IFRS 17 May Put Up Cost of Capital for European Insurers

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Wednesday, January 31, 2018 / 10:29AM  / Fitch Ratings                                                                                           

IFRS 17, the new international accounting standard for insurance contracts from 2021, could temporarily increase the cost of capital for European insurers while investors familiarise themselves with the new standard, Fitch Ratings says.

Many investors already perceive insurance as a complicated sector and we think some generalist investors may be driven away by the challenge of having to get to grips with IFRS 17 and its complicated "day one" restatement effects. In an audience poll at Fitch's Insurance Roadshow in London yesterday, 39% thought IFRS 17 would increase insurers' cost of capital, while only 13% thought it would reduce the cost.

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A higher cost of capital might appear at odds with the aim of IFRS 17 to improve consistency and comparability among insurers reporting in different jurisdictions, which should in theory reduce the "opacity premium" that investors demand for the perceived lack of transparency.

However, we do not see a contradiction. We think IFRS 17, like any change in financial reporting, could create confusion when it is introduced, as investors will need time to get used to the new accounts and to understand their impact on analytical metrics. Over time, though, investors will gain trust in IFRS 17 and any opacity premium for the sector will fall back towards, and ultimately perhaps below the pre-IFRS 17 level.

Once the challenge of adapting to a new accounting standard is overcome, we think IFRS 17 will improve comparability between insurers' accounts. Current comparability is poor as practices vary significantly between jurisdictions. In particular, accounting liabilities are often based on assumptions that are outdated compared to current economic conditions.

IFRS 17 is unlikely to directly affect insurers' ratings because the economic substance of their balance sheets will not change. Credit profiles, however, could be indirectly affected in the medium term if changes to the way insurers recognise profits make certain products more or less attractive to them, resulting in changes to their business models. 

IFRS 17 is due to replace the existing IFRS 4 standard from 1 January 2021, although industry lobbying may impede its adoption in some jurisdictions, and it will not be adopted in the US. 

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