Clarifying Guidance
With the introduction of the new International Financial Reporting Standard 17 (IFRS 17), financial authorities have prepared guidelines to prevent insurance companies from inflating Contractual Service Margins (CSM) through arbitrary and optimistic actuarial assumptions.
In particular, the guidelines aim to ensure that inappropriate actuarial assumptions are not derived from specific products such as medical indemnity insurance and non-cancellable or cancellable insurance. For medical indemnity insurance, consistent and objective statistics such as experience statistics should be utilized, while for non-cancellable or cancellable insurance, cancellation rates should be set lower than those for standard-type insurance.
The Financial Services Commission and Financial Supervisory Service announced these “IFRS 17 Actuarial Assumption Guidelines” on May 31.
With the implementation of IFRS 17, which evaluates insurance liabilities at fair value, insurance companies must now evaluate Best Estimate Liability (BEL) using optimal or unbiased assumptions utilizing their own experience statistics and reasonable grounds and methods. Insurance companies are not allowed to deliberately use optimistic or conservative assumptions.
However, confusion has already arisen in relation to the introduction of IFRS 17 due to insurance companies' arbitrary use of actuarial assumptions.
There are concerns that despite continuous losses in medical indemnity insurance, future profits may be estimated based on optimistic assumptions without objective and reasonable grounds. For example, if it is assumed that the insurance premium at the renewal of medical indemnity insurance will increase significantly more than past experience statistics, a loss contract could transition to a profit contract, and a large CSM could be calculated.
There is also a problem of classifying products with high cancellation rates during the premium payment period of non-cancellable or cancellable insurance as highly profitable.
High-interest products are loss contracts from the insurance company's perspective, so if the cancellation rate is calculated to be high, the BEL is measured small, and the CSM is measured large.
There is also a risk of not correctly reflecting the frequency and recurrence of guaranteed risks when depreciating the profit accrued in CSM. In such cases, the initial depreciation rate could be high, leading to large current profits being recognized.
Moreover, there are also issues where artificially increasing current profits occurs by applying different base data for calculating the final risk adjustment (RA) than the initial risk adjustment, thereby recording a large amount of depreciation.
The financial authorities have prepared reasonable guidelines for these major actuarial assumptions, which have a significant impact on financial statements.
After checking the operating status of actuarial assumptions of indemnity insurance for all insurance companies, reasonable standards have been established, such as maximizing the use of objective statistics such as experience statistics, and maintaining consistency with the insurance premium calculation method.
For the trend of indemnity insurance benefits (cash outflows), each company is required to estimate the increase in insurance benefits for a specific period using their experience statistics, and then adjust the insurance benefit increase rate for a certain period to converge to the final insurance benefit increase rate.
Regarding the adjustment of renewal premiums for indemnity insurance (cash inflows), each company's experience statistics are used to estimate the risk loss rate of the first year. After a certain period, the renewal premium adjustment rate is reflected to converge to the target loss rate.
For non-cancellable or cancellable insurance, standards were presented to apply lower cancellation rates than standard-type insurance and to reasonably reflect policyholder behavior assumptions according to the product structure.
Following this, standards have been set to apply different cancellation rates for high-interest contracts compared to general contracts. For high-interest contracts, where the interest rate applied to the insurance contract is significantly higher than the market interest rate, assumptions should be made separately from other general contracts when calculating the cancellation rate.
Also, standards have been established to use the same base data at the initial and final points when depreciating a risk adjustment.