IFRS 17 is going to put actuarial assumptions and model outputs at the front and centre of financial reporting. The resulting need to meet tight calculation deadlines and free up the time needed to get on top of heightened earnings volatility is going to demand an operational shake-up. How can your business get up to speed?
IFRS 17, the new accounting standard for insurance contracts, which will go live from 1 January 2021, is both an operational and investor relations challenge. If analysts are going to be putting CFOs on the spot, then CFOs will be fixing their glare on their actuarial and finance teams. So, what’s changed and what’s at stake?
Actuarial risk evaluation has long been one of the inputs into insurers’ financial results, though the influence on earnings has been limited in a system that’s still primarily focused on historic cost. The move to a framework based on risk-sensitive projected cash flows under IFRS 17 means that actuarial input is going to be at the core of the accounting results. Over time, the level of earnings is likely to be much the same as before. Yet, market movements and risk adjustments mean that both the profit & loss and the balance sheet could be more volatile.
Your CFO wants a smooth income and dividend stream, but this is going to be a much bigger challenge than at present. And this tough ask is going to fall squarely on actuarial teams. This includes closer evaluation and management of the impact of risk assumptions and adjustments on the numbers – some smoothing of the earnings may be possible, but only if there is sufficient analysis and justification. All of this requires time.
However, time is something that actuaries won’t have a lot of if they continue to rely on current processes. Their closer involvement in financial reporting requires a ‘hard close’ approach, in much the same way as their colleagues in finance. The financial returns might currently provide the starting point for Solvency II reporting, but once IFRS 17 is up and running, the twin operations need to be fully integrated and the timelines aligned.
A significant operational shift is therefore needed to enable actuarial teams to speed up turnaround, integrate their outputs into the financial reporting process and free up time to focus on the earnings and underlying assumptions.
Greater automation is in turn critical in separating the mechanical aspects of actuarial evaluation, especially reserving, from the human judgements that will be even more important under IFRS 17. The aim would be to extract the necessary data, cleanse it and run it through the life valuations and non-life triangles, and then feed the results into the general ledger and balance sheet almost entirely automatically.
The only other options are more staff or reliance on external resources, both of which are unsustainable. Can you afford the sharp rise in costs? Would you want to outsource something as critical as the evaluation of your earnings?
Installing automated systems is relatively straightforward. However, the need to collapse legacy systems and then make the switch can take at least three to six months depending on their complexity. While IFRS 17 doesn’t go live until 2021, you’ll probably need to start test runs in the middle of next year, so it’s important to get moving as soon as possible. So how can you get on track?
Work back from the deadline for opening disclosures to work out what you need to do by when. This includes testing (i.e. dry runs) and firm-wide staff training as well as process transformation.
Familiar metrics including the combined ratio are going to be very different under IFRS 17. You may even need new measures of performance. It’s therefore important to educate the board, analysts and investors in advance about the impact and the implications.
If you need to bolster your actuarial and finance teams, it’s important to start recruiting now. Experience of Solvency II shows how demand for and scarcity of key personnel can escalate as you get closer to the wire.
So, there is a lot to do to get ready in a short space of time and both actuarial and finance teams will be at the heart of the shift. The sooner you begin to upgrade operations, the more time you will have to come up with numbers on the new basis, assess the impact on how you will be judged by the markets and start to get stakeholders comfortable with the new way of valuing your business.