AM Best, a rating agency with a core focus on evaluating the financial strength of insurers and reinsurers, has conducted an in-depth analysis of the effects of IFRS 17 on financial reporting, profitability metrics, and market comparability. This new accounting standard, which applies primarily to listed insurers across Europe, MENA, APAC, and Canada, introduces significant changes in how insurance liabilities and performance are recognised and measured.

The primary focus of IFRS 17 is on insurance and reinsurance assets and liabilities. It replaces previous standards by requiring liabilities to be presented as a combination of:

• Discounted best estimate of cash flows: A forward-looking projection of future payments.
• Risk adjustment: Reflecting the compensation a company requires for bearing the uncertainty of cash flows.
• Contractual Service Margin (CSM): Representing the unearned profit that will be recognised as revenue over time as services are provided.

These new components bring a structured and comparable view of insurers’ obligations. The CSM, in particular, aligns closely with the embedded value concept used in older valuation frameworks, offering a clearer picture of the future profitability of existing contracts.

Adjustments in Income Statement Presentation

Under IFRS 17, there is a unified approach to revenue and profit recognition for both life and non-life insurers. The previous emphasis on “written premium” is replaced with “insurance service revenue,” which reflects income recognised as services are rendered. This change significantly enhances the comparability and transparency of life insurance financials, where profit recognition was historically front-loaded.

The standard ensures that profitability figures better reflect service delivery over time, particularly in life insurance, where contracts span multiple years. It aligns profit with performance, providing users of financial statements with more meaningful data on the timing of income recognition.

Implications for Analytical Metrics

Traditional metrics like Return on Equity (ROE) remain largely intact and comparable under IFRS 17. However, there are notable shifts in other key indicators:

Combined Ratio (Non-Life): Now includes discounting effects and incorporates non-attributable expenses differently, creating comparability issues across firms and accounting regimes. The combined ratio tends to appear more favourable under IFRS 17, particularly for reinsurers, due to the impact of discounting,  often accounting for an 8 to 10 percentage point shift.

Expense and Loss Ratio Splits: The separation between these components is less clear under the new standard. Expenses not directly linked to acquisition are now often included in the loss ratio, skewing traditional analyses.

Reinsurance-Specific Observations

Reinsurers, especially those with large life books, have seen a decline in reported equity under IFRS 17, with value shifted into the CSM. This reclassification doesn’t indicate a loss of financial strength, but rather a change in how future profits are represented.

The standard has also altered how seeding commissions and premiums are accounted for, with insurance service revenue typically reported lower than traditional premiums. This discrepancy complicates direct market rankings and necessitates new methods of comparative analysis.

Impact on Capital and Ratings

Despite significant presentational changes, IFRS 17 does not inherently alter the financial strength of an insurer or reinsurer. For AM Best, which operates a building block methodology in its ratings, the key input—audited financial statements—has evolved to provide deeper insights, particularly for life businesses.

Contractual service margins are now treated as an equity-like reserve in analysis, particularly for life insurance operations, albeit with a discount to reflect volatility and lack of fungibility. This treatment aligns with prior approaches used for embedded value reporting.

The evolution in reported equity and profitability timing necessitates careful interpretation, but these changes are not expected to drive rating shifts. Rather, they demand a recalibration of analytical frameworks to maintain consistency across differing accounting standards.