Premium Magazine: May 2020
By Noman Zafar and Raghav Ohri
The recent deferral by another year pushes the IFRS 17 implementation date to 1 January 2023 and is a relief to overburdened insurers, many of whom are firefighting to align multiple administration systems and aiming for adequate integration. This deferral, however, should not be taken as a breather, because simply put, the standard is complicated. To get an adequate understanding there are volumes of material explaining the complexities but adapting to the new normal is much more than academic.
Organising your implementation team, or even better, speaking to consultants who have completed financial impact assessments is recommended and will help insurers to come to grips with the many moving parts of IFRS 17 financial statements. This could be as simple as a Premium Allocation Approach (PAA) approximation or as complex as a calculation of a loss component for loss-making contracts.
How complex it can get is something that insurers need to answer sooner rather than later. Last year and during the early parts of this year insurance regulators forced insurers to undertake the first phase of implementation, titled as the ‘Gap Analysis’. This involved understanding products to determine measurement models, looking at contract boundaries, understanding internal pricing methodologies and potentially bridging risk management with IFRS 17. The crux of the exercise was to create awareness for insurers to glimpse the complexities ahead.
Underwriting functions were forced to assess how perspectives on risk might change. IT functions considered the importance of system integration. Actuarial functions became aware of how their role would expand to include much more than traditional functions. Where senior management were proactive, findings from gap analyses were also shared with the respective Boards and decisions taken as to the way forward.
From a regional perspective, ‘Gap Analysis’ sessions were successfully wrapped up in Q1 of 2019 in KSA and UAE and towards Q2 of 2019 in Oman. In Bahrain the CBB requires completion of the Gap Analysis by end May 2020. The key purpose of these Gap Analyses was to create an awareness of the challenges ahead and the potential solutions to consider in meeting these challenges.
The next phase in which most insurers are currently involved is the Financial Impact Assessment (FIA). This includes KSA and UAE where FIA exercises were initially set to be submitted by March 2020, but were pushed forward in the light of recent COVID-19 related developments, and now required to be submitted by the end of April 2020. Other regulators in the region are not far behind and have FIA covered as a part of later phases within the broad spectrum of IFRS 17 related regulation. The FIA includes using a recent experience to create Income Statements and Balance Sheets under the existing IFRS 4 Standard as well as IFRS 17, the key purpose being to provide stakeholders with a tangible view of changes to overall profits and the associated reasons. This is a key exercise to promote financial literacy along with highlighting key data deficiencies, which insurers will face in complying with the Standard in 2023. Some of these are highlighted below:
- Expense allocations by line of business level seldom exist at an adequate level of granularity. Insurers commonly allocate expense based on pro rate simplifications which is at best an untested rule of thumb and at worst wholly unrepresentative of reality. This affects allocations between expenses sub-categories such as policy maintenance claims handling.
- Misalignment of contract boundaries between direct contracts and reinsurance now comes to the fore. This could lead to application of different measurement approaches on gross and reinsurance business, which might be viewed as a necessary evil from an actuarial and operational perspective.
- A lack of adequate reinsurance data is an impediment to reinsurance modelling. Where retention ratios are sometimes employed by actuaries to determine net of reinsurance provisions, this will now change, as IFRS 17 requires explicit reinsurance modeling.
- Risk adjustments are a key area that insurers need to understand. Using approximations from other jurisdictions is a useful starting point but far from what is required. The differences from market to market imply that risk adjustment approaches should be customised to suit the local terrain as well as the risk appetite of the Board. Insurers should look to develop internal capital models to derive risk adjustment factors representative of their portfolios. This is also an area of local regulation where more focus is needed on the importance of an Enterprise Risk Management (ERM) function. It is expected the Companies with well-developed ERM functions will be the forerunner in IFRS 17 developments.
- The use and derivation of discount rates is an essential part of the FIAs. Traditionally non-life insurers do not apply discount rates to estimate liabilities. The lack of a sufficiently liquid bond market in some parts of the GCC further complicates the approaches to discount rate derivation. There are useful proxies such as the USD treasury curve; however, these should be used with caution.
The above is a sample of the challenges most non-life insurers will face. Things are more complicated for life insurers who do not have the luxury of applying simplified approaches.
Consider the following:
- Measurement Approach: Potentially, the General Measurement Model (GMM) is the Premium Allocation Approach (PAA) for long-term contracts. This is because if Variable Fee Approach (VFA) is applied then the system landscape required to capture liabilities for various cohorts at current discount rate can be a huge challenge.
- Transition Calculations: This will be an uphill challenge, particularly for Whole life business. There are three transition approaches permissible under IFRS 17: the Full Respective, the Modified Retrospective and the Fair Value approaches. If insurers wrote Whole Life or Permanent insurance contracts in the 80s then there is a high likelihood that economic assumptions set to price these contracts will be unavailable. Fair Value approaches would be suitable. However if all data was available then a Full Retrospective approach may also be chosen. For contracts written in the first decade of the 2000s we can expect some data to be available for a Modified Approach.
- Then there is a question of Risk Adjustment. Life Insurance liability valuations are usually long term and it is difficult to apply the element of Stochastic simulations. There is always an element of “provisions or margin for adverse deviations” within the liabilities but it can be difficult to quantify. As opposed to non-life where various approaches such as the Bootstrap or the Mack Method can be used to calculate stochastic reserves, life Stochastic simulations require either Risk Neutral and Real world scenario generators, which are not prevalent and widely used in this part of the world. The challenge lies in identifying a suitable method to calculate Risk Margin for life – LIC and LRC.
It is important to consider system implications at all levels. After VAT implementation insurers identified a number of system impediments ranging from manual adjustments to lack of integration. Systems were analysed by the VAT consultants in great depth and targeted changes were made with the help of IT teams spearheaded by Finance teams and with the help from System vendors. Some of the lessons learnt from VAT implementation can be leveraged for the IFRS 17. The difference would be the additional pivotal role of Actuaries.
In closing, the changing regulatory and economic landscapes must be considered. US GAAP is targeting changes to have a degree of correspondence with IFRS. Some international regulators have been proactive in taking the lead whilst others have placed less importance on this for now. The responsibility however lies with insurers who must own this alignment for the sake of their shareholders. Utilising the outcomes of the current IFRS 17 FIA exercises that many are busy with is important and should inform the decisions to be taken over the coming years.