Insurance companies often fail to recognise the importance and urgency of addressing the reinsurance aspects of IFRS 17. That’s a mistake. In this blog we look at why it’s important to tackle the reinsurance component of the standard early on, and how doing so will help you not only avoid major pitfalls, but also generate unexpected benefits across your business.
When we meet clients in different countries to talk about IFRS 17 (insurance contracts), a topic that comes up again and again is reinsurance. It emerges that this area of the standard is often neglected, but as companies start looking more carefully at what it says and think about the implications for their own reinsurance arrangements and the data required, they realise reinsurance should actually be a priority.
Harder – and more important – than it looks
One problem is that the standard’s requirement that an entity thoroughly review reinsurance doesn’t look particularly challenging at first glance. But take a closer look and you realise that that IFRS 17 can potentially affect not just the balance sheet at transition, but also crucial factors such as the future recognition of profit. It gets even more complicated when you consider some of the detailed requirements: under IFRS 17, for example, reinsurance contracts must now be valued and accounted for separately from the underlying contracts, with the result that that traditional ‘netting down’ (gross less reinsured) and approximate methods used to calculate these figures may no longer be valid, as there are significant requirements relating to the granularity of calculations and the approach to earning the contractual service margin.
Beware mismatches
While the situation will inevitably vary from insurer to insurer, it’s a mistake to assume that these issues are of negligible importance and potentially contained. This is because even an individual reinsurance contract could be material in the context of the overall balance sheet, possibly leading to a considerable mismatch between the value placed on reinsurance and the value placed on the underlying risks. This problem isn’t just an accounting issue: it could also have significant implications on a strategic and operational level, as well as impacting areas such as the transfer of risk, tax, capital, and Solvency II for European operations.
Mismatches can appear in more than one place in the valuation process, and have the potential to make profit and loss more volatile. Depending on the country there may be additional implications in terms of tax and dividends. Mismatches can happen for many different reasons, including a lack of alignment between risk exposures in the reinsurance contract and the underlying contracts, or differences in contract boundaries and allowance for future underlying business. If you want to find out more about the many other potential causes of mismatch and read a detailed discussion of this topic, check out the report on IFRS 17 and reinsurance published by PwC in the UK: https://pwc.to/2GZ7Vak.
What does this all mean for insurers?
The main message is that there’s no way around good-quality data if you want to make robust calculations under IFRS 17. Even insurers that are endeaavouring to leverage their Solvency II calculation are likely to encounter challenges with reconciling the valuation of reinsurance under the two different regimes, as they will be expected to make assumptions not previously required under IFRS 17, and more estimation means greater functionality than already exists for Solvency II. It’s worth investing time now to address these issues, especially as changes to reinsurance may need to be made well before 2021. The good news is that making the data you use for reinsurance fit for purpose will have additional benefits across your entire business.
To reap these benefits early on and avoid getting caught out, make reinsurance a high priority when you plan the implementation of IFRS 17. And feel free to contact us if you need to discuss the issues in more detail.