IFRS 17: The Challenges of Reinsurance

25 June 2018

We spend a lot of time travelling to many countries to meet with clients on IFRS 17 and one topic keeps coming - reinsurance. We hear again and again that this has been the forgotten area of the standard, but as companies get into the detail of what the standard actually says and how this interacts with their own reinsurance arrangements, or the data required, they are starting to realise this should be a priority.

The requirements within the standard to thoroughly review reinsurance may not look particularly challenging at a first glance, but IFRS 17 has the potential to impact not just the balance sheet at transition, but also critical considerations such as the future recognition of profit. Furthermore, the standard states that reinsurance contracts must now be valued and accounted for separate to the underlying contracts, meaning that traditional ‘netting down’ (gross less reinsured) and approximate methods used for these calculations may no longer be valid, as there are notable requirements surrounding the granularity of calculations and the approach to earning the Contractual Service Margin.

Although each insurer is different, it would be a mistake to assume that these issues are relatively minor and potentially contained, as even an individual reinsurance contract could be material in the context of the overall balance sheet, and so have the potential to create a significant mismatch between the value placed on reinsurance and the value placed on the underlying risks. As surprising as it may be, this problem is not just an accounting issue, and could have significant strategic and operational implications as well as an impact on the transfer of risk, on tax, on capital and on Solvency II for European operations.

Mismatches can appear in several places in the valuation process and have the potential to increase volatility in the profit and loss, with further implications for tax and dividends (depending on the country). There are many reasons mismatches may occur, including the reinsurance contract and the underlying contracts having risk exposures that are not aligned, or different contract boundaries and allowance for future underlying business. There are a plethora of other potential causes of mismatch – far too many for me to go into detail here, but to read more on this topic, please see our report discussing the impediments and solutions for IFRS 17 and reinsurance: https://pwc.to/2GZ7Vak.

So what does this mean for insurers? The key takeaway message here is that having good quality data is an essential prerequisite for making robust calculations under IFRS 17. Even firms seeking to leverage their Solvency II calculation will likely encounter challenges with reconciling the valuation of reinsurance under the two different regimes, as insurers will be expected to make assumptions they have not needed to before under IFRS 17, and more estimation means greater functionality than that which already exists for Solvency II. Ensuring that the data used for reinsurance is fit for purpose will have benefits across the business, so it is worth spending the time now to address these issues, especially as changes to reinsurance may need to be made well ahead of 2021. Don’t be caught out, and make reinsurance a high priority in your IFRS 17 implementation planning.

Alex Bertolotti

Alex Bertolotti | Partner
Profile | Email | +44 (0)7525 298694

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