IFRS 17: its impact on shareholders’ equity

For re/insurers that report under International Financial Reporting Standards (IFRS), the transition to IFRS 17 at the beginning of 2023 impacts large parts of their external financial reporting and metrics. In recent months several re/insurers accompanied their usual investor presentation with early estimates of a few major selected measures under the new standard.

This article analyses disclosures from certain larger re/insurers to identify some of the more significant changes, with a focus on shareholders’ equity, and then comments on inputs for non-life reserve risk into AM Best’s proprietary capital adequacy model (BCAR) under IFRS 17.

Wide range of impacts on shareholders’ equity upon transition

The impact of transition to IFRS 17 is far more pronounced in the life insurance segment. The range of outcomes is wide for the segment and biased to the downside.

For non-life insurers, the impact is considerably narrower and biased to the upside.

Life movements in shareholders’ equity on transition to IFRS 17 are heavily influenced by the profile of profit over the duration of an insurer’s policies under IFRS 4, the relationship of that profile to the new profile under IFRS 17, and finally the overall maturity of the policies on an insurer’s balance sheet. All three of these factors can vary considerably in the life segment.

Under IFRS 17 there is no profit impact on shareholders’ equity at inception of a policy. Instead, a profit measure—the contractual service margin (CSM)—is assessed explicitly, deferred as a liability, and then earned into profit over the life of the policy.

By contrast, under IFRS 4, profit recognition patterns varied significantly according to the type of product and the accounting policies used by the re/insurer, and usually included a profit on inception.

IFRS 4 grandfathered previous practice in the measurement of insurance contracts. In many cases IFRS 4 profit for life contracts was taken earlier than it will be under IFRS 17. However, in some cases, profit will be recognised earlier under IFRS 17.

The change in shareholders’ equity in the life segment on transition to IFRS 17 can be influenced by variation under IFRS 4 in the treatment of capital in participating funds. In some jurisdictions, only the share that would be allocated to shareholders when the capital is used for bonuses is recorded in shareholders’ equity under IFRS 4.

In other jurisdictions, the availability of all the capital to meet guarantees and a close relationship between financial accounting and regulatory reporting combine to mean that participating fund capital, or at least a large part of it, is treated as 100 percent shareholders’ equity.

Practice under IFRS 17 will become clearer over time but disclosure so far suggests some movement of participating fund capital from equity under IFRS 4 to CSM under IFRS 17.

In its balance sheet strength assessment, AM Best’s consideration of the BCAR ratio, other numerical inputs (for example leverage) and qualitative factors—such as the quality of capital—will no doubt evolve under IFRS 17. The weight attached to each and the composition of the qualitative factors are unlikely to be the same as under IFRS 4.

Figures 1 and 2 show illustrative ranges of outcomes for movements in shareholders’ equity on transition to IFRS 17 for the life and non-life segments. For the life segment the creation of the CSM, shown as applied first in the figure, is responsible for most of the variation in shareholders’ equity with a smaller widening of the range on application of each further step.

Figure 1: Life segment shareholders’ equity; illustrative transition to IFRS 17 drivers

Figure 2: Non-life segment shareholders’ equity; illustrative transition to IFRS 17 drivers

Figure 3: Changes in shareholders’ equity—selected examples

A reduction in shareholders’ equity is far from automatic for life insurers. For example, Aegon’s disclosure, during an IFRS 17 presentation in March 2023, suggested a positive impact from its international and UK operations, which in its case was more than offset by a reduction in shareholders’ equity from the group’s far larger US operations.

Phoenix Group Holdings, a UK life insurer, described a positive impact from the group’s UK with-profits products which was broadly offset by a negative impact on shareholders’ equity over the transition from bulk annuities, to produce a neutral outcome.

For non-life business, the narrower range of outcomes is due to the extension of discounting and the removal of implicit margins being mostly, but usually not completely, offset by creating an explicit risk adjustment.

Figure 3 shows the actual movement in shareholders’ equity for a selection of listed re/insurers that publicly disclosed early estimates.

Composite re/insurers inevitably experience a balance of life and non-life effects on shareholders’ equity over the transition to IFRS 17. Generali’s overall stable shareholders’ equity on transition, for example, is due to a decrease in shareholders’ equity on the life side and an increase for the P&C segment.

A complete picture involves also looking at the sum of shareholders’ equity and the CSM. Some re/insurers have suggested this is a more “economic view”. AM Best expects that a portion of the CSM and risk adjustment in the life segment, typically in the region of 50 percent, will contribute to Available Capital in AM Best’s BCAR model, and also may be considered in the interpretation of other financial metrics.

Figure 4 compares disclosed shareholders’ equity plus CSM under IFRS 17 (“IFRS 17 equity + IFRS 17 CSM”) against shareholders’ equity under IFRS 4. IFRS 17 equity + IFRS 17 CSM exceeds IFRS 4 shareholders’ equity by a range of 10 to 103 percent for the insurers shown.

Figure 4: Shareholders’ equity and contractual service margin—selected examples

Early disclosures on profitability and return on equity (RoE) were generally less detailed and more directional. Where shareholders’ equity reduces due to profit arising later in life policy durations under IFRS 17, current and future profitability will often be higher, thus increasing RoEs.

AM Best expects RoEs in the life segment to become closer to an achieved return on funds invested. Previously, stated internal rates of return on life new business contracts have usually not been visibly related to RoEs calculated from audited financial reporting.

Changes to the treatment of participating fund capital will have a separate, and often positive, impact on RoEs over the transition to IFRS 17.

Non-life reserves in the BCAR model

AM Best’s approach to non-life reserve inputs into the BCAR model will remain unchanged. This means undiscounted reserves are used, to which AM Best discount factors are applied specific to the line of business, thus ensuring a “level playing field” across all insurers.

Insurance debtors and creditors are future cash flows and are included within the present value of future cash flows component of insurance contract liabilities/assets under IFRS 17. AM Best will continue to use net (of reinsurance) liabilities for incurred claims that do not include insurance debtors and creditors as inputs for reserve risk in the BCAR model.