IFRS 17 Corner
By Bruce Rosner
The Financial Reporter, April 2023
On Jan. 1, 2023, all of the geological instruments across our planet simultaneously failed to register the long-awaited IFRS 17 and LDTI[1] effective date (from the IASB and FASB, respectively). Likewise, the work that we have been doing for the last few years to prepare for the new standards has also conspicuously failed to come to a halt.
To that end, we’re starting a column here on IFRS 17, to cover the new standard as information emerges over the course of the next year or so, supporting those of us who will continue the implementation and make any late-game course corrections. I’ll do my best to keep it brief and interesting, and perhaps somewhat relevant.
I’ve been asked recently on two separate occasions whether I prefer IFRS 17 or LDTI. It’s a bit of a fool’s game to actually answer the question, but it’s nonetheless interesting and important to think about. IFRS 17 sets out with a lofty goal to bring all of insurance products under a single framework, so the real question is whether it achieved that sufficiently to outweigh the complexity that comes along with such a goal. The FASB broke away from the joint project, and instead set out with the more modest goals of (a) greater use of current information, and (b) simplifying elements that were overly complicated.[2]
Interest rates are a great example of how the IASB and FASB took different directions, each being indicative of the different philosophies behind the standards. IFRS 17 has a principles-based discount rate reflecting the illiquidity of the liability, which one may consider a purer approach. LDTI uses the single A curve (as it’s widely interpreted), prioritizing a high degree of comparability between companies.
In fact, as we’ve seen information start to emerge through early disclosures, the move to current interest rates for equity purposes[3] under both standards is going to be one of the major stories of 2023. As of early January, we have better information on LDTI impacts, but a flurry of reports were issued by companies in December regarding IFRS 17. Under LDTI, as of transition, equity impacts ranged from no movement all the way to about a 100 percent reduction, with an average reduction of about 40 percent. However, this is going to fluctuate with interest rates, and we’re now seeing the average impact drift toward breakeven. Under IFRS 17, we have more limited data, but early indications are more modest reductions to equity as of the transition date. This potentially means that companies’ interpretation of the illiquidity premium resulted in discount rates that were generally higher than LDTI, or they applied the top-down method, which permits use of the illiquidity associated with the companies’ asset portfolio (such an approach would be anathema under LDTI[4]). Of course, comparing impacts under IFRS 17 is much more complicated than LDTI, because one needs to consider not only the destination, but also the previous standard to which IFRS 4 had reverted. But it’s clear enough that interest rates are a major driving factor in many cases.
IFRS 17 also establishes two margins impacting the equity position—the risk adjustment (RA) and contractual service margin (CSM). In looking through the (largely qualitative) reports issued by companies to date, the CSM is referenced frequently as another reason for the reduction to equity. As with discount rates, the impacts of the margins under IFRS 17 are much more complicated to interpret than are the largely nil modified retrospective transition impacts of LDTI. However, we can infer that the CSM often produced a higher margin than the prior standard, resulting in a hit to equity.
This topic is also playing out in the key performance indicator (KPI) arena. Two common KPIs that companies share with investors are the return on equity (ROE) and the leverage ratio. We’re already seeing with the handful of disclosures shared by companies that there are going to be different practices around what these mean now. There’s a desire among many companies to include the CSM along with equity in the denominator of both KPIs, as it represents future profits that are being held back as a contingency, but are ultimately expected to be returned to the shareholder. It’s not always clear from current qualitative disclosures whether the CSM is included pre- or post-tax. We have also seen at least one instance where a company previously backed asset AOCI out of equity in the leverage ratio, but is now comfortable including it as the assets and liabilities have similar treatment.
I hope this was a good start to the series and gives you a feel for the current events in the IFRS 17 universe. Stay tuned for more as the story continues to emerge.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or of Ernst & Young LLP or other members of the global EY organization.
Bruce Rosner, FSA, MAAA, is a managing director at Ernst & Young LLP. He can be reached at bruce.rosner@ey.com.