European insurers may face higher cost of capital due to IFRS 17

The new international accounting standard for insurance contracts from 2021, IFRS 17, could temporarily increase the cost of capital for European insurers, Fitch Ratings said in a Jan. 26 note.

The higher cost of capital would incur as investors familiarise themselves with the new standard.

Many investors already perceive insurance as a complicated sector and Fitch thinks some generalist investors may be driven away by the challenge of having to get to grips with IFRS 17 and its complicated "day one" restatement effects. In an audience poll at Fitch's Insurance Roadshow in London, 39 percent thought IFRS 17 would increase insurers' cost of capital, while only 13 percent thought it would reduce the cost.

A higher cost of capital might appear at odds with the aim of IFRS 17 to improve consistency and comparability among insurers reporting in different jurisdictions, which should in theory reduce the "opacity premium" that investors demand for the perceived lack of transparency.

However, Fitch does not see a contradiction. IFRS 17, like any change in financial reporting, could create confusion when it is introduced, as investors will need time to get used to the new accounts and to understand their impact on analytical metrics, according to Fitch. Over time, though, investors will gain trust in IFRS 17 and any opacity premium for the sector will fall back towards, and ultimately perhaps below the pre-IFRS 17 level.

Once the challenge of adapting to a new accounting standard is overcome, Fitch thinks IFRS 17 will improve comparability between insurers' accounts. Current comparability is poor as practices vary significantly between jurisdictions. In particular, accounting liabilities are often based on assumptions that are outdated compared to current economic conditions.

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