A new international financial reporting standard on accounting for insurance contracts, IFRS 17, came into effect on January 1, 2023. Canada’s property and casualty (P&C) insurers continue to transition to this new reporting standard.
The new global standard replaces IFRS 4, which had been in place since 2004. In general, IFRS 4 was consistently applied in Canada’s P&C insurance industry, aside from insurers using different assumptions on reserving inputs inherent in actuarial practice. Globally, most P&C insurers reported liabilities the same way, with an unearned premium and an incurred claims provision including case reserves and incurred-but-not-reported claims. Many of the key performance indicators were also aligned globally, with slightly different definitions inherent in all measures that are not generally accepted accounting principles. This was not true for the life insurance industry and long duration contracts, which did not consistently apply IFRS 4 globally.
The aim of the new financial reporting standard is to provide consistent, transparent principles for all aspects of accounting, as well as deeper insights into an insurer’s financial health. The new standard also increases comparability between insurers by fostering greater global consistency. Here are some of the key differences for the P&C insurance industry.
Slightly different financial metrics: The industry continues to monitor gross written premiums and the combined ratio, among other items reported under the previous standard. Several factors in the new accounting framework may result in differing ratios and metrics. For example, expenses are now allocated between insurance results and non-insurance operating expenses, affecting the combined ratio. Equity may have transition adjustments, thus impacting the return on equity. Insurers can differ in their interpretation of IFRS 17, which may impact ratios between companies. It is important to understand the source of the changes in combined ratio when evaluating differences under IFRS 17.
Onerous contracts: Contracts are now grouped where insurance risks are managed together (e.g., provincial, line of business), and profitability is grouped in a similar way. If a group of contracts is expected to lose money (without considering investment returns or reinsurance), the loss is recognized upfront as an onerous contract. This is different from the previous premium deficiency requirements, resulting in some blocks having more upfront losses.
Insurance income versus financing: IFRS 17 fundamentally changes how earnings are presented on the income statement. The insurance financing impacts (i.e., accretion on reserves) and investment income will be presented separately from insurance performance. The discount rate on liabilities no longer reflects asset yields, but instead is based on a risk-free rate plus illiquidity premium based on insurance contract characteristics. Investment spreads from credit risk and other market risks will show as profit from investment activities.
Data to source disclosures: There is significantly more disclosure around movements in the reserves, causing more complexity in sourcing data from new reporting systems.
IFRS 17 will need to be in place for a few years before key performance metrics emerge and benchmarks for an accurate year-over-year comparison will apply. Some P&C insurers may have long-duration contracts, which require an accounting model similar to life insurance contracts, with long-term cash flow projections and a deferred profit margin recognized over time, which is called the “contractual service margin.” Long-term contracts are quite complex, and stakeholders should understand whether the P&C insurer is applying this measurement model.
Insurance Bureau of Canada’s (IBC’s) key observations on analyzing the results of the first two quarters of 2023
Favourable impact on underwriting profitability: The implementation of IFRS 17 has generally had a favourable and permanent impact on underwriting profitability. Specifically, as noted earlier, some claims costs and expenses previously reported within underwriting expenses are now reclassified as non-underwriting expenses and moved to other components of the net income, resulting in an improvement in underwriting performance, even with the same premiums and claims.
New performance metrics: IBC is working closely with members to develop performance metrics that accurately measure underwriting profitability. This process will be extensive and require collaboration from many stakeholders. We do see a trend of global and public P&C insurers showing metrics that are closer to previous reporting metrics where possible. The rationale for this trend is that the market was comfortable with those metrics, and investors and stakeholders continue to demand them.
Data consistency and quality: The insurance industry has a long way to go to improve data consistency and quality in filing regulatory returns under the new standard. It has added days to the reporting timelines. Companies will look to further automate and improve data sourcing over the next year.
Challenges beyond financial reporting
IFRS 17 also poses significant challenges and changes to taxation and capital requirements.
Specifically, a scalar charge was added for the Office of the Superintendent of Financial Institutions (OSFI) capital, which reduced capital across the industry. However, interest rate increases have seen many companies recover some of this capital charge through a required decrease in insurance risk and lower credit risk, as those values are linked to interest rates. OSFI took steps to level the playing field by including acquisition costs within capital so that expense allocations would not impact capital. IBC is waiting for further direction from OSFI on the potential changes in capital framework and for an evaluation on IFRS 17 reporting in 2023. IBC is also actively engaging with regulators and governments to address concerns about IFRS 17 and other related policy issues.