How IFRS 17 changed two key P&C financial metrics

IFRS 17 will change the presentation of company results in 2023 Q1, eliminating one standard property and casualty insurance financial metric completely, and subtly affecting how combined operating ratios are presented.

The most obvious and straightforward change will be doing away with the time-honoured metric of direct premiums written (DPW), as explained at an IFRS “Teach-in” provided by Intact Financial Corporation’s CFO Louis Marcotte Thursday.

“Direct premiums written, or DPW, which is our key metric for measuring growth, will no longer be an IFRS metric presented in the financial statements,” Marcotte observed. “That said, DPW, which is a more forward-looking measure than earned premiums, will continue to be our main growth indicator and as such we will continue to present it in our MD&A (management, discussion and analysis statement).”

One change to how unpaid claims are recorded under IFRS 17 will alter the traditional understanding of P&C companies’ combined operating ratios (COR).

Stated simply, COR is calculated by adding together the insurance company’s incurred claims losses and expenses (including operating expenses), and then dividing the total by earned premium. A number below 100% indicates a profit, while a number above 100% equals a loss.

IFRS 17 will change the way insurers record their unpaid claims expenses, which in turn will change the meaning of the insurers’ COR results.

“The most significant change is the re-classification of the [claims reserve] discount unwind between the combined ratio and net investment results,” as Marcotte summed it up.

When insurance companies create a claim, they record a risk adjustment, which is a new concept under IFRS 17 that essentially describes a new reserve that compensates insurers for uncertainty.

Insurers also create a “discount build,” another type of reserve in which projected future claims payments are discounted to present value using discount rate assumptions. Among other things, a discount reflects the time value of money and liquidity of insurance contracts (i.e., how quickly and easily they can be converted into cash at present market rates).

A discount build is favourable and mostly benefits the current accident year, as Marcotte described. A discount unwind is unfavourable, mostly impacting the prior accident year.

“As time goes by, assuming no change to the ultimate claim’s expected value, we will release the risk adjustment and discount to bring the claim back to its expected payment value,” as Marcotte explains.

“The claim’s payment value does not change with IFRS 17. What does change is where the different elements are presented in the P&L (profit and loss statement).

“Under IFRS 4, both the favourable build and the unfavourable unwind of the discount were presented within the combined ratio.

“Under IFRS 17, the new standard is clear that the unwind of discounting should now be considered an insurance financing activity, recorded outside of insurance results. This is a major change because it improves the lifetime combined ratio permanently.

“We will therefore move the unwind of discount within our investment results.”

Intact’s combined ratios going forward will reflect the undiscounted combined ratios for all of its business segments, Marcotte said. The question then arises: How will other insurers present their combined ratios? Will they present undiscounted combined ratios, or will they have discounted combined ratios, excluding the unwind of the discount?

“When comparing our [combined] ratios to those of our peers, it will be important to ensure that combined ratios are on a comparable basis,” Marcotte cautioned. “That is either discounted but excluding the unwind of discount, or undiscounted.”

 

Feature image courtesy of iStock.com/takasuu