Transparency in transition

When the Apache attack helicopter was developed it included a monocle for the pilot which gave a heads up display to their right eye featuring a plethora of high level information - keeping an eye on things became a more challenging task when you had to divide your vision to get a holistic view of the battlefield.

The implementation of IFRS 17 will create similar, albeit civilian, headaches for insurers. There will be a continual need to focus on so many different and difficult aspects of implementing the standard. This could lead to a ‘wood for the trees’ loss of focus on core business issues as companies grapple with the myriad of transformative changes imposed by the standard.

For one thing many complex and significant judgments need to be made early on around such areas as choice of method for calculating the risk adjustment, the chosen retrospective approach to be taken or the assumptions surrounding the discounting and amortisation profile of the contractual service margin.

The risk for insurers arising from this is that after attempting to meet all the bottom up requirements for implementing the standard they end up with a mixed bag of inconsistent outputs often developed in different silos of the business. This could limit the availability of consolidated financial forecasts and impair management information. Crucially the methodological decisions made at a grassroots level could paint management teams into a corner when it comes to strategic decisions and future financial performance.

Going right to left

It is vital that insurers engage in a ‘right to left’ exercise around financial performance considerations to complement the bottom up implementation of the new standard. Given the recent implementation of IFRS 9, IFRS 15 and soon IFRS 16 in other industries there exists a roadmap for external communication around material changes in financial reporting.

With IFRS 17 rapidly coming over the horizon insurers need to engage with shareholders and capital markets now on an issue which has substantial ramifications for currently reported business strategy and performance measures.

Transparency in transition

For example external stakeholders want understand and make sense of the transition impact and how shareholder’s equity will be adjusted on restatement as this could affect distributable reserves, and therefore dividends, where the insurance sector offers healthy pay-outs.

Another issue is the availability of historic financial trends where analyst and rating agency models look at underlying performance in disclosed metrics such as premiums and claims data. Historically these metrics show volume growth and allow for the interpolation of market share. Analysts will struggle to maintain their earnings visibility as IFRS 17 throws up a new selection of financial metrics such as insurance revenue which are derived from internally generated models. This could have the effect of raising the cost of capital in the industry due to greater opacity of results (contrary to the aims of the IASB!)

In Europe analysts are likely to increase their focus on Solvency II disclosures in the interim period since that reporting base offers a limited but increasingly mature anchor point for understanding individual companies results should the transition to IFRS 17 not provide the required level of detail and insight, at least at inception.

Where does this leave Embedded Value? Many insurers have adopted metrics and reporting to demonstrate the long term value of their business and for analysts a promising aspect of IFRS 17 is the more economic nature of the standard. There remain differences between EV and IFRS 17 such as contract boundaries but the recording of expected profits on the balance sheet gives a form of economic value that should be readily comparable between entities. Analysts can use movements in the CSM over the period to understand the sources of profitability for insurers. However subsequent amortisation of profits into the income statement is more a profit smoothing exercise.

Getting it right

If at this early stage in the implementation of IFRS 17 insurers can understand what their external stakeholders use to understand and measure the performance of their business, there is an opportunity to minimise the turbulence of transition to the new standard through financial communication, disclosures and anchor points. This could potentially improve the cost of capital for the business as a whole through best in class transparency.

 

 

Andrew Boag

Andrew Boag – Senior Manager, Audit & Assurance

Andrew is a Senior Manager in the audit practice leading the IFRS 17 Investor Relations proposition for the UK firm.

Andrew qualified as a chartered accountant in insurance audit with Deloitte in London and has 12 years’ experience in the financial services industry including 4 years as a senior equity research analyst at a FTSE 100 asset manager.

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