Challenges for insurers with the implementation of the new IFRS – part 1
Residual Margin - the IFRS Insurance deferred profit
Looking at the challenges insurers should be preparing themselves for, ahead of the implementation of new IFRS
While there are many similarities between the new IFRS Insurance and Solvency II frameworks, the goals of Solvency II and IFRS are actually quite different. The former focuses on shareholders’ interests while the latter is designed to protect policyholders. Although both frameworks use a common valuation for insurance liabilities (the “building block approach”) their opposite goals produce a number of detailed differences that are not easy to manage. Solvency II systems cannot deal with these differences and additional system work is necessary.
Residual margin – the IFRS Insurance deferred profit
- One of the IFRS Insurance requirements (from IFRS 4 Phase II) requires insurers to earn their profit as they fulfil their obligations with policyholders. This deferred profit is transparently reported and accounted for in the residual margin balance. An equivalent concept does not exist within Solvency II.
- In addition, IFRS 4 Phase II requires the residual margin to be recalibrated based on the changes in assumptions affecting the future cash flows from in-force business
- Residual margin data requirements will be at a granular cohort level i.e. groups of contracts by inception year, policy term and shape of earning pattern.
- Residual margin data will provide powerful insight in an insurer’s embedded profitability and ability to price risk effectively. Linking pricing guidelines to the accounting for residual margin could introduce stronger and clearer underwriting discipline.