One source of confusion sometimes is the difference between regulatory capital standards such as risk based capital (RBC) and IFRS 17. If we are solvent under regulatory standards does that mean, we will look good under IFRS 17? Written differently: can we rest easy, or do we still need to worry about IFRS 17?
In Malaysia we have been blessed with regulations which have ensured that regulatory reserving (gross premium valuation, GPV) is consistent with accounting standards, IFRS 4. This has not been the case in many markets, where the regulatory basis has differed from the IFRS 4 basis. The regulatory basis in Malaysia and elsewhere consists of two pieces: reserving (GPV) and solvency standards (RBC). GPV ensures that we have sufficient funds to cover future outgoes such as benefit payments, expenses and commissions. This is done on a best estimate basis with padding. Under IFRS 17 this is equivalent to fulfillment cash flows, with a risk adjustment being used rather than padding. The risk adjustment and padding might be the same or could be different. Although both GPV and fulfillment cash flows use best estimate assumptions, the discount rate used could be different. Thus, with some (or a lot of) effort GPV and fulfillment cash flows could be the same or provide similar results. If nothing else the spirit and purpose of both are similar. This skims over some details, but this is the overall message.
The challenge in comparing regulatory capital standards and IFRS 17 is in the other piece, namely the calculation of RBC and the contractual service margin, CSM. For regulatory standards, above and beyond GPV is the need to ensure there is enough capital available by the shareholders in case any adverse events happen to the insurance company. These events might be related to insurance activities, investment activities or operational risk. Some regulations have a simplified methodology for this calculation whereas in markets such as Malaysia the calculation is rather precise. In Malaysia the methodology for calculating the various risks is specified, and becomes the total capital required. If we have just enough capital (beyond our GPV reserves) to cover this capital required we are said to have a capital adequacy ratio, CAR, of 100%. We then have a minimum CAR ratio as well as company specific target CAR and whatnot, perhaps 200% being a common target CAR. These calculations purely specify how much capital the regulator feels is needed to run the business. It does not differentiate to whether the products are profitable or unprofitable or might become unprofitable in the future. It is up to the insurer to price the products appropriately and manage the risks of the company to keep the CAR to acceptable levels.
On the other hand, CSM makes no reference to the potential risks of the company. The CSM simply takes the future profit of the product (split into cohorts, one-year tranches of business) and releases it over the lifetime of the product. It would simply be luck that the CSM and the RBC produce similar results. What will this relationship be and how can we manage the risks of the company and pricing of the products to ensure a similar message is given with respect to the ability of the company to cover the CSM requirements as well as target CAR?