The CSM will be a critical value in determining the profile of profit recognition of a company under IFRS 17. Unlike the prescriptive compulsory margin approach prescribed by SAP104 there are a number of areas in the practical application of the CSM methodology which are open to interpretation and choice. These can pose a unique challenge to South African Insurers who operate in a high interest rate environment where both premium increase rates and the impact of changes in financial assumptions can be material.
Through our work with the IFoA CSM working group we have gained a global perspective of the challenges facing insurers with respect to the application of the IFRS 17 CSM. Performing our retrospective transition work has highlighted the challenges which have the potential to be uniquely impactful in life insurance markets like South Africa.
In our paper we explore these challenges and discuss potential solutions under a range of relevant scenarios, with a particular focus on the CSM under the General Measurement Model (GMM).
In particular, we discuss the implications of measuring the CSM at initial recognition rates and how this can result in first order earnings volatility through the use of different financial assumptions on the various components of the carrying value of the insurance contract liability. This in turn can lead to potentially material second order earnings volatility driven by differences in the capitalized value of changes in fulfilment cashflows relative to the release of CSM. This is an issue on any life insurance policy but in particular policies with escalating premiums, whether inflation linked or not. We explore how disaggregating insurance finance income and expenses using other comprehensive income (OCI) can be used as a tool to not only mitigate the first order impact, as expected, but also these potentially material second order impacts.
We also discuss the calculation of coverage units with a particular focus on discounting and investigate alternative approaches given the materiality of this decision in high interest rate environments like South Africa.