International Financial Reporting Standards (IFRS) 17 will reshape insurance accounting from Jan. 1, 2023 onward. Preparing for the new standard has, at times, been arduous, but S&P Global Ratings anticipates that the improved transparency will be worth it. In particular, IFRS 17 should make it easier to identify and compare how insurers and reinsurers generate profits and handle risk.
The accounting change is, by itself, unlikely to trigger rating actions. That said, if insurers change their risk appetite or capitalization strategy following the introduction of IFRS 17, these second-order effects could lead to rating actions.
We have previously answered frequently asked questions about the treatment of IFRS 17 elements within our rating analysis (see "Credit FAQ: How Will IFRS17 Affect Our Assessment Of Insurers' Capitalization?" published on Aug. 11, 2020). Here, we address some of the more recent questions. All comments reflect the application of our current criteria, and apply to both insurers and reinsurers.
On Dec. 6, 2021, we published a request for comment on proposed changes to our risk-based capital adequacy criteria for insurers and reinsurers. For more details of these proposals, see "Request For Comment: Insurer Risk-Based Capital Adequacy--Methodology And Assumptions," and "Credit FAQ: Understanding S&P Global Ratings' Request For Comment On Proposed Changes To Its Insurer Risk-Based Capital Adequacy Methodology," also published on Dec. 6, 2021.
Frequently Asked Questions
How will S&P Global Ratings treat non-life insurers' risk adjustment and CSMs in its capital model?
IFRS 17 introduces new elements to account for the risk component of insurance contracts: the risk adjustment and contractual service margin (CSM). Both would normally be disclosed, unless the insurer has chosen to use the premium allocation approach.
For non-life insurers, we expect to regard both the risk adjustment and the CSM as audited reserve margins. Where we determine that an insurer's loss reserves are in surplus, we may give credit for the surplus in our capital assessment, subject to the haircuts defined in our criteria. We deduct any reserve deficits in full when determining total adjusted capital.
When a firm takes on an insurance liability, it does not know the amount and timing of the cash flows associated with it; the risk adjustment represents the insurer's compensation for accepting that uncertainty.
The CSM indicates how much profit an insurer expects to earn over the remainder of the contract. Under IFRS 17, insurers would set up a CSM reserve, thus bringing insurance accounting in line with the general IFRS principal that profits should be recognized as they are earned.
The premium allocation approach would mean very similar disclosures to those required under IFRS 4. We expect many non-life insurers that focus on short-tail lines to choose this approach.
Will unrealized gains on insurers' life bonds receive credit in the capital model?
Under IFRS 4, life bonds are typically valued at market value, and liabilities at book value, requiring us to exclude unrealized gains and losses from our capital model.
IFRS 17 addresses this issue and provides a market-consistent balance sheet. We therefore expect to include unrealized gains or losses on life bonds in our view of total adjusted capital under the new standard.
How will the share of unrealized gains on insurers' investments booked in CSM be treated?
IFRS 17, combined with IFRS 9, allows insurers to display unrealized gains or losses on equity investments, properties, bonds, and other securities in two ways. They can choose to report it in the CSM, through reported shareholders' equity; or through the income statement itself.
If unrealized gains or losses are partly disclosed in the CSM, we may choose to incorporate them into total adjusted capital in the same way as we currently do, under IFRS 4.
How do you expect to treat the various elements of life insurers' value-of-in-force business (VIF)?
VIF measures the future profits expected from a particular life insurance portfolio. We may include up to 50% of a life insurer's VIF in our total adjusted capital if the valuation is based on an audited embedded value report. Alternatively, we may consider proxies for VIF within our capital model. For example, under IFRS 4, we could use the reconciliation between the IFRS balance sheet and a market-consistent solvency balance sheet as a proxy for VIF. We expect to continue to recognize a portion of the value of future profits within our capital model under IFRS 17.
How do you plan to quantify VIF under IFRS 17?
Our view of VIF is not solely based on accounting, but we would require robust and transparent documentation of any data that we intend to use as a VIF proxy. In many cases, the CSM or risk adjustment could give us useful data to use as a proxy for most of a life insurer's VIF. Other areas of the IFRS 17 balance sheet may allow us to extract additional elements of VIF, such as that for unit-linked life insurance. IFRS 17 provides a market-consistent balance sheet, which IFRS 4 did not. In most cases, this might provide documentation of a robust VIF proxy.
Will the financial leverage calculation for insurers change following the introduction of IFRS 17?
The implementation of IFRS 17 will change reported shareholders' equity for many insurers that report under IFRS. Given that our financial leverage calculation is based on reported shareholders' equity, we expect this to have an impact. In particular, the introduction of CSM could affect our calculation. If we determine that distortions in reported balances have caused reported equity to be materially understated, we may consider this as a mitigant when the financial leverage ratio is close to our thresholds.
Related Criteria And Research
Related criteria
- Insurers Rating Methodology, July 1, 2019
- Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010
Related research
- Credit FAQ: How Will IFRS17 Affect Our Assessment Of Insurers' Capitalization?, Aug. 11, 2020
- Credit FAQ: Understanding S&P Global Ratings' Request For Comment On Proposed Changes To Its Insurer Risk-Based Capital Adequacy Methodology, Dec. 6, 2021
This report does not constitute a rating action.
| Primary Credit Analysts: | Volker Kudszus, Frankfurt + 49 693 399 9192; volker.kudszus@spglobal.com |
| Mark D Nicholson, London + 44 20 7176 7991; mark.nicholson@spglobal.com | |
| Secondary Contacts: | Eiji Kubo, Tokyo + 81 3 4550 8750; eiji.kubo@spglobal.com |
| Daehyun Kim, CFA, Hong Kong + 852 2533 3508; daehyun.kim@spglobal.com | |
| Robert J Greensted, London + 44 20 7176 7095; robert.greensted@spglobal.com | |
| Judy Chen, Hong Kong + 852 2532 8059; Judy.Chen@spglobal.com | |
| Research Contributor: | Ami M Shah, Mumbai (91) 22-4040-8340; ami.shah@spglobal.com |
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