The UK life insurance industry is currently in a period of rapid change.
Not only are life insurers furiously pricing and bidding on bulk annuity contracts from defined benefit pension funds, but they are also trying to find the talent to beef up their teams to support growth in this market.
Not only are they figuring out how to integrate the array of insurtech products now available to them, but they are also in the midst of a sea change in terms of incorporating generative AI into their businesses.
And not only are they having to spend hours in the weeds of spreadsheets and systems to model their asset management strategy because of the planned changes to Solvency II, they are simultaneously dealing with IFRS 17, the first global accounting standards initiative for the insurance industry.
This past year marked the first that UK insurers had to report interim results under the IFRS 17 regime, with divergent practices in terms of the disclosures included at HY 23 and the level of detail included in these disclosures. That’s not surprising, given the bigger picture.
“It took the insurance industry from 1997 to 2020 to get a global accounting standard – 23 years in the making. It’s been a long journey to get here, and it’s complex and most insurers have faced challenges to differing degrees. It has been quite a challenging process because of the need to set up more systems and infrastructure, particularly to deal with the granular data requirements. Insurers have spent a lot of money on it,” said Anthony Coughlan, Partner at PwC in London.
But now, here we are, and the beginning of 2024 will see life insurers start to report full year accounts under the new regime for the first time.
One immediate impact of IFRS 17 on the UK’s bulk annuity market is at the transparency level, according to Jignesh Mistry, Director at PwC in Bristol, UK, which could lead to a medium-term impact on the asset side.
“Insurers will have to disclose onerous, i.e.: unprofitable – business separately from profitable business and the distinction will be based on the premium they charge at outset for the buy-in / buy-out of the scheme. If premiums ultimately aren’t enough to cover the liabilities, then insurers will have to report those schemes as onerous. This might help to refine the market in terms of the assets that back a pension transaction and how these deals are constructed,” he said.
Additionally, IFRS 17 requires insurers and reinsurers to recognise profits during the course of the contract, as opposed to booking the majority up front (the existing model). However, the impact of longevity assumptions are calculated at the locked-in interest rate at the time the deal is completed rather than at the current discount rate at the time the assumption changes are made, so it’s likely that the profitability – or not – of individual schemes will fluctuate.
“To the extent that the current discount rate is different from the locked in rate, this can cause unintuitive volatility in the current year and can be difficult to predict without good information on the locked in rates by year of scheme inception compared to current interest rates. This won’t always be systematically more volatile – there could be years where the current rate and locked-in rate are well aligned or where changes in assumptions and the impact due to differences between current and locked-in rates offset, but profitability will be less intuitive and more difficult to predict,” said Coughlan.
Mistry refers to the potential for a refining of the assets that back a pension buy-out. The prevailing interest rate regime has seen some insurers tweak their asset allocation model in the past 18 months as the greater available yield on liquid fixed income makes the risk / return profile of these investments more attractive, at least to an extent, when compared to illiquid credit opportunities.
“Some insurers either on adoption of IFRS 17 or through new investments have classified certain assets for accounting purposes so that unrealised gains or losses are not immediately recognised in profit. This is to achieve a better match to the IFRS 17 liabilities (technically, the contractual service margin) with no impact on Solvency II,” said Coughlan.
Value in force reinsurance transactions might also see diminished activity as profits will now be deferred, as opposed to being recognised up front.
“The IFRS 17 changes will make VIF securitisation and similar structures less attractive across all lines of business, from an accounting perspective,” said Mistry. “However, they may still be attractive from an economic perspective.”
Which brings in the proverbial elephant in the room. The UK Government’s planned reforms to Solvency II – Solvency UK – call for significant changes that British politicians hope will divert investments into long term assets such as infrastructure and green energy. Whether that happens in the short term or not remains to be seen and ultimately, it’s the lawmakers that will have more of a say in how life insurers construct their asset portfolios in the next decade than the accountants will.
“The Solvency UK reforms will have a much bigger impact on the asset management function of a life insurer than IFRS 17,” said Mistry. “That’s partly because for IFRS 17, a global standard, the UK government has little influence, but with Solvency UK, it has a lot of influence.”
