Analysts at S&P Global Ratings have warned that ratings actions could be taken if insurers and reinsurers make significant changes to their risk appetite or capitalization strategies following the implementation of IFRS 17 in 2023.
International Financial Reporting Standards (IFRS) 17 will reshape insurance accounting from January 1st in a move that aims to improve reporting transparency.
Overall, S&P believes the move will make it easier to identify and compare how insurers and reinsurers generate profits and handle risk, and does not expect the accounting change itself to trigger rating actions.
But it added that ratings could be affected via “second order effects,” depending on how individual companies respond to the implementation of the new rules.
Specifically, IFRS 17 introduces new elements to account for the risk component of insurance contracts: the risk adjustment and contractual service margin (CSM).
For non-life insurers, S&P expects to regard both the risk adjustment and the CSM as audited reserve margins, and it may give credit in its capital assessment where an insurer’s loss reserves are determined to be in surplus.
S&P explained that the risk adjustment represents an insurer’s compensation for accepting an insurance liability, as the amount and timing of the cash flows associated with a liability are not known at the time it is taken on.
The CSM indicates how much profit an insurer expects to earn over the remainder of the contract. Under IFRS 17, insurers would set up a CSM reserve, thus bringing insurance accounting in line with the general IFRS principal that profits should be recognized as they are earned.
S&P also expects that the implementation of IFRS 17 will change reported shareholders’ equity for many insurers, which will impact its financial leverage calculations.
