Although International Financial Reporting Standards (IFRS) 17 will transform the way in which insurers report their profit & loss accounts and balance sheets, S&P Global Ratings does not anticipate that its introduction will prompt any rating changes. After a second postponement, it is now set to be introduced into many major European and Asian insurance markets in January 2023. All else being equal, an accounting change should not reshape the fundamental risk of insurance operations. That said, if insurers change their strategies or operations because of IFRS17, against our expectations, we could see rating actions.

Here, we answer some of the most common questions that our analysts have received on how the new accounting standard will affect our assessment of capitalization within our broader credit analysis.

This FAQ supplements our earlier publications on IFRS17 (see "IFRS17 Accounting Standard Revision Will Shine A Fresh Light On Global Insurers' Profit Drivers," published on May 18, 2017, and "How Will IFRS17 Affect The Credit Quality Of Insurers?" published on June 5, 2018).

Frequently Asked Questions

How significant is capitalization within S&P Global Ratings' analysis of insurers?

Externally, the outcome of our capital model is often the focus of attention when reviewing our ratings on insurers. However, this does not recognize the importance of the other key rating factors that we use to assess the creditworthiness of insurers. In assigning a credit rating to an insurance company, we also assess an insurer's operating environment, competitive position, risk exposure, funding structure, liquidity, and governance (see "Insurers Rating Methodology," published on July 1, 2019). The application of our analysts' judgement is also critical in determining ratings.

Our assessment of capitalization is, however, a key rating factor. Within this assessment, our model is supplemented by an evaluation of regulatory capital margins and the application of our own judgement, both in terms of our prospective view of balance sheet strength and in recognizing strengths and weaknesses in the modeled outcome. Nonetheless, the outcome from our model is an important starting point for our capital assessment and, as such, we discuss the impact of IFRS17 on aspects of the model below.

How will reported equity for life providers be different under IFRS17?

Under IFRS17, profit is not recognized at the beginning of a long-term contract and may be accrued more slowly under IFRS17 than it would be for an identical product under IFRS4. This means that the shareholders' or members' funds of a life insurers would generally be lower under the new standard, although accounting policies and judgements may evolve on or ahead of the implementation of IFRS17. As shareholders' or members' funds are a highly significant quantitative and qualitative part of our assessment of capital, this means that, considering this line item in isolation, capitalization might be lower under IFRS17. This increases the importance of our treatment of the contractual service margin (CSM) and risk adjustment on an IFRS17 balance sheet.

How might the contractual service margin for life business be viewed in the context of our capital model?

The CSM is a new accounting element under IFRS17. Essentially, it is a measure of future profitability, similar in concept to value in force (VIF). It measures the profit that an insurer expects to make on a contract over the remaining life span of the product, but that has yet to be earned. As with VIF, it is likely to be more significant for companies that write long-term business.

Under our criteria, we give up to 50% credit in our capital model for VIF. Consistent with our treatment of VIF--and in the absence of embedded value information--we could include up to 50% credit for CSM in our capital model, as a proxy for VIF. As the CSM will be a robustly audited on-balance-sheet measure, we may be more likely to give the full 50% credit to CSM than we presently do to VIF.

Also consistent with our approach to VIF, we may regard the CSM as a weaker form of capital. If the composition of an insurer's capital relies primarily on weaker forms of capital, this could result in a negative adjustment to our capital and earnings assessment. The value of the CSM is also highly sensitive to assumptions; in particular, to the discount rate used. Consequently, our view of the suitability of assumptions used in calculating the CSM, particularly the discount rate used in calculating the liquidity premium, could also affect our treatment, as it does at present in our assessment of VIF. Based on our view of the underlying assumptions supporting the CSM, a committee could adjust the capital & earnings assessment upward or downward.

How do we expect to treat the risk adjustment in our capital model?

Another new item under IFRS17, the risk adjustment, is the compensation received by an insurer for taking on insurance risk. It can be viewed as a measure of the uncertainty that an insurer faces, or as an additional reserve margin.

We would likely treat the risk adjustment as a reserve surplus that we have not reviewed ourselves. We include up to 25% credit for such reserve surpluses in our capital model.

Will unrealized gains on life bonds still get no credit in the capital model?

To date, we have not included unrealized gains on life bonds in our model because of the asset-liability mismatch that is often present under current IFRS reporting. Although assets are generally held at market values, liabilities are often not valued based on market-consistent assumptions, artificially inflating reported equity (see paragraph 38 of "Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model," published on June 7, 2010). IFRS17 introduces a fully market-consistent balance sheet, under which assets and liabilities are reported on market values. Therefore, we expect to include unrealized gains on life bonds in our capital model calculations.

Does S&P Global Ratings expect to use supplementary metrics in its capital model?

Key inputs to our model, notably net premium written and gross receivables, would not be reported under IFRS17. We expect that insurance companies will continue to calculate and report these numbers. However, where these are not also required for regulatory solvency purposes, they are unlikely to be audited. We do not expect this to affect their use in our model, given that we already use several unaudited figures to complete the capital model, such as embedded value and property/catastrophe exposures, as well as other information provided by issuers. As with the current unaudited numbers, we would consider the consistency and appropriateness of any unaudited figures before using them in our model, adjusting where necessary.