IFRS4: a headache for insurers but good news for rates?

- Herman Schoeman, MD of Guardrisk

International Financial Reporting Standards 4 (IFRS4) - dealing with financial reporting for insurance contracts - is not only going to change the way that insurance companies report their financial results but may also impact on the industry's entire pricing model.

In the past, insurers priced products primarily to sustain and grow their business model; in future, they will have less leeway with regard to pricing because the degree of transparency enforced by IFRS4 will give policyholders more insight into how the business is managed, and therefore how products are priced.

In complying with IFRS4, insurers' reporting will need to mirror the day-to-day operational structure of the business. Perceptions created in the past are now going to be able to be tested and policyholders will have a better idea of the type of business that their insurer is conducting, as well as the profitability of each business area. And, it's not just policyholders who will gain clarity from segmental reporting: competitors will also be able to identify each others' weak and strong business areas. Insurers will be challenged to meet IFRS4 requirements without disclosing their business model.

Traditionally, insurers have used their more profitable lines to "subsidize" less profitable lines but, with the various sectors now being reported individually, a case could now be made by shareholders for the management of insurers to increase premiums on loss making lines which could result in a decrease in the level of cross subsidisation between risk areas.

Another issue raised by IFRS4 that could influence pricing is the disclosure of claims development, which is at the heart of the pricing structure. Now, for the first time, policyholders will be able to have a better idea of the insurer's cost of claims. It will no longer be possible for insurers to include reserves within these costs.

The Short-term Insurance Act stipulates that Incurred But Not Reported (IBNR) reserves must be provided for at minimum 7%, but once the actual claims experience is taken into account this 7% could come down to somewhere between 3% and 5%, which will also contribute to lower rates. Going forward, the pricing model will be more accurate because it will be based on actual claims experience and will exclude inflations previously included in the interest of prudence. In fact, IFRS4 deals specifically with prudence and clearly cautions against "excessive prudence".

Catastrophic losses now have to be accounted for in the year of the actual event and, since insurers are required to release their reserves, a huge catastrophe which is not adequately provided for by way of reinsurance could arguably wipe out the entire company. The short-term insurance industry will have to increase their focus on developing reliable data tables - similar to the mortality tables used by life insurers - in order to provide for major catastrophes in future.

One thing is certain: IFRS4 will continue to challenge insurers as they try to find ways to meet the profit expectations of shareholders; the pricing requirements of policyholders and the compliance criteria of the regulator - all within the ambit of auditors' interpretation and management's implementation of IFRS4.

For further information please contact:
Herman Schoeman, MD of Guardrisk
Telephone: +27 11 669-1001

Issued by:
Melanie Davis, PR@Work
Telephone: +27 11 615-3309 / +27 83 225 7450