The sky is the limit – how quality data and advanced analysis support your business
IFRS 17 is about recognizing profits during the insurance policy based on new profit patterns related to policyholders’ services. In an ideal world, the expected release of contractual service margin (CSM) would be the same as the actual release of profit. But in reality, profits can be higher or lower than expected due to operational and experience variance, changed assumptions, and so on.
Insurance companies need to understand the discrepancy and conduct change analysis to see the sources of profit and loss. These fundamentals are similar to what actuaries use when performing profit analysis and market consistent embedded value (MCEV) reporting. But now this has to be done on a different level of granularity using different methods and assumptions.
IFRS 17 is a catalyst for a broader strategy
When it’s time to dive into product development and business strategy, it helps integrate stakeholders from different departments. Many Asian insurance companies, for example, have written off a significant amount of short- to medium-term savings with a marginal profit margin. Risk-adjusted profit is recognized at start-up in accordance with IFRS 4.
However, profits are amortized over the policy period under IFRS 17. In a low interest rate environment with potentially more stringent risk-based capital requirements, this triggers key issues such as:
- Is it our best use of capital to write such a business with a low profit margin?
- What is the relevant business strategy to drive product development?
The IFRS 17 numbers can tell the story
When a profitable new business is written, the respective risk-adjusted profit is recognized on day 1, when it is entered in the book under IFRS 4. In accordance with IFRS 17, the creation of CSM means that the IFRS profit is set at zero at the start – even if has created positive economic value. CSM acts as a balancing item. And for a profitable contract, it is set at an amount that is equal, but with an opposite sign to the present value of the amount of expected fulfillment of cash flows at the start of an insurance contract.
Given these features of CSM, those who prefer a market-consistent approach may seek additional KPIs to gain a deeper understanding of business performance. KPIs that can record this change in the expected future IFRS 17 profit and the change in CSM should help address such concerns.
The criteria for grouping insurance contracts in accordance with IFRS 17 allow KPIs at a more detailed level. For a more meaningful analysis, you can look at the analysis of changes using different dimensions. So you can aggregate the analysis of change results from insurance funds, product classes and entry into force periods instead of analyzing changes at the cohort level.
When identifying the main sources that contribute to profit or loss, question the cause. For example, ask:
- Is it due to exceeding costs or underrun?
- What about the injury experience? Has it improved or gotten worse (compared to what was expected)?
- Are the actuarial assumptions used for expected cash flows reasonable?
From the fund level, you can then – if necessary – drill down to portfolios, business areas and product classes after different entry into force periods. Once you have identified the sources of profit or loss over time, you can make informed decisions about product development or re-pricing, insurance, claims management and cost management. You can identify which products are good to distribute and which are not. You will also be able to monitor profitability trends over time and compare the actual results with the business plan or forecast.