Why insurers’ combined ratios under IFRS-17 can’t be compared in 2024

Varying assumptions in how Canadian P&C insurers are reporting their combined operating ratios — a longstanding measure of company profitability — has, under IFRS-17 rules, undermined the intent of the new accounting standards, industry executives say.

The issue bubbled to the surface at the Insurance Bureau’s 27th annual Financial Affairs Symposium in Toronto Wednesday.

“The most concerning part about [the new financial accounting standards] is the lack of consistency in IFRS-17,” said conference moderator Bryan Lillycrop, vice president of financial reporting at Definity, and chairman of the Insurance Bureau of Canada (IBC)’s finance standing committee.

“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.”

Discounted vs. Undiscounted

Intact Financial Corporation warned about this as far back as in 2023 Q1, when it reported its first-ever IFRS-17-guided results.

“When comparing our ratios to those of our peers, it will be important to ensure that combined ratios are on a comparable basis,” Louis Marcotte, executive vice president and chief financial officer of Intact Financial Corporation, said at the time. “That is either discounted, but excluding the unwind of discount, or undiscounted.”

Simply put, a discounted unpaid claims estimate is an “actuary’s estimate of the present value of the unpaid claim estimate,” as the Actuarial Standards Board states.

Insurance companies create, or ‘build,’ a discount at the inception of a claim, which is unwound over time, Marcotte explained in a quarterly conference call last year.

That’s because it can take years between the time a claim is first made and the time it is ultimately paid out. A ‘discount’ essentially helps to translate the estimated cost of a future claim payout into its present-day value. The estimate is based on many factors, including the impact of interest rate variability on claims costs.

A discount build is favourable to an insurer’s results and mostly benefits the current accident year. A discount unwind is unfavourable, mostly affecting the prior accident year’s results.

The new IFRS-17 accounting standard is “clear that the unwind of discounting should now be considered an insurance financing activity, recorded outside of insurance results,” said Marcotte. “This is a major change because it improves the lifetime combined ratio permanently.”

For Intact, the upshot is that the company provides undiscounted combined ratios for each of its business segments. “The explanations we provide within our segments will thus be focused on the fundamentals of that business, rather than changes in discount rates,” Marcotte said.

IBC’s Financial Affairs Symposium highlighted the debate emerging about whether or not to present discounted or undiscounted rates as part of an insurer’s combined operating ratio (COR) metrics. (Note, insurers still reserve for claims the same way; IFRS-17 only affects how companies report the unpaid claims estimates on their financial returns.)

Why you can’t compare companies’ combined ratios 

How does the accounting change lead to inconsistency?

Put simply, a company’s COR is calculated by taking the sum of a company’s incurred losses and expenses and then dividing them by the earned premium. A result over 100% represents a loss, while one under 100% represents a profit. The IFRS-17 debate is about how incurred [claims] losses are reported, which in turn affects the way the COR is presented.

Basically, in the first year of IFRS-17, insurers’ COR results are not comparable, because they reflect different accounting assumptions. Some include discounted estimates of future claims costs within the COR results, while others reflect undiscounted numbers.

“What’s very clear is that we’ve all made different choices on how we’re looking at things.,” said Lillycrop.  “A lot of you who are non-public companies have started to look at our [public company] disclosures in the quarters of last year. And if you look at the public company, we’ve all made nuanced differences on how we’re actually looking at what was COR as an example.

“Do you have it discounted? Do you have it undiscounted?…

“Some keep two separate sets of books — one for their MD&A [management discussion and analysis], that’s under IFRS 4, and one that’s IFRS 17 for your financial statements.

“What that means for us as industry is pretty challenging to say, ‘Well, how are we doing relative to each other? What is an industry standard?’ I don’t have an answer for that yet.”

And that creates issues when it comes to approaching investors or reinsurers for more capital, or for seeking capital discounts from the country’s solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI).

“What does that mean for capital?” Lillycrop asked. “How are you going to talk to your capital providers? You’re not comparable to the company down the street. It adds the complexity of having those discussions from a regulatory capital perspective.”

Making things comparable again

Some say the issue can be resolved by companies reporting both discounted and discounted rates, and their associated impacts on the COR.

Others worry if the industry doesn’t agree on a standard for presenting COR metrics, the industry’s solvency regulator will.

Jacqueline Frieland is OSFI’s executive director of risk assessment and intervention, and leader of the regulator’s hub supervision sector. She told the Financial Affairs Symposium OSFI was ready to pursue an undiscounted reporting requirement last year, but the initiative foundered because insurers weren’t at the table to express a view one way or another.

“We meet twice a year with our regulatory advisory committee,” Frieland said, prior to her prepared remarks. “And some of those actuaries, about six or nine months ago, really wanted us to change our regulatory returns so they were undiscounted loss ratios. We were all ready to. I had our RDA, our data people, our regulatory return – everybody was on board to do what we were going to do. We were going to fast-track it.”

“But IBC wasn’t there. They hadn’t made their decision, and I couldn’t do something or push something that didn’t really have the full support of the industry.”

Feature image courtesy of iStock.com/mdworschak