Impacts of New Accounting Standards on Business Results of Insurers in Korea
Implementation of IFRS 17 and 9
The insurance industry has begun to implement the International Financial Reporting Standards 17 and 9 (IFRS 17 and 9) since January 1, 2023. This transition in accounting standards represents a significant and comprehensive change to financial reporting for insurers. The objective of IFRS 17 is to establish consistent, principle-based accounting guidelines for insurance contracts, leading to fundamental transformations in accounting, actuarial, and reporting practices within the insurance industry. The standard aims to provide a globally standardized framework for the accounting of insurance contracts and the financial reporting of the insurance industry.
IFRS 17 Insurance Contracts replaces IFRS 4, while IFRS 9 Financial Instruments replaces IAS 39, ‘Financial Instruments – Recognition and Measurement’ and introduces new methods for the classification of financial instruments and the recognition of impairment losses on receivables and loans. One of the major effects of the IFRS 9 implementation on the insurance industry is increased volatility in business results because more assets are measured at fair value, with changes in fair value recognized in profit or loss as they arise. Other changes include earlier recognition of impairment losses on receivables and loans and new hedging requirements.
Business Results of Insurers for Q1 2023
The implementation of IFRS 17 and IFRS 9 has turned out to have a significantly positive impact on the performance of insurers in Korea in the first quarter of 2023, with their net income increasing noticeably. The aggregated net income of major life and non-life insurance companies in the first quarter of 2023 amounted to KRW 4.75 trillion, representing a 27.9% increase compared to the same period of the previous year. Many of them also reported an increase in contractual service margin (CSM), one of the key profitability indicators under IFRS 17.
According to the Financial Supervisory Service (FSS), the total combined net income of all insurers is estimated to improve to around KRW 5.23 trillion in the first quarter of this year. Insurance companies previously did not include evaluation gains or losses from available-for-sale securities in the income statement. However, with the adoption of IFRS 9, evaluation gains or losses arising from available-for-sale securities are now recognized in profit or loss. This change has helped boost insurers’ net income in the first quarter of 2023 as a decline in interest rates caused mark-to-market gains of fixed income securities to increase, which was particularly pronounced among life insurance companies who hold a large amount of such assets. The FSS estimates that the results would decrease year on year when the transition effects are excluded.
How New Accounting Standards Affect Business Results of Insurers
In general, IFRS 17 appears to benefit non-life insurers more than life insurers. Under the new accounting regime, insurance liabilities are measured at market value rather than cost, while gains and losses are recognized over the entire duration of a contract rather than just based on cash flow. These changes are likely to work in favor of non-life insurers because they typically have a higher proportion of protection policies compared to life insurers, and a large part of their business portfolio consists of short-term insurance contracts, which tend to generate lower liabilities and can positively impact their earnings.
Non-life insurers also have a lower portion of savings products compared to life insurers, as their focus is primarily on providing non-guaranteed insurance coverage. Savings insurance products often come with guarantees, such as minimum interest rates or investment returns. These guarantee features increase the insurance liabilities of insurers. Moreover, IFRS 17 requires the separation of the insurance coverage component and the investment component within an insurance contract. The insurance coverage component represents the protection provided by the contract, while the investment component or savings element does not relate to the provision of insurance service. This non-distinct investment component is not presented as part of the insurer’s revenue or insurance service expenses.
These implications have been demonstrated by a recent analysis report released by the Korea Insurance Research Institute (KIRI), which shows the financial impacts of IFRS 17 on 22 life insurers and 12 non-life insurers that sell long-term insurance as of the end of 2022. The report suggests the new accounting standard is projected to increase non-life insurers' net income by 51% from KRW 4.7 trillion under IFRS 4 to KRW 7.1 trillion. On the other hand, life insurers' net income is estimated to increase by a relatively low rate of 6% from KRW 3.7 trillion to KRW 3.9 trillion.
In addition, life and non-life insurance companies are expected to see their capital increase by 139% and 95% respectively, with liabilities decreasing by 16% for life insurers and by 21% for non-life insurers, according to the report. This impact has also to do with the timing of the implementation of IFRS 17. The recent trend of rising interest rates led insurance liabilities to be evaluated at a higher discount rate than expected, resulting in a decrease in liabilities.
The adoption of IFRS 17 can give rise to different levels of profit and capital for insurance companies depending on the transition method used. There are three methods available for transition: the full retrospective approach, modified retrospective approach, and fair value approach. When applying the fair value approach, liabilities may be reduced compared to the retrospective approaches, resulting in an increase in equity. However, this approach also leads to a reduction in the expected profit, known as the contractual service margin, which could decrease future earnings. These effects might have been considered when insurers were choosing the transition method.
Meanwhile, many insurance companies are likely to use the CSM as a key performance indicator. Some may use the 'Adjusted CSM' that takes into account various adjustments such as market risks. New business CSM and the growth in the CSM balance can also be adopted as important performance indicators.
The new insurance accounting system based on fair value evaluation has the potential to bring about significant impacts on the insurance industry including the higher volatility of insurance industry capital and performance. Therefore, it is crucial for insurers to do continuous monitoring of financial impacts and business implications and have effective communication to manage expectations of multiple stakeholders including management, shareholders, investors, the regulator and external auditors. As financial statements based on the new standards have been published for the first time, much scrutiny is expected by key stakeholders going forward. Educating relevant stakeholders, including analysts and investors, about the new metrics introduced by IFRS 17 is also essential to ensure accurate understanding of financial information being disclosed and prevent any misinterpretations. In other words, adequate efforts should be made to familiarize these stakeholders with the new requirements and standards.