make use of] swaps to hedge devaluation in the Canadian currency,” said So. “Another way we’ve seen the insurers hedge foreign exchange risk is through purchasing bonds in the other currency, such as purchasing U.S. bonds. While most insurers wouldn’t leave foreign exchange risk exposed, it’s still important to stay on top of your hedging strategy.”

Different balance sheet approaches among insurers are expected to make initial IFRS 17 results hard to compare, according to a Jan. 23 report from Fitch Ratings.

Fitch’s analysis of 10 major European insurers’ accounting policies and calculations found differences that can significantly affect results. Canada’s federal solvency regulator likewise recognized the changes are complex and will be challenging.

One area of inconsistency, Fitch noted, is that some companies incorporate an illiquidity premium into their discount rates based on their own asset mixes. But others apply an illiquidity premium that’s based on a standard investment portfolio.

That means two companies with similar investment portfolios could end up reporting contractual service margins (CSMs) that are quite different. CSMs represent “the unearned profit an insurer expects to earn as it provides services,” the report said.

CIAA webinar panellists noted interest-rate sensitivity also will be an issue – on both sides of an insurer’s balance sheet.

Interest rate-sensitive assets and liabilities are those with fair values that change alongside interest rate shifts. Examples include term deposits, short-term securities, bonds, preferred shares, and the insurance contract assets.

Interest rate-sensitive liabilities, meanwhile, include liabilities for incurred claims and reinsurance contract-held liabilities.

“The interest rate margin is then determined by calculating maximum impact of an insurance rate shock factor, either increase or decrease,” So told the webinar. “Under IFRS 17, insurance liabilities are no longer discounted using the market yield on assets.”

While IFRS 17 is now in place, a temporary adjustment is giving insurers breathing room.

In response to a 2021 industry focused Quantitative Impact Study, the Office of the Superintendent of Financial Institutions (OSFI) established a two-year temporary relief period starting at the beginning of 2023. It’s intended to position companies to meet investment, lending and borrowing limit standards by Dec. 31, 2024.

OSFI’s study showed total assets for each company are expected to decline about 20% on average upon transition to IFRS 17. This is due to a decline in asset balances for various accounts such as insurance-related receivables, deferred policy acquisition expenses, and other recoverables on unpaid claims.

The two-year relief period means regulatory prudential limits will increase by 25% for federally regulated P&C insurers to adjust for the 20% decline in total asset balances.

Feature image courtesy of iStock.com/smolaw11