Time is running out to optimise your reinsurance programme for IFRS 17

Reinsurance is a key management tool in smoothing profit volatility, managing capital requirements and access to finance. IFRS17 fundamentally changes the model of reinsurance measurement and will change the drivers of need, and therefore the type of reinsurance available.

IFRS 17 brings issues for current reinsurance structures

Issues relating to reinsurance under the standard have been there, largely, since early exposure drafts and are reasonably well known. The new accounting for reinsurance will mean existing reinsurance programs either no longer deliver their intended benefits or with complications in the accounting that need to be addressed. These include:

• Reinsurance programs to finance or defer acquisition expenses may no longer deliver the intended benefits; acquisition expenses will be part of the future fulfilment cash flows, and hence through the Contractual Service Margin (CSM) be spread over the insurance coverage period
• The benefits of reinsurance under IFRS 17 change are driving altered behaviours in terms of the risks insurers want to cede; Asset Liability Management (ALM) and asset-intensive reinsurance are likely to be more in demand
• The contract boundary for reinsurance runs up until the end of the renewal window on the treaty. With many treaties having 30-60 day renewal terms, modelling the yet-to-be-sold business into this future window can prove difficult and will misalign with the accounting for the underlying contracts
• Some of the groups of insurance contracts covered by the reinsurance treaty can be onerous whilst the treaty itself is profitable. This can lead to a mismatch.
• The prohibition in IFRS 17 on applying the Variable Fee Approach (VFA) approach to reinsurance will give rise to accounting mismatches. Many large-scale transfers of with-profits and unit-linked insurance contracts have been implemented through reinsurance (e.g., to/from European subsidiary as part of Brexit) and the inability to recognise the impact of changes in financial risk in the reinsurance leg will mean entity level accounts are at best opaque

To date, reinsurers have had little direct interaction with insurers

We consulted with some reinsurers around the world; they have not experienced a significant amount of interaction with their cedant insurers looking to solve any issues with IFRS 17 adoption and their reinsurance programs. Some reasons for this are:

• Cedants primary focus is to get the basic reporting planned out under IFRS 17, technical policies finalised and implemented, and operational changes overcome
• A lack of communication between the deeply technical IFRS 17 implementation workstreams and the commercially focused teams responsible for the design and operation of the reinsurance programmes
• Reinsurance in IFRS 17 is deemed complicated and would be looked when the rest of the IFRS 17 implementation and methodologies have been finalised

Reinsurers trying to anticipate the reinsurance needs of their clients

Reinsurance groups are considering IFRS 17 not only from their own implementation perspective but also trying to anticipate their client requirements. Several issues are however becoming apparent, including:

Existing program amendment

• Where the reinsurance program’s main aim is to provide deferral of acquisition expenses, these programs are being wound up on mutually acceptable terms
• Treaty design amendments are being incorporated to shorten the renewal window to reduce contract boundary issues
• Reconsideration of how the reinsured risks attach reinsurance contact to create clarity on what constitutes a group of insurance contracts, with a view to reducing mismatching of groups with the underlying business

Fair value transition

For insurers who will use fair value (FV) as a transition approach rather than fully or modified retrospective valuations, external reinsurance will provide a tangible benchmark for the FV in an illiquid market

Longevity swaps

It may make sense to enter into any planned longevity swaps prior to IFRS 17 “go live”. Entering into a swap post-go-live could release profit from the CSM but if tax losses on transition are spread over 10 years, the profits and losses could end up not matching, as tax leaving profits exposed to tax would otherwise be sheltered

Asset intensive reinsurance

Some reinsurance groups are considering increasing their asset exposure through their reinsurance in order to provide an ALM service to their clients, which would be of benefit their own economies of scale

Aggregation of onerous and non-onerous contracts

Where onerous and non-onerous groups of contracts are reinsured and they are not split separately in reinsurer reporting, the aggregation in the reinsurer can provide a beneficial mismatch reflected in the terms offered to the cedant. This provides an opportunity for management performance measures (such as adjusted operating profit) to better reflect the economics of a seemingly onerous group of contracts

What do reinsurers need to do now?

Over the next six months insurers should:

• Actively engage their IFRS17 implementation teams with their reinsurance programmes
• Review their existing reinsurance programs to determine whether the cover still achieves its aims
• Look into the contract terms around renewals and negotiate amendments where necessary and build modelling capability where this is still required
• Test existing FV pricing approaches with external parties and consider external reinsurance for blocks where this accounting is expected, and further support is needed to obtain the desired outcome
• Sharpen the analysis on profit emergence and specifically the periods where tax losses arising on transition will emerge - consider using reinsurance to optimise this outcome
• For onerous contracts consider whether there is a reporting benefit in bundling these into an overall aggregated profitable reinsurance cover and recognising reinsurance recovery component immediately

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