The future of Management Information and Key Performance Indicators under IFRS17

Fundamentally, no existing insurance product is going to change. The future cash flows are going to be the same; therefore, the overall profit is the same. IFRS 17 does not change any of that. However, the timing of recognition of profits will change and could change very substantially. This will affect the profits in an individual year – and hence will result in a change in the value of any metrics that use profit in an individual reporting year.   

Transition adds a further layer of complexity, as, depending on the approach taken, there will be a shift between Shareholder Equity and Future profits. Some companies will see a hit to equity, offset by higher subsequent profits (remember – there is no change to overall profits), while others may see an increase in equity, offset by lower profits thereafter. Metrics that use equity in the denominator, therefore, also be impacted. 

Companies will need to think about the initial step change and the trend thereafter. This will be a bigger issue for companies with big back books, such as life companies, though it will vary depending on the product mix and the approach to transition.

The Claims Ratio and the Combined Ratio are key profitability metrics for non-life insurers.  

The combined ratio [(Claims + Expenses)/ Premiums] is a very useful ratio that tells us what proportion of premium is used to cover Claims and Expenses, and hence, what remains as profit. It is widely used in non-life insurance. As GWP will no longer be readily available as a line item in the P&L, perhaps the industry might consider Insurance Contract Revenue as an alternative? i.e. What proportion of insurance revenue is used to cover claims and expenses? This could be a sensible approach to take, either as a replacement for GWP in the Combined metric, or as a new metric.

These will be based on the new profitability information in the P&L and new information produced by the accounting systems.  

We expect that Insurance Service Result will give a very clear view of operational margins, or underwriting profits, i.e. those that relate to the true nature of the business written; while non-operational items (incl. other operating expenses and investment income on shareholder assets) will be separately identifiable. We expect that analysts will be very interested in the Insurance Service Result and will expect a good degree of stability within it. It is, therefore, likely that Management MI will include this metric going forward.  

We also expect that internal New Business MI will include information on onerous contracts at the level of aggregation required by IFRS17 for calculation, rather than at the portfolio level which can be used for the disclosures to the financial statements. This will give shine a spotlight on loss-making contracts, thereby facilitating management's review of whether or not these are within appetite and aligned with strategy, or perhaps they need to be repriced.

New metrics:   

IFRS17 calculates two new value metrics: the Fulfilment Cashflows (Present value of future cash outflows minus inflows) and the Contractual Service Margin (CSM), both of which will be contained in the disclosures.  These are consistent at the outset, using the same assumptions and discount rates, and the same contract boundaries. However, over time they move out of alignment as the Fulfilment Cashflows remain market consistent and on best estimate biometric assumptions, while the CSM uses locked in financial assumptions under the General Measurement Model (GMM). Furthermore, the Fulfilment Cashflows unwind as cashflows occur, but CSM unwinds, or is amortised, in line with coverage units at the level of aggregation used. So the pattern of release of the two metrics is quite different.

The Fulfilment Cashflows reflects the actual cash flows that are expected to happen on all policies.

The CSM reflects the value of profits yet to be recognised in the P&L on groups of insurance contracts (GICs) that are not onerous. 

Which one should be used and when? 

That will depend on the user and the purpose. For example:

1. A potential buyer for a business will most likely be interested in the Embedded Value of the whole business. Shareholder Equity + release of (CSM +RA) is useful here because there is consistency in relation to onerous GICS.  
2. A buyer of a book of business within a portfolio will be more interested in the PVFCs + corresponding RA.  
3. Analysts and Investors who are interested in year on year dividend streams will be interested in the CSM yet to be released, as there tends to be a correlation between profits recognised and dividend distributions.  
4. Management wanting to understand the value of new business may wish to consider both.
   Fulfilment Cashflows will give a full view most comparable to the NB Gross Margins they have considered previously. CSM is problematic in that it relates only to profitable cohorts, and to express it as a % of APE would overstate the overall profitability of new business due to the exclusion of the losses recognised on onerous cohorts of new business.
   As mentioned earlier, the value of Onerous Contracts is expected to be a focus for management; it will highlight cross-subsidies in pricing and will give greater sight of unprofitable products generally. This will enable management to consider if this is appropriate (perhaps from a strategic perspective) or if repricing is required
5. CSM release as a % of CSM could be a useful management metric for the aggregate book and for individual cohorts and lines of business. The inverse of it, i.e. CSM / Insurance Revenue, would provide a useful rule of thumb as to the capitalisation factor for the business.  
6. Management wishing to capitalise future profits, e.g. in a VIF capitalisation – may be able to negotiate better terms if they only capitalise the profits on non-onerous contracts, as this could be considered to provide greater certainty and a faster repayment schedule for lenders.