Category: reporting

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Financial stability implications of IFRS 17 Insurance Contracts

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.

See also:

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.

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Just managing

Just Group interim out today, with an upbeat commentary that pleased the analysts. Who are easily pleased, it seems.

  • Solvency Coverage is up to 145% from 141%, but as they say this figure allows for a notional recalculation of TMTP as at 30 June 2020, and without it the SCR would have fallen to 123%, see p.61.
  • Page 8 shows that the TMTP (a regulatory asset that bolsters a firm’s balance sheet) increased from £1,891m to £2,201m). There is no explanation for the increase that I can find in the report.
  • They claim that “movements in the financial markets have had limited impact to date on the Group’s capital position”, but then perversely note that credit downgrades have affected over 16% of the Group’s corporate bond portfolio.1
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Unbalanced sheets

The Independent Expert report on the Prudential-Rothesay transfer has a curious statement in footnote 17.

The figure of c.£11.3 billion differs from the figure of c.£12.9 billion in paragraph 5.17 because £11.3 billion is the gross BEL held by Rothesay in relation to the reinsured business, whereas £12.9 billion is PAC’s gross BEL in relation to the reinsured business. The difference between these figures principally arises because the Transferring Business is not part of PAC’s Matching Adjustment portfolio (and therefore its BEL is not calculated using the Matching Adjustment), whereas the inwardly reinsured business in Rothesay under the Laker Reinsurance Agreement is part of Rothesay’s Matching Adjustment portfolio, which means that Rothesay’s BEL is calculated using a discount curve that includes a Matching Adjustment, resulting in a higher discount rate and a lower BEL.

My emphasis.

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Just Group interim

The Just Group 2019 interim statement is out today. It has already received coverage in mainstream financial media, and we don’t normally repeat what is already said.

What caught our eye, however, was the mention on p.50 of the put option on property index, the NNEG hedge we discussed earlier. We speculated whether the firm has put the hedge in place, or whether they are still waiting to establish ‘appropriate regulatory treatment’ with PRA. Turns out (and we should have spotted this from the 2018 financial statement – 2018 p.72, section 25 ) that it was already in place by 2018, so it is merely the regulatory treatment they are waiting for .

But here’s the interesting thing.

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The whole truth

I wrote on 10 August2 about how possibly material facts – in this case a missing £1bn itemised as ‘other valuation differences’ – have been hidden in plain view, scattered across different reports or couched in opaque regulatory language. But there was something else in plain view that I failed to notice. Page 4 of Just Group’s 2017 Solvency and Financial Condition Report states

The main reason for the change since the publication in March 2018 follows the Group’s decision to change the assumptions underlying the valuation and credit rating of the LTM notes (described in D.2.6) in the Matching Adjustment in JRL as at 31 December 2017.

My emphasis. Further on it says that the impact of the reduction in Matching Adjustment was £470m. I had previously queried this with the firm on 31 July, via their publicist Alex Child-Villiers, who simply reiterated the same statement, and declined to answer my question about the £1bn. I asked again, and the whole firm (and their auditor KPMG) went into radio silence. A number of others have asked since then, and received the same stony silence.

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Past and present tense

Our postbag is bursting its seams with comments, largely critical, about how we have misunderstood the ‘two balance sheet’ approach used by Just group. We have claimed that Just were (past tense) using an implied deferment rate of minus 2.75% for both their IFRS and Solvency II balance sheet. Our critics say that, while the firm are using that rate for the IFRS balance sheet, they are (present tense) using a rate of 0.5% for Solvency II purposes. See their 2017 Solvency report, p.54.

We are wrong, and must apologise immediately!

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