Most insurers favour IFRS 17 bottom-up approach for discount rates
Pardon the Interruption
This article is just an example of the content available to mallowstreet members.
On average over 150 pieces of new content are published from across the industry per month on mallowstreet. Members get access to the latest developments, industry views and a range of in-depth research.
All the content on mallowstreet is accredited for CPD by the PMI and is available to trustees for free.
Three-quarters of insurers around the world expect to use the bottom-up approach to determine discount rates under IFRS 17, according to a report published by KPMG.
This pattern is more common among European insurers in order to align with Solvency II, said the consultancy.
The report, which analyses insurers’ initial disclosures of IFRS 17 and IFRS 9, said the discount rate approach was disclosed by 49 insurers. Of those, 74% favoured the bottom-up approach and 12% expect to use the top-down approach, while the remaining 14% say they will use a hybrid model.
As a principles-based approach, IFRS 17 leaves room for insurers to determine certain aspects of the standard, such as the discount rate and the risk adjustment.
Discounting adjusts an insurance contract’s expected cashflows to reflect the time value of money and financial risks.
KPMG said under the accounting standard, which took effect this year, the discount rate needs to be consistent with observable current market prices and reflect the characteristics of the cashflows and the insurance contract’s liquidity characteristics.
Insurers have the choice to apply either a bottom-up approach – reflecting a risk-free yield curve and an illiquidity premium – or a ‘top-down’ approach, using a reference portfolio of assets adjusted to eliminate any factors that are not relevant to the insurance contracts, such as credit risk.
The consultancy explained that the most common source of the risk-free yield curve is Solvency II risk-free rates, through European Insurance and Occupational Pensions Authority curves.
“Other common sources include swap curves and government bond rates,” said KPMG.
The report found insurers derived the illiquidity premium using different approaches, including:
· The long-term weighted average credit spread of a reference portfolio of assets, less credit risk and other factors that are irrelevant to the illiquidity characteristics of insurance contracts; and
· Observable market liquidity premiums for financial assets, which were adjusted to reflect the illiquidity characteristics of the cashflows or liabilities using risk-adjusted spreads of corporate and government bonds.
KPMG noted: “Some insurers disclosed that certain non-life products are disclosed with a risk-free rate without an illiquidity premium, because the insurance contracts are fully liquid.”
Other findings of the report
The findings form part of KPMG’s wider analysis. All insurers disclosed the key accounting policies they expect to apply under IFRS 17 and IFRS 9, but the level of detail varied widely.
Many insurers disclosed the expected impact on opening equity.
Many aim to provide restated 2022 comparatives before or together with their first interim report.
Some insurers report the expected impact on restated profitability in 2022 and key performance indicators.
The report analyses disclosures from 60 insurers worldwide. Breaking down into segments, one-fifth (20%) of those analysed were life and health insurers, 12% were non-life firms, 40% were composite insurers, 7% reinsurers and the remaining 21% bancassurance firms.
What is your approach to discounting?
