Fundamental Changes in the Presentation of Income

The main elements of the IFRS 17 standard address the reporting of earnings related to insurance contracts in the Statements of Financial Performance. IFRS 17 introduces a dramatically different approach to the definition and presentation of profit or loss and comprehensive income, which is expected to have significant impact on the role of actuarial models in financial reporting.

The IASB have described significant benefits that will be realized by the changes in financial statement presentation for insurance entities subject to IFRS 17. Rather than being a cash flow focused statement, reported revenue will reflect the services provided during each period, distinguishing between insurance services and investment components. The intent is to reflect the fundamental economics of insurance in the presentation, enabling clearer understanding of the sources of profitability and improving comparability between companies.

To achieve this, the primary Income Statement develops the Insurance Service result as the difference between insurance revenue and insurance service expenses. Revenue is not based on premiums invoiced or paid, but on the costs of current insurance services provided which are derived as part of a roll forward of the FCF and CSM balances from insurance liabilities over the period.

The CSM roll forward includes an amortization of the deferred profit into income. The method of amortization is based on the ratio of selected drivers of insurance services for the current period vs. the remaining expected product lifetime. While the details of the service driver calculation are not clearly defined in the IFRS 17 standard, it is almost certain that an actuarial projection of in-force policies will be required as well as a calculation of delivered services based on actual movements of in-force business over the preceding period.

Finally the Insurance Service Expenses during the period are based on actual benefits paid to policyholders and the related costs of administration during the period, but again are not purely cash flow based. Where a payment to a policyholder reflects a return of the deposit element of their premiums, the return of deposits is considered a financing transaction and not an insurance service transaction. AXIS will be enhanced to separate actual costs of benefits into these two components.

It appears that current service costs required for income statement disclosure can only be accurately developed by an application of the underlying valuation assumptions at the beginning of the period to the in-force at that date, with adjustments for the impact of new business written. Since these numbers are not based on cash flows or other general ledger sourced data, they must come from an Earnings by Source (EBS) analysis, which AXIS is already capable of producing through the AXIS EBS modules.

The new Income Statement format also requires a separate disclosure of insurance financing revenue, expressed as the excess of investment income over insurance finance expense. The latter requires first a separate determination of the expected accretion of interest on the opening liabilities reflecting the discount rates assumed at inception and possibly, depending on company election, an adjustment to reflect the impact of changing the current estimates of financial assumptions over the period on the insurance contract liabilities. Companies will have the option to disclose this assumption change impact in Other Comprehensive Income (OCI) or in P&L. AXIS will be able to quantify these finance expenses using EBS module functionality and relying on multiple Assumption Sets linked to IFRS method reserve calculations within the Cells of the model or to defined IFRS Groups.

Reliance on Earnings by Source Functionality

As indicated in the preceding comments, IFRS 17 requires a number of detailed calculations of expected benefits and actual benefits for the determination of specific lines in the new Statements of Financial Performance. Some of these calculations will also support the amortization of the CSM and the release of insurance liabilities due to experience adjustments. There will be various reconciliation statements that support the roll forward of the Insurance liabilities that are essentially Movement of Reserve type exhibits similar to those already offered in the EBS Modules of AXIS.

While AXIS has offered EBS functionality for many years, many clients have indicated in the past that they face significant challenges in obtaining useable detailed data as to the effective date, type and economic details of transactions that reflect terminations and all other changes in the in-force business, which are necessary for any detailed earnings analysis. It appears likely that IFRS 17 will provide insurance companies with an auditor-driven mandate to obtain this additional data.

Further technical discussions relating to the detailed implications of IFRS 17 and how Moody's Analytics is addressing its challenges will continue to be developed and communicated to all of our clients.