Smoke & mirrors: How IFRS17 could enable near-term price gouging

A move by European insurers into a new accounting standard could spread just enough fog over the field to enable a short-term burst of price gouging, even in the most competitive commercial segments, a key analyst group has claimed.

The long-awaited IFRS17 accounting standard – mandated for the industry since January 1 – leaves non-life policy holders “unlikely to be able to assess how much profit insurers are making,” analysts at the Berenberg equity brokerage said in a note to investors.

“We believe this means that insurers should be able to earn higher margins for longer,” analyst Michael Huttner wrote.

While natural price competition will eventually normalise margins, Berenberg feels that the first line of client defence against being overcharged begins when savvy major commercial line policy holders sit down with their also-savvy brokers to review their carrier’s accounts.

This “key mechanism” setting some upper pricing limits on the best accounts “is now much less effective than in the past,” Huttner wrote.

The times were already tough for firms to guess how rich their carriers were or were not getting from the business they bring. Underlying margin trends that had been standard functions of frequency and severity got added moving parts from the advent of heightened inflation, all at differing levels and paces across every line of business.

Insurers may largely have fallen behind the curve at the onset and may have recovered to varying degrees in varying lines, but now stand ready to “earn more non-life underwriting profit for longer.”

IFRS17 has revolutionised the view to the insurance sector P&L. To date, the rules treated the industry like a production firm with revenues (net earned premiums) and costs (current claims, reserve adjustments, sales costs and opex) all allocated to the latest earnings period, then subtracted one from the other to render an underwriting profit.

The new system tracks the value of the complete portfolio of insurance contracts over time, including projected margin, releasing some of that profit-bearing value each quarter as insurance revenue, before subtracting more current costs. The accountancy gods at the International Accounting Standards Board (IASB) who could no longer tolerate comparing one period’s insurance rate to another period’s claim, made margin implicit from the very top lines.

There’s a lot of hoops for clients and markets to jump through in order to unpack underlying margin from an IFRS17 profit and loss statement. The evolution of portfolio value over time is blurred by changes in forward-looking risk adjustments, messy net present value calculations tied to interest rates and the pace at which the portfolio releases that value each quarter, i.e. the duration of the insurance portfolio. And unpacking all of that only gets you to the ‘insurance revenue’ line, still a few lines from any ‘profit’ measure. The ‘value over time’ thinking also blurs the line between unearned premiums awaiting recognition and investment earnings.

“There are now so many levels on which to analyse the combined ratio that most stakeholders will likely be confused about whether the underlying margin, the difference between pricing and claims inflation, is widening (i.e. improving), stable, or declining (i.e. worsening),” Huttner concluded.

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