IFRS 17: Learnings from the 2022 Financial Condition Test … And, what to prepare for next year
Insights – August 2022
By Ping-Teng Lin
All views expressed are the author’s own and do not necessarily reflect the official position of any agency, organization, or company.
With IFRS 17 going live next year, the 2022 FCT analysis is essentially the dry run for the full IFRS 17 FCT forecasting next year.
The Eckler life insurance team would like to share what we discovered when putting together the IFRS 17 base scenario forecast for our FCT reports. While the 2022 CIA guidance was not overly prescriptive regarding IFRS 17 impacts on the adverse scenarios, we know the analysis will have to be more rigorous for next year. So now is a good time to note these considerations for 2022 and build on them for the 2023 FCT planning cycle.
Here’s what we learned.
Do conventional IFRS 4 approximations still work?
We regularly use “rules of thumb” to forecast financial statements and capital. Many of these approximations were perfected through years of experience with IFRS 4 and the LICAT.
It is common practice to use current relationships between PfADs, assets or reserves to forecast LICAT capital components. However, as an example under IFRS 17, companies on the cost of capital approach may find the linkage of risk adjustment to insurance risk no longer reliable. If you haven’t already done so, this may be a good reason to implement the SCR functionality in AXIS for capital required projections.
Another example is the current tendency to focus on net liabilities and treat the ceded liability as an afterthought. This is fine when all experiences flow through earnings. However, with the asymmetric treatment of gross and ceded Contractual Service Margins (CSM), we need to look more carefully at the reserve drivers independently.
IFRS 17 forces us to do low-level surplus management via the CSM and loss component. This means apportioning the correct future service amounts to their respective CSM’s and P&L and recording the right movements to the loss (recovery) components.
With the many changes introduced by IFRS 17, we should reconfirm if presumed relationships continue to hold. A few other areas to consider with regards to the base scenario:
- Lock-in mechanics of new business and how best to forecast them (being mindful that whatever you implement would ideally need to apply just as effectively to the adverse scenarios).
- Loss component presentation is relatively simple at the group level but challenging to attribute at the enterprise level without high-level approximations or robust IFRS 17 actuarial models.
Do the adverse scenarios still represent the right risks?
In theory, an accounting basis shouldn’t change the underlying risks of an insurer’s operations. But when liability measurement is revamped dramatically with IFRS 17, that may not be true in future.
For example, suppose today’s investment policy can only hold risk-free bonds. Whereas CALM will effectively reflect this policy, IFRS 17 introduces a liquidity premium to the valuation discount rate. If the liquidity premium is defined as a function of credit spreads, does this imply the company is suddenly exposed to spread risk?
There’s also onerosity testing. A short-term group business may be less likely to turn deficient across the whole portfolio. However, IFRS 17 forces a more granular onerosity assessment. We may wish to develop simple rules to approximate the onerosity impacts without having to assess every group while still respecting the Standard.
Other considerations that may warrant revisions to the selection of adverse scenarios.
- What are the meaningful changes to risk sensitivities in accounting earnings due to the elimination of CALM?
- Due to delinking of assets and liabilities, poor asset liability management practices are hidden away as experience losses over time.
Are there new behaviours to consider?
As with all things IFRS 17, the devil is in the details. New behaviours may emerge that pose interesting challenges. A few such examples:
Capital management practices
- IFRS 17 defers profits and dampens changes in future expected experience. How does the new accounting earnings pattern affect future dividend payout (or capital repatriation) strategy? How could the capital policy react under adverse scenarios?
- Your company may also have defined a target confidence level for risk adjustment. Part of the scenario validation work would be checking if the projected risk adjustment remains within range, and if a base scenario basis change would be warranted.
LICAT forecasting implications
- LICAT 2023 changes can add new curveballs to the forecast, such as the definition of negative reserves and their associated caps or the changes to the treatment of unregistered reinsurance. Other challenges could be business strategy driven, including downstream impacts of IFRS 9 / 17 investment strategy changes on the interest rate risk requirements.
New policyholder behaviour assumptions
- IFRS 17 may have added new assumptions to the valuation, such as future policyholder deposits. These are new profit sources especially for segregated fund products. Therefore, we should consider them for adverse scenario testing.
We encourage you to consider what is taken for granted in the FCT today. If you happen across an unexpected impact, let us know — we would love to connect and work through any brain teasers along with you.
This issue of Insights has been prepared for general information purposes only and does not constitute professional advice. Should you require professional advice based on the contents of this notice, please contact an Eckler consultant.