IFRS 17/Ind AS 117 implementation: Understand your profit to drive your business

In my previous article I mentioned about the massive shift the new standard is going to bring to the business.

Why Life Insurance industry?

The change of standard is not unique to insurance. It’s impacting other industries too. But there is not as much buzz there, as it is creating in insurance business, particularly life insurance. What’s making this industry so different? Because, the revenue, expenses and hence the profits of life insurance are not obvious in the current financials.

Issues with the current accounting

In the current accounting regime, recognizing premium as revenue is the core issue. To balance this, a component called ‘change in reserve’ is shown as expense.  Net of these two numbers is expected to reflect the revenue. All claims including maturity and surrender are shown as expenses. They also impact change in reserve. All this results into a very complex picture and one needs an expert to decipher each of these items in the financials. To get better understanding on the business, you may have to rely on other information such as NB Value and Embedded Value. But they need not necessarily reduce your confusion.

The new standard and the profit drivers

To address this, the new standard will bring a lot of transparency. The drivers of profit come out very clearly. It’s very critical to know those drivers to drive your business in a better way.

As we discussed, the premium collected from the policyholder will no longer be shown as income but will form part of the liability. The liability will release, year on year, for the services provided during the year.

There are three components that are relevant for revenue, which is called Insurance Service Revenue. Those components are:

• The release of liability towards expected insurance claims and expenses

• Release of Contractual Service Margin (CSM) or profit margin for the service period

• Release from the risk adjustment (additional liability to reflect risk in running the business)

On the expenses side, there will be reported claims and incurred expenses. The profit release therefore would be net of liability release and actual outgo of expenses and claims along with release of CSM and risk adjustment.

One component that might, arguably, become significant in the emergence of profit, will be release of CSM, assuming that the business written is on profitable terms.

Impact on your business strategy

If you are a decision maker at middle or senior level of a life insurer, you need to understand these drivers and how they impact your business. For example, savings products with high investment guarantee may have lower margin as compared to low guarantee or term products. Similarly, your profit margin would be dampened if you spend more in acquiring the business. Accordingly, you may need to tweak your business strategy. Your focus will have to be on maximising this insurance service revenue. Even the industry rankings will have to be based on insurance service revenue or new CSM addition and not on new business premium.

What is your take on criterion for industry rankings?