Aviva CFO: Most IFRS 17 impact seen in 40% of business
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Aviva’s chief financial officer has said that most of the impact of IFRS 17 will be reflected on its annuity and protection business, accounting for 40% of the group’s operating profit, while the remaining 60% of the business will be largely unaffected by the transition to IFRS 17.
The accounting standard for insurance contracts is taking effect next month.
As of December 2021, the group had £2.3bn of IFRS 4 adjusted operating profit, according to figures presented by CFO Charlotte Jones to investors on Friday.
Contracts written by the insurer fall into four categories, typically allocated by product type. Under IFRS 17, different approaches will apply to different contracts to measure liabilities.
Aviva’s annuities and protection business, which represents 40% of the firm’s operating profits, will be accounted for under the general measurement model, the default model for measuring insurance contracts.
IFRS 17 introduces the contractual service margin, which represents a stock of future profits over the lifetime of a contract. The standard also introduces the concept of the risk adjustment, which replaces IFRS 4 margins and is similar to risk margin under Solvency II.
“Under the GMM approach, the CSM is measured using a locked-in discount rate from inception. Profit is driven by the release of both the CSM and risk adjustment into the P&L (profit and loss) over the lifetime of the policy,” said Jones.
“The release of profit matches the delivery of the insurance service to the customer and reduction of risk. The impact of any demographic and operating assumption changes is recognised in a similar way over the life of the contracts. And as a result, profit recognition is more predictable over time.”
Limited impact for the rest of the business
The insurer’s general insurance and health segment, accounting for 35% of the business, will apply the premium allocation approach, a simplified method for short-term contracts “with limited impact for Aviva”, according to CFO Charlotte Jones.
“There is no CSM for the business measured under the PAA. Instead, we hold a liability for remaining risk coverage, which will flow to the P&L in much the same way as our current unearned premium reserve.”
Jones added that under the new standard, all claims liabilities for its GI business will be discounted. This differs to IFRS 4, the current accounting standard for insurance contracts, where only long-term liabilities such as periodical payment orders are discounted.
The group’s heritage segment, which includes with-profits and unit-linked products and accounts for 15% of the business, will be measured under the variable fee approach with “modest impacts”, Jones said.
“Profit will be driven by the release of the CSM and the risk adjustment over the remaining life of the contracts,” Jones said, referring to the company’s heritage business. “However, as no new business is being written here, we will continue to see run off broadly in line with previous guidance. The business remains a significant source of predictable profits for the group.”
Wealth, equity release and Aviva Investors, which represent the remaining 10% of Aviva’s business, are all out of scope of IFRS 17, Jones said, as this is where the company will apply IFRS 9 “with no impact for these business lines”.
CSM more than offsets lowered shareholders’ equity
The composite insurer expects to create a CSM of between £4bn and £5bn net of tax.
IFRS 17 is expected to dent Aviva’s shareholder equity from £19bn under IFRS 4 to around £16bn to £17bn under IFRS 17. However, Jones argued it was important to consider the CSM alongside shareholder equity “as it represents the large stock of future profits”.
On this basis, the group's opening adjusted shareholder equity, at 1 January 2022, is expected to be around £21bn to £22bn under IFRS 17, according to Jones.
“In aggregate, shareholders equity plus the value of the CSM represents a reasonable measure of the value to shareholders,” the CFO said.
What are the different methods of IFRS 17 to measure liabilities?
Within IFRS17 there are three possible measurement models: GMM, PAA and VFA. Also known as the building block approach, the GMM is the ‘default’ measurement model for insurance contracts. This is based on the ‘building blocks’ needed to calculate liabilities such as expected discounted cash flows, the risk adjustment and the CSM.
For contracts with a coverage period shorter than one year, there is the option to choose PAA as a simplified measurement model. Longer-term contracts can also use the PAA, although the entity will have to show that the result of the PAA is no different than the GMM. Many general insurers expect to use the PAA for most of their contracts.
For contracts with direct participation features such as with-profit or unit-linked contracts, entities are required to use the VFA.
At inception, the CSM is the same under both VFA and GMM. However, the difference between the two models is evident in subsequent measurement in later years.
The CSM is adjusted to reflect the variable nature of the fee. The variable fee is based on a share in the underlying items for which the value varies over time and reflects both the investment performance of the underlying items and other cash flows needed to fulfil the contracts.
Insurers expect part of the profit of those underlying items to be returned to policyholders. Therefore, the CSM does not reflect the unearned profit for the insurer as part of it is returned to the policy holder.
Where do you see the effect of IFRS 17 is seen in your business?
