The introduction of IFRS 17, a new global accounting standard for insurance contracts, will create some temporary distortions and comparability challenges while the regime beds in.

One key change under the new system, which applies to reporting periods after Jan. 1, 2023, is that liabilities will be discounted according to current interest rates. This will remove mismatches in how reported assets and liabilities respond to changes in interest rates. However, one effect of the new rules is that it will also temporarily flatter some combined ratios, which measure nonlife underwriting performance.

While the effect has been relatively muted for insurers writing short-tail business with high-frequency, low-severity losses, reinsurers in particular have seen a "step change" in combined ratios, according to Will Keen-Tomlinson, a senior analyst at Moody's. Reinsurers' combined ratios for the full 2022 year were "quite a lot lower" under IFRS 17 than in the previous regime, mostly due to the discounting effect, Keen-Tomlinson said in an interview.

The combined ratio for Munich Re's nonlife reinsurance business in 2022, for example, was 96.2% under IFRS 4 but 83.2% under IFRS 17, according to the company's first-quarter investor presentation.

When interest rates are stable, the discounting of new liabilities is offset by the unwinding of the discounting on older liabilities. But because interest rates are rising, the discounting benefit from new business is greater than the offsetting unwind from older business written when interest rates, and thus discounting levels, were lower.

"Once the interest rates stabilize and the release is based on the same interest rate as the new discounting, it will be more stable," Stephan Kalb, senior director at Fitch Ratings, said in an interview.

Reporting options

IFRS 17 also gives insurers some reporting options to ease their transition to the new standard, which will temporarily make comparisons between companies more difficult. Where possible, insurers have to use a fully retrospective approach when calculating IFRS 17 metrics, treating existing contracts on their books as if IFRS 17 had applied from when they were first written. Where not practical, an insurer can use a modified retrospective approach or a fair value approach.

Life insurers in particular are using the varying methods at their disposal to comply with the new requirements. Based on an analysis of 27 insurers' investor reports, 14 insurers are using the full retrospective approach where possible, of which 9 will use all three approaches, KPMG said in a Jan. 27 report.

It will take "a couple of years" before the effect of transitional measures works through and reporting quality stabilizes, Kalb said.

Steep learning curve

It will also take time for both companies and users of accounts to adjust to the new regime, which is fundamentally different from its predecessor. Familiar metrics such as gross written premium and underwriting profit have been replaced by "insurance services revenue" and "insurance service result," which are different in content as well as name. The combined ratio persists, but it is calculated with IFRS 17 metrics, which include or exclude elements that their IFRS 4 analogues did not.

Another major change is that insurers will no longer recognize expected future profits from long-term contracts, such as life insurance policies, when they first underwrite them. Instead, expected future profits must be reported under a new heading, the contractual service margin (CSM), and released gradually into profit over the duration of the contract.

Investors face a "short and steep" journey in building their knowledge about the new standard, Francesco Nagari, global insurance IFRS leader at Deloitte, said in an interview.

Companies and users of their financial statements will need to derive new key performance indicators from the IFRS 17 metrics to aid their understanding of financial positions. There is little consensus so far on which key performance indicators will become widely used, Mark Nicholson, director at S&P Global Ratings, said in an interview, although more consensus should form as people get more familiar with the new accounting standards.

Also, users of insurers' financial statements have yet to see the full picture. Many companies, particularly in Europe, do not report full financial results for the first and third quarters, and so users will have to wait until the half-year for 2023 figures for several companies, including big names such as Axa SA and Aviva PLC.

While reporting so far has already yielded useful information, more disclosure will come at the half year and full year, when users will get a full set of accounts and all the accompanying notes, Jignesh Mistry, a director at PwC, said in an interview. "I think only then we'll be able to really judge the usefulness of the new information," Mistry added.

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Lasting effects

Some comparability problems will persist even after the standard has bedded in. IFRS 17 does not prescribe which interest rate curves a company can use for discounting, and different discount rates can produce large variances in results, according to Kalb. "This is something which will stay and make it challenging to compare numbers," Kalb said.

It is a similar story, Kalb said, with the risk adjustment, a new balance sheet metric under IFRS 17, where companies can choose, among other things, the confidence level they report at.

Even with the comparability challenges, all agree that IFRS 17 is far more consistent and reflective of the underlying economics of insurance business than IFRS 4, which was introduced as an interim standard in 2005 and largely allowed companies to continue reporting under their various local accounting conventions.

"This is the most amazing transformation of a particular sector in terms of the accessibility to the fundamental economic data that a set of financial statements is supposed to produce for the readers of those financial statements," Nagari said.

He added that investors had told him they would be able to perform what they consider a normal fundamental financial analysis of insurance company performance with IFRS 17, which was "nearly impossible to do under IFRS 4" because of the variance in reporting it allowed.

In particular, the CSM and risk adjustment are among the most revealing of the new metrics. Both will make explicit information that was previously only implicit in margins and reserves, Mistry said. "That transparency is going to be helpful as we start getting more and more information, and it's going to allow us to make those assessments of strength between insurers more easily."

Where comparability problems remain, IFRS 17's disclosure requirement, under which companies will need to explain choices they have made, "is going to be key to enable that comparison across ... differing approaches," Mistry said.