Introduction
A recent piece by Insurance Europe highlighted that The Solvency II risk margin currently ties up around €190bn of EU insurers’ capital asserting that, “This is unnecessarily high and reduces insurers’ capacity to take on risks and to invest in the economy.” There are always two sides to a coin and arguments in favour of the ‘high’ Solvency II margins if tied to the risks that some companies are writing or running. However, it is fair to comment, at least in respect of captives and smaller domestic insurers, that the rules of proportionality are not always applied by respective local regulators, resulting in a higher cost of compliance for smaller companies or captives.
Solvency II has brought not only significant technical discipline to the market but also improved governance, accountability and more uniform disclosure at or from all echelons of an enterprise. Having worked in certain insurance markets in the past my knee-jerk response to any one taking a dig at Solvency II (and I am not suggesting that Insurance Europe is criticising Solvency II per se) is, “try working in a less regulated market!” Nor am I suggesting that markets that have not embraced Solvency II are necessarily less regulated. But where it has been applied, it has brought greater thoroughness to the market. Can Solvency II be improved or made more fair or proportional to certain sectors of the industry? Yes. But I would hasten to add that, for the insurance industry, it is the best thing since the invention of sliced bread. My only regret is that it was not universally applied the world over. But the reasons for that may require volumes to unravel.
It terms of prominence it is going to have to exit stage left because of the appearance of a new actor, IFRS17.
IFRS17 101
I am not an accountant but an insurance practitioner so please excuse me if this piece seems like teaching grandma to suck eggs for the accounting professionals reading it. The intended audience are non-accounting professionals working in the insurance industry that do not quite know what is going to hit them with IFRS17.
‘IFRS’ stands for International Financial Reporting Standard and these standards are set by an international financial standards Foundation whose mission is to do specifically what it states on the label. Their standards are implemented in close to 150 countries or jurisdictions around the world. What they achieve is a common accounting language and a universality that allows peer review and comparison across all jurisdictions that embrace them.
IFRS17 is set to replace IFRS4 by January 2023. IFRS4 which deals with disclosure of insurance contracts. In addition to providing a ‘common platform’ to compare financials across different countries and jurisdictions, the differences (or improvements) between the outgoing standard and IFRS17 can be synthesized in 5 areas namely:
With companies only just having come more or less fully in line with Solvency II, why roll out IFRS17? From an insurance company perspective this has been perceived by many as a double whammy of increased costs/ consulting fees and waste of management time. The truth of the matter is that the 2 standards
Because the 2 standards address 2 different set of ‘problems’, in tandem they will complement each other in creating a more financially robust and more transparent insurance sector (SII from a solvency perspective and IFRS17 from a disclosure and transparency perspective).
Credit Rating Agencies: Quo Vadis?
By definition, a credit rating agency provides a professional opinion on the financial credit worthiness or strength of a company and their ability to pay debts. In a nutshell, several assessment areas with different weighting contribute to a ‘score-card’ leading to a rating agency’s verdict on a company’s financial strength.
From an insurance company perspective this was a very operational valid tool, for example, when assessing reinsurers or fronting companies, or who to enter into a ‘cut-through’ arrangement with and so on. It also had more strategic or investment implications. Credit Rating opinions were made even more valid because of the lack of uniformity in the disclosure and presentation of financial information as well as the lack of standardization vis-à-vis regulatory solvency and capital requirements and supervision across different jurisdictions.
Will the implementation of IFRS17, in tandem with the implementation of Solvency II and Solvency II equivalent regimes, render redundant the service currently provided by rating agencies to insurance companies and/or their investors? For financially literate people, IFRS17+SII will make it easier for people to interpret and compare sets of financial information. For those who, for whatever reason, still require the Credit Rating stamp on their company they will essentially be paying dearly for the credit rating agency’s product that will become cheaper and easier to execute thanks to the combined information of IFRS17 and Solvency II.
End of the Road?
The advent of a new standard reminds me of H. G. Wells’ cliché, “war to end all wars!” No standard, no matter how good or comprehensive, is a panacea to present and future problems. It only addresses known and foreseeable issues. New ones will inevitable emerge and, as a result, new standards and regimes would need to be re-designed and implemented.
Even before its implementation, there are some perceived inherent shortfalls in IFRS17. The main criticism, from an accounting perspective, is that despite the otherwise rigorous standardization, IFRS17 remains largely principle-based. Therefore, there will still be, more so from the eyes of the accounting and auditing fraternities, an element of subjectivity in the measurement of transactions and or contracts. Maybe this is not perceived as such by insurance practitioners since many are quick to quip that under the current principle-based governance and regulatory regimes we are perhaps more rules-based then ever before! And, in the meantime, life is what happens while we are otherwise busy with other matters.
James Portelli is a chartered insurance risk manager holding a senior executive role in an international insurance undertaking, non-executive directorships and Risk Chair on a portfolio of insurance companies operating in or from Malta by virtue of the EU Freedom of Service Directive. James is also a member of the Cutts-Watson Consulting panel and lectures on insurance programmes at the University of Malta. Views expressed are personal and may not be deemed to constitute advice.
www.linkedin.com/in/jamesportelli | E: james@cuttswatson.com | james@portelliassociates.com