By Holly Deakin ,
Senior Vice President, Marsh Risk Analytics
22/11/2022 · 3-minute read
This blog is the second in a three-part series containing practical pointers, simplified solutions, and top tips to prepare for IFRS 17 implementation, with this part focusing on technical actuarial topics.
IFRS 17 states that fulfilment cash flows of an insurance contract should consist of “an explicit, unbiased, and probability-weighted estimate of the present value of the future cash outflows less the present value of the future cash inflows that will arise as the entity fulfils insurance contracts”. These cash flows include, but are not limited to, premiums, claims, expenses, and commissions.
The reserving philosophy of case estimates and “incurred but not reported” claims is key. Are you able to justify that your current approach is on a best estimate basis? Your auditor may challenge you on this.
In addition, “actual” verses “expected” analysis must be disclosed. Therefore, you may need to review the current process, and consider automation/industrialisation, to ensure it is efficient on a business as usual basis.
IFRS 17 requires an entity to “adjust the estimates of future cash flows to reflect the time value of money and the financial risk related to those cash flows, to the extent that the financial risks are not included in the estimates of cash flows”.
Check the availability of the asset data and external market data that is required to derive the discount rates. This may need to be purchased from your asset manager and should be factored into your overall implementation plan.
Key considerations for deriving the discount rates are:
Consider how to interpolate between maturity points in the discount rate curve or extrapolate beyond the last given maturity. Different methods can be used, from linear interpolation to more complex modelling. Consider how this can be implemented on a business as usual basis, and if the process can be automated/industrialised.
IFRS 17 requires an entity to “Adjust the estimate of the present value of the future cash flows to reflect the compensation that the entity requires for bearing the uncertainty about the amount and timing of the cash flows that arise from non-financial risk.”
Explore different methods to determine the risk adjustment, and justify the chosen approach based on your risk profile. In our experience, entities rarely conclude on the confidence level the first time. There are numerous ways to determine this and it could be an iterative process, and it is important to ensure the risk adjustment is aligned to the company’s risk appetite.
If you calculate the risk adjustment at a higher aggregation level for actuarial calculation credibility and precision, think about how to allocate this down to the IFRS 17 cohort level.
“The contractual service margin is a component of the asset or liability for the group of insurance contracts that represents the unearned profit the entity will recognise as it provides services in the future.”
The coverage unit pattern can materially impact the timing of profit recognition in the income statement and the outcome of any “premium allocation approach” eligibility testing. Therefore, check if you have the data required for coverage unit calculations available.
Practical considerations regarding the three permitted methods to assess future profits on existing business at the transition date:
Full Retrospective: This approach may require extensive historical data and actuarial assumptions. Check if this is available without using hindsight, and at the level of granularity required.
Modified Retrospective: This is not necessarily easier because you still need sound data on actual cash flows and justification for why you cannot apply the full retrospective approach.
Fair Value: Practical challenges may be encountered when deriving a fair value risk adjustment or discount rate, for example. This is a highly subjective area that can significantly impact the valuation.
If you work for an insurance company or captive that reports under IFRS and are concerned about implementation, get in touch with the Marsh Actuarial Solutions team to discuss how to prepare for a smooth transition.