Connecting MSA.Legend, 20.14 & 20.18 from CCIR and IFRS17 Discount
I found the best way to understand what is going on here was to relate the MSA legend to CCIR returns 20.14 and 20.18 and the IFRS17 discount paper.
Some definitions from 20.14:
(Total) Insurance Revenue = This is the equivalent to GEP Pre-IFRS17
Insurance Service Expense = Incurred Claims and Other Insurance Service Expenses + Amortization of Insurance Acquisition Cash Flows + Losses and Reversal of Losses on Onerous Contracts + Adjustments to Liabilities for Incurred Claims
Out of these 4 items 3 are claims related:
1) Incurred Claims and Other Insurance Service Expenses
2) Losses and Reversal of Losses on Onerous Contracts
3) Adjustments to Liabilities for Incurred Claims
And 1 is expense related:
1) Amortization of Insurance Acquisition Cash Flows
Net Finance (Income) Expense from Insurance Contracts is a time value of money calculation that is not included in ISR but is instead included in NIR. ISE includes the discounted insurance contract liabilities but the undwind of that discount is included in NIR under Net Finance (Income) Expense from Insurance Contracts.
Some definitions from 20.18:
Allocation of reinsurance premiums paid = To me this is like Ceded EP from pre-IFRS17. This means Total Insurance Revenue + Allocation of reinsurance premiums paid is the equivalent to NEP. As we will see this is the denominator for our net ratios.
NOTE: Allocation of Reinsurance Premium Paid should be a negative amount otherwise NEP>GEP which doesn't make sense
Amounts recoverable from reinsurers = Incurred claims recovered and other reinsurance service expenses + Amortization of reinsurance acquisition cash flows + Recovery of loss and reversal on recovery of losses + Adjustments to Assets for Incurred Claims
Like above this has 3 claim related components and 1 expense related component.
Claim related are:
1) Incurred claims recovered and other reinsurance service expenses
2) Recovery of loss and reversal on recovery of losses
3) Adjustments to Assets for Incurred Claims
Expense Related is:
1) Amortization of reinsurance acquisition cash flows
Effect of changes in non-performance risk of reinsurers is our change in reinsurance credit risk and is counted as an investment component.
Net Expenses from Reinsurance Contracts Held (NRE) (from 60.25)= Allocation of reinsurance premiums paid + Amounts recoverable from reinsurers + Effect of changes in non-performance risk of reinsurers
The naming Net Expenses from Reinsurance Contracts Held is misleading. This is more like "income from reinsurance contracts" and we can split it into 2 components:
Reinsurance Outflows = Allocation of reinsurance premiums paid
Reinsurance Inflows = Amounts recoverable from reinsurers + Effect of changes in non-performance risk of reinsurers
Net Finance (Income) Expense from Reinsurance Contracts Held is a time value of money calculation that is not included in NRE.
Like pre-IFRS 17 combined ratio includes expenses not attributable to portfolios of contracts which are lumped under General and Operating Expense
Now that we have this knowledge we can simplify what these ratios in the MSA.Legend really are:
MSA.Legend
Net Expense Ratio = (Acquisition expenses - Acquisition expenses recovered from reinsurers + General and Operating Expenses)/NEP
Subbing in IFRS 17 terms we get:
(Amortization of Insurance Acquisition Cash Flows - Amortization of Reinsurance Acquisition Cash Flows + General and Operating Expense)/(Total Insurance Revenue + Allocation of Reinsurance Premium Paid)
Net Claims Ratio (Partially Discounted) = (Gross Claims - Ceded Claims (including any adjustment for credit risk))/NEP
Substituting IFRS17 terms:
[(Incurred Claims and Other Insurance Service Expenses + Losses and Reversal of Losses on Onerous Contracts + Adjustments to Liabilities for Incurred Claims) -(Incurred claims recovered and other reinsurance service expenses + Recovery of loss and reversal on recovery of losses + Adjustments to Assets for Incurred Claims + Effect of changes in non-performance risk of reinsurers)]/(Total Insurance Revenue + Allocation of Reinsurance Premium Paid)
Another way to write this ratio is: (ISR - Amortization of Insurance Acquisition Cash Flows) - (Reinsurance Inflows - Amortization of Reinsurance Acquisition Cash Flows) / (Total Insurance Revenue + Allocation of Reinsurance Premium Paid)
Essentially the net claims ratio (partially discounted) is the claims only (no expenses) ratio to NEP.
Net Combined Ratio (Partially Discounted) = Net Expense Ratio + Net Claims Ratio (Partially Discounted)
A good test would be to reconcile this high level formula with the previous 2 formulas and as you will see the acquisition expenses cancel out and we get (ISR - Reinsurance Inflows + General and Operating Expenses) / (Total Insurance Revenue + Allocation of Reinsurance Premium Paid)
This matches exactly the MSA.Legend formula if we remember Reinsurance Inflows is allocation of reinsurance recoverables + effects of change in credit risk
Net Combined Ratio (Fully Discounted) is Net Combined Ratio (Partially Discounted) adjusted for Insurance Finance Expense. This can be written as:
Net Combined Ratio (Partially Discounted) - [Net finance income (expense) for insurance and reinsurance contracts]/ (Total Insurance Revenue + Allocation of Reinsurance Premium Paid)
What is the whole deal with net finance income / insurance finance expense?
This is what is special about IFRS17 and relates to the IFRS17 Discount paper when they talk about Insurance Service Expense vs Insurance Finance Expense.
Say an Insurance Company A writes a policy and collects 100$ in premium at time 0 but is guaranteed to pay out 105$ at time 1. Although this technically wouldn't qualify as an insurance contract lets pretend that it does for example sake. Assume the discount rate is 1.05, so at time 0 the company has 100 is assets and 100 in liabilities. Also assume that the company expects 3% return on investments.
If we don't disaggregate insurance service from insurance finance expense at year end we will see U/W income = 100-105 = -5. Investment Income = 100*0.03 = 3. It looks like the company has poor U/W operations and good investment operations. But that's not what is really happening here.
Under IFRS 17 at time 0 we have assets = 100 and LRC = 100. At time 1 we have ISE = 100 and IFE = 100*0.05 = 5.
ISR = Total Revenue - ISE = 100 - 100 = 0. As you will note ISE is discounted but doesn't include the unwind on discount or changes in discount rate. This is called partially discounted.
NIR = Net Investment Income - IFE = 3-5 =-2. Now we get a better picture of what is actually going on. Well the policy is neutral from an insurance perspective with no gain or loss the investment side of the business is inadequate. The discount rate on liabilities is 5% while we can only earn 3%.
A paper not on the syllabus describes the purpose of splitting IFE and ISE: "highlight the relationship between insurance finance income or expenses and investment returns on the related assets the entity holds in order to provide investors with
sufficient information for them to understand the sources of net financial income or expenses in the statement of profit or loss and other comprehensive income".
Coming back to Net Combined Ratio (Fully Discounted) = Net Combined Ratio (Partially Discounted) - [Net finance income (expense) for insurance and reinsurance contracts]/ (Total Insurance Revenue + Allocation of Reinsurance Premium Paid)
We need to recognize the increase in expense due to insurance finance expense that is not included in insurance service expense. Insurance service expense is discounted too much as it doesn't account for the discount unwind that when added in will increase claim costs.
Comments
Given there is no content in the wiki other than the screenshot I figured I would post this to help others study this exhibit. Its possible ive made some errors so feel free to highlight if thats the case
Thank you for this - It is useful and very good. An additional point is that it is not really correct to say that the investment side of the business is inadequate simply because the yield is less than the discount rate used. The discount rate chosen has nothing to do with your own asset portfolio, but rather deals with the liquidity characteristics of your liabilities.
Are the following items from the two pages the same?
Page 20.18
1. Allocation of reinsurance premiums paid (201811919)
2. Amounts recoverable from reinsurers (201814919)
3. Effect of changes in non-performance risk of reinsurers (201816019)
4. Net expenses from reinsurance contracts held (201819919)
Page 60.25
1. Allocation of reinsurance premiums (602559932)
2. Amounts recoverable from reinsurers for incurred claims (602559934)
3. Effect of changes in non-performance risk of reinsurers (602559936)
4. Total (602559939)
I ask for confirmation because the MSA format for allocation of reinsurance premium in the denominator of NISR & RSR is different from that of Net Expense/Claims/Combined Ratios.
Apologies for the delay in answering. We are looking into your question.
They should both be the same. I have no idea why the formula's are set up that way. The only difference is one is on a quarterly basis and one is on an annual basis