This memorandum from the European Systemic Risk Board highlights discount rates as a key risk in IFRS 17.
IFRS 17 allows two methods (bottom-up and top-down) to calculate discount rates which, in turn, determine the ultimate amount of insurance contract liabilities. In practice, the bottom-up and top-down methods may result in different discount rates. Furthermore, IFRS 17 is going to be applied in an environment of low interest rates, with increased importance of unobservable components (expected and unexpected credit losses, as well as an illiquidity premium). Together with the level of discretion in the requirements of IFRS 17, the behavioural response of insurers may have consequences for financial stability, mainly as a result of large cross-sectoral heterogeneity in the computation of discount rates and ultimately in the valuation of insurance liabilities.
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The significant weight of the unobservable component of discount rates under IFRS 17 may require close attention from audit firms, accounting enforcers and microprudential supervisors. Potential actions could include setting audit expectations, issuing guidelines on how to compute the unexpected components of the top-down and bottom-up methodologies, a benchmarking exercise across European insurers, and setting out expectations on adequate disclosures.