Insurance entities produce a myriad of information for different users internally and externally. The metrics within internal Management Information (MI) along with the Key Performance Indicators (KPIs) that are monitored by analysts and investors, provide insight into the entity's profitability, risk profile, solvency position, & value. Internal MI packs tend to focus on the year to date, on performance against plan, and trends over time. Investors turn to financial ratios to help analyse a company's fundamentals. They focus on KPIs and disclosures, which they primarily source from insurers' financial statements and solvency reports (SFCRs).
This latter set of stakeholders has been a primary catalyst for IFRS17, as they considered that the existing reporting by Insurance companies had issues such as lack of consistency with other industries (re. revenue recognition), & lack of transparency. Now, IFRS17 is changing the face of the financial statements and the contents of the disclosures. These changes will impact the KPI, and it is in the interests of the industry that they quickly come to understand these and, where possible, replace old metrics with the new. The alternative – having yet another suite of metrics which must then be reconciled to the current metrics – is a situation that we must aim to avoid and is surely not what was envisaged by IFRS17.
The more commonly used metrics fall into five categories: Liquidity, Solvency, Activity/Efficiency, Profitability and Market Prospects. In this article I will consider the extent to which these are likely to change, or be replaced, due to IFRS17.
Liquidity Ratios reflect a company's ability to meet its short-term obligations. They focus on cash, cash net of expenses, current assets and current liabilities. These elements will all be available in the new financial statements, while no additional "liquidity" metric has been created. Therefore, this category of metric will remain unchanged due to IFRS17.
Solvency Ratios indicate a company's resilience and ability to meet its obligations under a severe stress scenario. Many solvency regimes are now risk-based and quite prescriptive, such as Solvency II. The calculations are independent of the Financial Reporting regime, and so they are not expected to change or be replaced when IFRS17 becomes effective. There may be some second-order impacts – e.g. if IFRS17 results in a change in reinsurance strategy – but there will be no direct impact on the Solvency metrics. IFRS17 introduces a new risk metric, the Risk Adjustment, along with disclosure of the confidence interval chosen. This may lead to some analysis relative to the Risk Margin in solvency II.
Activity or efficiency ratios
Activity or Efficiency Ratios indicate the level of productivity of a business. Metrics include Gross Written Premium (GWP), Annual Premium Equivalent (APE) and the Expense Ratio. We do not expect much change here, but there will be some challenges as a number of the components of these metrics will not be immediately visible in the Financial Statements. For example, GWP will no longer be a line item in the P&L. It should still be available in the disclosures, however, meaning that a little extra effort may be required to produce the metric.
Profitability metrics include IFRS Profit, Underwriting Profit, Operating Profit, ROE, ROA, ROC, the Claims Ratio and the Combined ratio. We expect that this category will undergo significant change and consider that there are at least three types of change possible.
The first is a shift in the value of metrics.
The second is a change in the component of a ratio.
The third is a suite of new metrics that IFRS17 will introduce.
Market prospect ratios
Market Prospect ratios include metrics such as dividend yield, P/E ratio, EPS and price/book; metrics that are used to predict earnings and future performance. Many of these are based on the value of a business. For the purposes of this article, I will refer to them as Value Metrics.
These metrics are of critical importance to insurance companies, because, unlike most other industries, the transaction with the policyholder is not one-and-done. It takes time. Though we see some very short term insurance business, such are monthly renewable cash plan business. It is more typical to see policies with terms of 1-3 years in non-life business and group life business, while life insurance policies can range extend to whole of life with 20-year terms are very common.
Some of the key-value metrics used currently include Embedded Value (NAV + VIF, or SII Own Funds + uplift), New Business Value (PVNB) or Gross Margin (PVNB/AP(E)).
Investors have not always liked these value metrics and consider them with a degree of caution or scepticism. This has resulted in more expensive capital for the industry and has also driven some insurers to engage in "VIF capitalisation" transactions which deliver cash to the balance sheet at a cost (typically a # bps above IBOR).
As set out above, IFRS17 will have a significant impact on MI & KPI produced by insurance companies. Profitability metrics are likely to see the biggest change, and most likely will include a greater number of metrics post-implementation. Within Value metrics, we are likely to see new metrics replacing the old, hopefully delivering added insight and value to management. Other metrics are unlikely to change. But each business is different, and you know yours best. If you're at the stage of beginning to look at MI, I would suggest that you start with the following three questions:
- What MI do I currently receive that I do not find useful?
- What new MI would be useful?
- Looking out 3-5 years, what would our current metrics look like under IFRS17?
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