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Financial KPIs in the New IFRS 17 World

By Pelle van Vlijmen and Antonio Borelli

International News, January 2023

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This article is an abstract of the Deloitte whitepaper “Financial KPIs in the New World” that will be published in January 2023. It provides a market view of how the new Financial KPIs will be integrated in the insurers’ decision-making process and about the main challenges and opportunities for insurers’ management and external stakeholders in the jurisdictions that have adopted IFRS17 and in particular countries in the EMEA region

The IFRS 17 go-live is introducing multiple new challenges not only for insurance companies’ management but also for shareholders, investors, financial analysts and policyholders. While insurers are currently mainly focused on the implementation and on the accounting choices finalization, IFRS 17 reporting has already been a key item of the 2022 capital markets days of insurance companies.

The new accounting standard aims at providing a more transparent and fair evaluation of insurance companies and at improving comparability within the insurance market and across industries. IFRS 17 and the related KPIs will surely be welcomed as an improvement since, under current IFRS, insurers evaluate the technical liabilities according to local standards and with limited disclosure.

However, in the short term, it is unclear to what extent IFRS 17 KPIs will replace solvency and traditional indicators, both in terms of management’s performance measurement and investors’ perspective. Given the complexity of the new standard, some reporting periods will likely be necessary to make all the relevant users acquainted to the new reporting and to the necessary reconciliations between new and traditional indicators.

The identification of the most informative indicators and how the new KPIs will be integrated into insurers’ decision-making processes are still unclear. This is of particular interest since current financial KPIs widely vary depending on the geographic area, the business and the market tier. The IFRS or Local Operating Result/Margin and the directly derived ratios (like ROE, ROI, EBITDA[1]) are commonly considered in assessing performance, in setting targets and in defining dividend payouts. Insurers have also built specific non-GAAP KPIs to breakdown profit source and to better represent profitability and growth perspective. These indicators are often based on solvency reporting.

From a geographical perspective, in the Northern European countries (U.K. and Netherlands first) the Solvency II Capital Generation is the leading indicator. Compared to traditional GAAP, it has the advantage of providing a market-consistent liability evaluation. Nevertheless, solvency reporting may be extremely sensitive to short-term market fluctuation. This holds especially for long-term insurers whose asset portfolio is not aligned to the volatility adjustment reference portfolio. Hence, it could not fully reflect the fundamental company value and the long-term profitability picture. To address this point, this metric is often adjusted (also referred to as “Organic CG” or “Normalized CG”) in order to exclude short-term market impacts and to capture the “sustainable” growth as well as the outcome of the management strategy. Similar adjustments are applied to the Swiss Local GAAP result in the Business Operating Profit (BOP). Even if rarely disclosed, Traditional Embedded Value (TEV) and Market Consistent Embedded Value (MCEV metrics) are still relevant non-GAAP indicators especially in Southern European countries where Capital Generation KPIs are less common.

However, the adjustments applied to the Local or Solvency reporting are generally based on diverse and discretional methodologies and assumptions that reduce insurers’ comparability.

On the contrary, IFRS 17 reporting provides a consistent view of the fundamental economic value through a definition of a liquidity premium consistent with the liability features, through the introduction of the amortization of the embedded profit represented by the Contractual Service Margin (CSM) and through the introduction of the company specific risk-appetite. In light of this, IFRS 17 could become in the medium term the main tool for business decision making and steering as well as for investors and analysts.

Therefore, Performance Management and pricing are expected to be the most impacted areas by the newly available KPIs where, as mentioned, the underwriting profitability has been traditionally measured by TEV indicators—like the Value in Force (VIF) and the technical profit (also called underwriting profit)—unless Solvency Capital Generation is adopted. Both those KPIs are largely dependent on the local accounting rules and the discretional adjustment adopted.

IFRS 17 CSM introduces a standard measure among companies and enables management to perform detailed analysis at a line of business or product level to better identify the source of the profit and loss and to better optimize the product strategy. This is possible thanks to the deeper reporting granularity and the additional KPIs. However, some challenges arise from the use of the CSM, such as the bridging between VIF and CSM. The reconciliation is not straightforward since the latter is dependent on the historical experience built up over the period. Furthermore, the CSM starting value is largely dependent on the specific IFRS 17 assumptions used by the company and the transition methodology, which can reduce the comparability among peers.

Regarding the Income Statement result, multiple factors affect the change in technical profit from the current reporting to IFRS17. Under the new standards, profit recognition is based on the CSM release pattern and it can be slower (as in UK annuities) or faster (as in UK with-profit product) than the cashflow/benefit pattern. In the latter case, even if profit is accelerated, shareholders cannot access them for distribution since the underlying cash is not yet available.  Also transition choices are relevant: in the Italian and Dutch markets the modified retrospective approach is generally leading to a larger CSM than the fair value approach. Finally, prudential assumptions, liability evaluation method and expenses attribution of the current local GAAP can lead to additional differences.

Since the impact can vary depending on the factors mentioned, insurers will be called to adequately explain the drivers behind the CSM starting value and amortization pattern in order to provide a solid profitability picture and to ensure the availability of the relevant information for business steering.

Similar to the VIF, the New Business Value (NBV) is also a non-GAAP key indicator built according to different assumptions and methodology among players. Only some insurers (mostly in North-EU and U.K.) adopt a Solvency-like approach as part of the Capital Generation KPIs. Then, IFRS17's New Business CSM is expected to become a new leading metric in the disclosure primarily thanks to the lower granularity and to the separate reporting of the Loss Component of onerous contracts. Also, the replacement rate (or turnover ratio) of the CSM will provide management and investors with key information about growth at a granular level. Moreover, some insurers (especially in the life with-profit business) are already discussing how to update product policies to align the policyholder financial benefits and the sales network remunerations to the slower IFRS17 profit recognition. Hence, IFRS17 reporting can become a powerful tool to better optimize pricing policies and product structuring. However, the capital absorbed will remain a leading indicator especially in the U.K. market.

The transition brings additional challenges for the insurers: especially Spanish and Italian insurers appear very sensitive about the reporting of onerous contracts and about the consequent effect on the reporting users. Moreover, especially for the life business, the understanding and the reconciliation of the Solvency NBV and the NB CSM is a key requirement for management.

From the investors’ point of view, the comparability among peers can be impacted by the discretionary methodology used to split in force and new business result as well as from the general IFRS 17 accounting choices. However, an appropriate and extensive disclosure of the accounting policies and actuarial expert-judgements applied could improve the figures’ reliability.

Beside NB profitability evaluation, IFRS 17 does not explicitly require disclosing the Gross Written Premium or other volume KPIs. However, those KPIs are expected to still be considered and disclosed since they can provide in a very simple way information about insurers’ market share and selling capacity. Together with the Gross Written Premium, the Combined Ratio, Loss Ratio and Expenses Ratio will remain the most important indicators in the non-life business. Some reporting periods will be probably necessary for management and analysts to define new KPIs fully based on IFRS 17.

As for the ALM and Capital Management, the introduction of IFRS 17 is expected to improve the consistency with IFRS 9. Nevertheless, transition brings an additional challenge to the investment and financial risk units that must already deal with at least two bases—current GAAP and Solvency. Usually, the ALM process objective is to contribute to a stable dividend achieving a stable Local GAAP profit and Solvency Coverage ratio. On top of that, good IFRS 17/9 Asset-Liability matching may become an additional target since investors may consider IFRS 17 Equity in the companies’ assessment.

Furthermore, many players across all geographic areas are likely to report a drop in equity arising from the transition that can lead to lower Retained Earnings and, automatically, to a low Distributable Reserve. Even if this is not a regulatory constraint to the dividend payout, the disclosure of a negative IFRS 17 Distributable Reserve is hardly acceptable. For this reason, Distributable Reserve capacity and stability over time became one of the key targets in the finalization of the accounting policies.

This implies a trade-off between Equity and profit in the first years. Higher transition CSM implies a lower Equity but larger profit releases and a better financial stability since CSM amount can absorb more market volatility in VFA business. Similarly, a larger opening Net OCI implies a lower starting Distributable Reserve but can absorb the equity volatility arising from market fluctuations. Many insurers are preferring to align as much as possible the IFRS 17 and Solvency assumptions to handle these issues too.

However, even if in the short term no massive impact in the ALM/Hedging framework or in the Dividend policies is expected, in the future the full integration of the Capital

As mentioned, from the investors’ and analysts’ eyes, the introduction of IFRS 17 reporting will certainly provide new information. Even if the most common ratios (ROE, ROI, Financial leverage…) are expected to still be the main indicators, the underlying quantities and dynamics will massively change. Therefore, a full adoption of IFRS 17 ratios as leading indicators is unlikely to happen before that reporting users get acquainted with the new metric, with the multiple available KPIs and with the sensitivity of the bottom line to the market conditions. For example, since financial analysts usually consider medium-term/long-term time series, a proper recalibration of the historical information and past performance indicators could be necessary.

Furthermore, financial analysts and investors could choose to adjust KPIs to factor in assumption and methodological differences among insurers. This also regards the use of the OCI options: the OCI-adopters profit will barely be subject to financial market volatility compared to insurers that will choose FV through PL accounting (more common in U.K. market).

In this context, insurers will be required to provide an accurate explanation of the IFRS 17 figures as well as a reconciliation to the Solvency reporting. Also, an ex-ante/planning projection that can explain the expected profit pattern, the impact of the New Business as well as how the economic environment can affect the return projection is expected to be required. Finally, a detailed and transparent explanation of the accounting policies and the actuarial judgement will increase trust and will support reporting users to perform comparisons within the industry.

In conclusion, the added value of the information provided by the new KPIs is unquestionable and insurers’ management will have the opportunity to optimize their underwriting strategy accordingly. At the same time, a full understanding of the expected profitability and growth and an explanation about how accounting choices and the market environment affect company figures will be one of the key challenges in the next years.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.


Pelle van Vlijmen, is partner at Deloitte in the Netherlands. He can be reached at pvanvlijmen@deloitte.nl.

Antonio Borelli is a manager at Deloitte in the Netherlands. He can be reached at anborelli@deloitte.nl.


Endnote

[1] ROI: Return on Investment, ROE: Return on Equity, EBITDA: Earning before interests, taxes, depreciation and amortization.