Publication of IFRS 17: Insurance contracts

On 18 May 2017 the International Accounting Standards Board (IASB) published its new International Financial Reporting Standard (IFRS) on accounting for insurance contracts: IFRS 17. IFRS 17 will apply for accounting periods starting on or after 1 January 2021, but prior year comparative figures will be required.1

The Standard is directed at insurance contracts, rather than insurance entities. So it will apply, for example, to equity-release mortgages written by banks, as well as to those listed insurers required to report under the IFRS and to those insurers that adopt the IFRS voluntarily.

The publication was accompanied by webinars conducted by members of the IASB Staff, including Q&A sessions.2 The responses provided by the staff were caveated as being their own views, and not necessarily those of the IASB. Nevertheless, the answers offer some interesting insights, which are briefly summarised in this blog.

Overview
The aim of the Standard is consistent accounting for all insurance contracts, with increased transparency in financial information reported by insurance companies and calculated information based on current estimates. However, the staff acknowledges that the Standard is not directionally convergent with the aims of the Financial Accounting Standards Board (FASB), the standard setter for the United States.

In summary, the principle-based Standard requires an assessment of the profitability of insurance contracts when they are first issued and, if positive, recognition of that value (the Contractual Service Margin or CSM) over the lifetime of the contracts in a manner that reflects the timing of the insurance services provided by the insurer.3

The staff expects firms to incur significant implementation costs.

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Predictive analytics for the mortgage industry

How can predictive analytics help Government National Mortgage Association (GNMA/Ginnie Mae) issuers decide whether they want to buy out a nonperforming loan or not? In their article “Enhanced vision,” Milliman’s Jonathan Glowacki and Makho Mashoba provide perspective on an algorithm used to analyze loans that are likely to bounce back in order to reissue them as a mortgage-backed security.

Here is an excerpt:

The XGBoost model, like similar algorithms, is easy to implement. Once the mechanics of the technique are understood, and the parameters are tuned correctly, the model can be turned on a data set to produce accompanying predictions. The model can be updated continuously each month based on new data feeds. Pointing an XGBoost program toward a new data set and running it again is virtually all that is needed to refresh the results. It is also possible to retune the parameters for the update to further enhance the effects.

A use case of this type of model would be to pursue early buyouts for mortgages that have a high probability of re-performing and potentially not pursue early buyouts for mortgages that have a low probability of re-performing, as long as this policy is consistent with GNMA servicing guidelines.

This same technique can be used on a variety of data for alternative purposes. Predictive analytics can capture predictive power from internal data, whether that involves established and go-to data sets or whether that involves bringing together data from across an organization to make predictions. Predictive analytics can also help a firm leverage industry data and other outside sources to forecast trends or improve decisions. This case is a concrete example of how using the tool should result in higher return on investment on GNMA early buyouts.

Considering the growing amounts of data available, the mortgage industry should pay attention to predictive analytics tools. Investing in the technology has proven to generate significant returns. GNMA issuers is just one group to which predictive analytics can be applied. Predictive analytics can be applied to many other techniques and tools to increase efficiencies within the mortgage industry. The future depends on it.

How can self-insureds benefit from independent actuarial services?

Companies should try to avoid any conflict of interest when subscribing to the principles under the Sarbanes-Oxley Act. When determining if an actuarial firm is independent, a company can ask two questions: Is the actuarial firm a provider of another service to your company? Does the firm present any possible conflicts?

In the article “Why independence matters in actuarial services,” Milliman’s Richard Frese and Tony Bloemer discuss how actuaries in various roles interact with key decision-makers and the business benefits of working with an independent actuary.

SFCR: An initial picture

This blog is part of the Pillar 3 Reporting series. For more blogs in this series click here.

Following the first annual reporting deadline under Solvency II for most companies on 20 May, there is now a wealth of information available through companies’ Solvency and Financial Condition Reports (SFCRs).

We are currently analysing the contents of the Irish SFCRs, both quantitative and qualitative, and will be publishing more detailed analyses in the coming weeks. However, as a taster, we’ve looked at solvency coverage across life and non-life insurers in Ireland. While this initial analysis does not include every company, the sample includes 46 companies with aggregate Own Funds of €26.4 billion, including all the major players.

The good news is that the Irish insurance industry is in a healthy position in terms of solvency coverage. Only one company has an SCR coverage ratio below 100% at year-end 2016 and it has since received a capital injection to remove the shortfall.

The graph below shows the relationship between Own Funds and SCR coverage ratio for companies. This shows that the majority of companies (66%) have a coverage ratio between 100% and 200%, including those with Eligible Own Funds in excess of €1 billion. The weighted average solvency coverage ratio is 167% (178% for life and 154% for non-life).

Our later analysis will also include a pan-European focus on the public disclosures. However, we’ll have to wait a little longer for this analysis as the group reporting deadline is 1 July. This includes the publications of single SFCRs where groups have opted to include all their subsidiaries within a single public disclosure document. We understand that some of the large groups in the UK have gone down this route.

Paid family leave proposal leaves states with funding issues to consider

President Donald Trump’s 2018 budget proposal includes a paid family leave insurance program for workers in the United States. Under the president’s proposal, states would be allowed to design the paid leave program for their own jurisdictions as long as the benefits meet minimum standards. This means that some states may have a lot to consider when preparing for a new insurance program, such as funding methods, administration, and specific benefit design features. The article “Paid family leave in the United States” by Paul Correia offers some perspective.

Captive actuaries are as indispensable as your traffic app

One of the primary rewards from operating a captive is the ability to place more emphasis on the risk management process, in order to stabilize annual budgets, reduce long-term costs, and utilize capital more effectively. To accomplish these goals, captives rely on experienced service providers to manage almost all of their operations.

An actuary is one of these indispensable service providers. Simply put, actuaries can quantify the level of risk, which allows the company to better manage it. And actuaries provide value throughout a captive’s life cycle, from formation to dissolution (if applicable). Risk factors change all the time, so having an actuary review your experience regularly is crucial to avoiding problems.

Speaking of avoiding problems, we all love the functionality of the Waze traffic app, which steers us from one location to another in the most efficient manner possible. At its core, this traffic app helps you figure out what path to take to avoid unexpected delays, thereby reducing stress levels. Anyone who has traveled I-95 in Connecticut knows this value first-hand.

Actuaries essentially function like a Waze app for captives. They largely provide a means to keep captives on the right path by avoiding surprises and reducing potential for management stress.

Initially, actuaries are engaged in feasibility processes to help ensure a company knows what to expect as it sets out on its journey to create a captive. Where necessary, actuaries utilize data from the local environment (the industry) to supplement the company’s own experience. The main deliverable of the feasibility study is a five-year pro forma financial model, which includes a projected income statement and balance sheet of a new captive’s financial business plan. Actuaries provide these projections on both an expected loss outcome basis and an adverse loss scenario basis; this is because it is crucial to understand the potential risks involved, not just what to expect on average. Both the captive business owner and regulator are key stakeholders for whom the feasibility study reduces stress levels right from the outset.

Once the journey begins (the captive is formed), actuaries perform ongoing loss reserving and loss forecasting (budgeting). As the captive’s losses emerge, the actuary has to gauge how much weight to place on an individual insured’s experience versus that of the industry when estimating ultimate losses. This is a delicate balance amidst the “noise” of random variations in losses. In the end, actuaries hold the keys to how fast the captive can travel from a loss recognition standpoint.

Periodically, at least every three years, the actuary should update the pro forma model, adjusting to the conditions of the road map that was created. This provides a continuous means of reasonableness testing of underlying assumptions, including loss ratios, loss development patterns, loss payment (discount) factors, expenses, investment income, taxes, etc.

All of this effort ultimately supports a smooth ride—the issuance of fairly stated financial statements with adequate funding of loss reserves. The actuary’s road map and process needs to be transparent enough to allow another actuary to essentially reproduce the analysis (even though no two actuaries would use all of the same assumptions or necessarily take the same route to the destination). During the process, the captive’s actuary needs to engage in dialogue with the audit firm’s actuary to ensure audit sign-off is secured; this helps to arrive at your final destination from a financial reporting standpoint.

As actuaries, we certainly wish our models could be as straightforward as the Waze traffic app. Even though we face complex questions, our processes and expertise have proven to be successful in navigating the risky terrain of running a captive insurance company. In Connecticut, our tourism branding is “Still Revolutionary.” In today’s ever advancing age of big data and analytics, using actuaries to help captives take calculated risks to justify the potential rewards noted above is still a state-of-the-art approach. And the Hartford, Connecticut area has the highest number of actuaries per capita in the United States. Talk about an opportunity. So you may want to consider the Waze-like advantages of using an actuary to help you navigate a new route to establishing a captive in Connecticut.

This blog post was first published by the Connecticut Captive Insurance Association.