How to reconcile financial results pre- and post-IFRS 17

Insurance professionals looking to reconcile financial results pre- and post-IFRS 17 implementation need to understand specific accounting policy choices their company has taken because it’s “not going to be apples to apples right across the board,” a Wawanesa executive said.

Traditionally, the measure of profitability within the P&C insurance world has always been the combined operating ratio (COR) and this will continue, said Gord Dowhan, chief financial officer and senior vice president with Wawanesa Mutual Insurance Company.

With insurers reporting under the IFRS 17 insurance accounting standard since the beginning of 2023, and the first audited financial statements to be issued in early in 2024, it’s important to know which COR is being used.

There are three different CORs that are now commonly applied:

• Most companies are familiar with the IFRS 4 COR and continue to monitor this ratio, which traditionally applied to all contracts, including reinsurance contracts. This is essentially the costs of underwriting (claims/losses and insurance expenses) expressed as a percentage of underwriting revenue. COR lower than 100% means profitable underwriting; over 100% represents a loss.
• Undiscounted – the COR ratio that has not been adjusted for the impact of time value of money (i.e. presenting future costs/revenues in today’s dollars).
• IFRS 17’s “partially discounted” COR, driven by where discounting is presented in financial statements and how the ratio is reported.

“The initial discounting on claims goes into your Insurance Service expense,” which captures claims and underwriting expenses in IFRS 17, Dowhan explained.

Related: How Canada’s P&C insurers are faring under IFRS 17

“And that’s where COR is measured, but the changes in discount rates — and we’re seeing a lot of those in the last 18 months — as well as the unwind of discount rates actually goes below the line into Finance Expense,” he said. “So, that’s not captured in the IFRS 17 COR.”

Insurance expense is part of Net Insurance Service results and includes claims incurred, risk adjustment, loss component from onerous contracts, acquisition expenses and fulfillment expenses.

Finance Expense includes the cost of amortization/movement in discount rates when revaluing insurance contract liabilities. Essentially, as rates change there is revaluation of insurance contract liabilities. To present financial information in today’s dollars, companies would have an amount that was discounted previously, and they would adjust the amount based on the change in rates. This is referred to as the unwind of discounting; the size of the unwind depends on the interest rate levels of prior periods.

A lot of companies are including both IFRS 4 and 17 CORs. Still, it’s crucial to understand accounting policy choices, which may not be publicly available for non-publicly traded companies.

“It’s so important that when you’re looking at financial statements, looking at [key performance indicators], you understand what is actually included in there,” Dowhan said during AM Best’s Canada Insurance Market Briefing in Toronto last October. “Is it the component which is in Insurance Service expense? Or is it the component within the Finance Expense?

Related: Do you know what’s a material change in IFRS 17?

“You need to understand those accounting policy choices that the company has taken because it’s not going to be apples to apples right across the board,” he said during a panel discussion called Implications of IFRS 17.

Another factor to look at is return on equity (ROE) and Other Comprehensive Income (OCI), both are impacted through the adoption of IFRS 9. This has increased income statement volatility for many insurers as most fair value changes are now recognized through earnings, rather than OCI. OCI are items not recognized within the Income Statement by an entity, such as remeasurements of defined benefit plans like pensions.

“On those KPIs, are you really understanding what is included in the calculation?” Dowhan asked. “Is it the old world, new world and what is included in return on equity? Is it including OCI? What is actually included within income?”

While not new in the accounting world, the concept of onerous contracts is new under IFRS 17, Dowhan said. He describes these contracts as essentially “loss making at inception. And you’re taking those losses right up front, which is relatively new in the P&C industry, and that drives down equity.”

But for Wawanesa in particular, equity went up at IFRS 17 transition. However, insurers may see other measurers move in the opposite direction, such as the minimum capital test, Dowhan said.

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