The COVID 19 pandemic and the resulting lockdowns have had a devastating impact on most industries and financial markets. The IMF has predicted a severe downturn for FY 20, much worse than the 2008 financial crisis. The existing rock-bottom asset valuations, bond yields, and so on, have and would continue to impact the profitability of insurance companies.
IFRS 9 (financial instruments) and IFRS 17 (insurance contracts) were issued to create transparency in the financial statements of companies that would adopt them. Most insurance companies are working towards implementing these accounting standards to become compliant effective January 1, 2023. It would be interesting to ponder over the impact on measurement of various investment and insurance portfolios according to IFRS 9 and IFRS 17, if a similar downturn were to take place post 2023.
The IFRS 9 standard will govern the accounting and reporting of insurance investment portfolios, a majority of which will get measured at fair value (either FVTPL or FVOCI, depending on the nature of the financial instrument). Under this accounting regime, insurance companies would be required to continue to reflect these valuations in financial statements by accounting for major valuation losses from time to time during a downturn. Additionally, the investments that qualify for amortized cost measurement will also take a severe blow due to falling yield curves and would need to be assessed and accounted for as impairment losses. As such, there would be severe profitability impact due to low asset valuations.
When focusing on insurance liability, in addition to the pandemic induced steep claims, there would be new IFRS 17 measurement models, viz. General Measurement Model (GMM) and Variable Fees Approach (VFA) which define the valuation of insurance liability and revenue measurement for long-term contracts. The mechanism of liability and revenue accounting is based on the play of cash flows (actual versus estimated and their present valuations), the non-financial risk adjustment, and the contractual service margin. Long-term insurance contracts that are not directly participating in nature would be measured under GMM. The falling interest rates would severely impact the present valuations of the future cash flows. In most cases, insurance finance losses will have to be accounted for almost immediately. Reinsurance portfolios will have to follow parallel accounting and reporting.
Additionally, insurance portfolios that are directly participating in nature, would bear the brunt of plunging asset valuations and increasing insurance liabilities, and would have to be re-assessed for onerousness from time to time, and more frequently during an economic turmoil like the ongoing COVID-19 crisis.
We believe, the economic curves will reflect more starkly in the profitability under the regime of the new accounting standards. Therefore, insurance companies need to deal with the double blows of steep claims due to the pandemic on one hand and the downturn in financial markets leading to rock-bottom valuations. The pro-cyclical nature of the insurance business and the dependency of insurance companies' profitability on financial markets’ performance would immediately and more deeply be reflected in the financial statements of the companies as they will need to separate insurance service results from insurance finance results under the regime of the new accounting standards.