Stress Testing the Insurance Industry

Many people have heard me say, “I’m a weird actuary because I like accounting.” It is a relatively known fact (at least in my experience) that most actuaries are not passionate about accounting. My journey has been a bit different.

When I was younger, I dreamed of being the next Warren Buffet, and I read everything I could on stock trading. I even quit a four-month internship to do day trading. (Not something I’m proud of!) My journey was short and unsuccessful, but it was through this fling that I discovered the method of fundamental analysis and the study of financial statements. Over time, my interest in accounting and financial statement analysis kept growing, and I continued educating myself about it. At some point, books were not enough, and I decided to find a job that would allow me to further develop my skills and knowledge. So, in 2015, I joined the actuarial/finance department of the largest mortgage insurer in Canada.

Because the actuarial group was relatively small, I had the opportunity to work on everything actuarial in nature, including reserving, pricing, predictive analytics, capital modeling and management, and financial planning and analysis. Through interactions with accountants, investment experts, tax experts and risk modelers, I developed a deep expertise in financial modeling and built sophisticated models used for different financial exercises, such as corporate planning, stress testing and capital management. I did not realize it at the time, but this background and experience would make me an excellent candidate for working on International Financial Reporting Standard (IFRS) 17.

The first time I heard about this new accounting standard was in 2017. The director of finance had sent me an email asking me to comment on the potential impacts of IFRS 17 on our capital and financial position. Challenge accepted! I read everything I could on the topic and quickly designed a prototype modeling the financial statements under IFRS 17 (using the general measurement model). The wheel was in motion, and IFRS 17 has been part of my life ever since.

For the same mortgage insurer, I was given the chance to be the lead actuary on the IFRS 17 implementation, and I was involved in every step of the process. I’ll admit that I’ve developed a love-hate relationship with IFRS 17. The additional workload sometimes would squeeze every ounce of creativity and energy I had. I know I’m not the only one—IFRS 17 has been stress testing the entire industry, and the demand for qualified resources has been putting tons of pressure on the market. But overall, I’m grateful for everything I’ve learned and the opportunities it gave me.

Knowing those skills and knowledge were portable, I decided to join the consulting industry in late 2021. Since then, I’ve been helping many insurers with IFRS 17 and providing advice, which ultimately brings us to this article. This article is not meant to be technical. Rather, it is a humble attempt at sharing the lessons I’ve learned so far and what I think is next to come with IFRS 17. Although IFRS 17 is an international accounting standard, it should be noted that my experience is predominantly based on the Canadian market. My comments and observations reflect my experience and may not be applicable to all markets and situations.

Creativity and a Cohesive Team

At times, IFRS 17 can feel like an endless series of problems to solve. It’s a bit like playing the video game The Legend of Zelda: Breath of the Wild! Creativity, innovation and problem-solving skills are essential ingredients for a winning recipe. You should make sure the assembled team has those skills—otherwise it might be difficult to get things moving at the beginning of the project with too many process-oriented personalities. I’ve seen teams make little progress simply because of a lack of creative leadership and cohesiveness.

In his book, The Advantage, Patrick Lencioni describes the four steps needed to build a cohesive team:

1. Build trust where people are comfortable being vulnerable and sharing their opinions
2. Generate healthy conflicts/debates within the group
3. Create commitment and accountability around the team’s decision
4. Focus on results

The same principles are applicable to a project and journey like IFRS 17 implementation. To achieve the best results, make sure the team you assemble is cohesive. Healthy debates and conflicts will increase the odds of developing better solutions significantly.

Cost of Aiming for Perfection at First

I’ve designed and used many financial models in my career. Based on my experience, it takes users about three years to know the model inside and out and to be able to identify the perfect design. It’s like buying a house—it’s only after living in it for a few years that you really can tell what your dream house would be like.

For that reason, I personally don’t like automating and aiming for perfection at first. In my opinion, trying to automate too soon can lead to inefficiencies and opportunity costs. With a project like IFRS 17, you can expect to discover new problems throughout the life of the project and even beyond the go-live date. I’ve seen teams sacrifice optimal design and develop a series of workarounds because they were already committed to a certain design and automation. Not only might those workarounds create frustrations for the users in years to come, but they also might incur significant costs trying to fix them down the road.

My preference is to use something like the lean startup methodology and create an agile environment, even if it means having a more manual process in the early stage of the product. My recommendation is to let the users get familiar with the product for at least one year and create a feedback loop that will help improve and develop a more optimal design. It’s worth noting that a more manual process might generate additional auditing and governance fees and could increase operational risk (e.g., human error). Employers need to consider the trade-off and weigh the pros and cons before making a final decision.

Mental Health and Operational Risk

The insurance industry underestimated the mental toll IFRS 17 would have on people. I’ve seen multiple people go on sick leave or quit for another job out of being fed up with IFRS 17. Moreover, when those people leave, it creates a significant knowledge gap, which ultimately generates additional costs to the employer.

Even hiring recently has become more difficult since many actuaries don’t want to work on IFRS 17 anymore and are declining opportunities. Not everyone can nor wants to work on the same project for many years. It is a real operational risk that every employer should consider with any projects of such magnitude. Planning for rotation and knowledge transfer within the duration of the project should be contemplated.

What’s Next?

There are still many things to be done before the go-live date, including communication and knowledge transfer to the different stakeholders, but financial reporting-related work is somewhat well-advanced at the industry level. In fact, many corporations are trying to shift gears from financial reporting to financial projections.

Financial projections include exercises such as pricing, asset-liability management and most important, financial statement projection models required for business planning, stress testing, capital modeling and capital management. For instance, some of our clients recently have asked us to help them quantify the impact of IFRS 17 on their economic capital and stress testing results to complete their own risk and solvency assessment (ORSA). This is where our experience can be useful. In fact, we already have designed and developed a few models that reflect the impact of IFRS 17 on the projected financial statements in different scenarios. In my experience, the design of such models is rarely the same and needs to be adjusted based on client needs (e.g., desired runtime) and ideally integrated with existing tools. The IFRS 17 software programs used for financial reporting are not necessarily built or designed to perform financial statement projections efficiently. For instance, trying to project balance sheets over time would require a lengthy manual process for some of the software programs. Moreover, significant customization generally is required to include other parts of the financial statements, such as assets, taxes and capital metrics.

The most sophisticated models will be designed to perform nested projections (often called “actuary in a box”) where one tries to replicate what the reserving actuary would book on the balance sheet at a projected point in time, not knowing the future. Through this modeling, corporations will gain a deeper understanding of IFRS 17 and its impact on key financial and capital metrics in different scenarios, ultimately crystalizing and solidifying the implementation of IFRS 17 in the industry.

Closing Remarks

IFRS 17 has been one hell of a storm, and it’s not over yet. Its tail will continue to stress test the industry and put pressure on resources in 2022, 2023 and probably into 2024. Like any other storm, we then will need time to recover and recoup from it. But just like when you take your actuarial exams and the process seems endless, eventually you cross the finish line.

A few years from now, we will look back with more detachment and perspective, and we will be proud of our accomplishment. At the end, we will have built more granular and transparent financial systems. Stakeholders will have a better understanding of the industry’s financial position, and companies will have gained a better understanding of their products’ profitability and risk drivers.

So, to all my fellow actuaries and everyone else involved in IFRS 17, I say: “Don’t quit. Keep running. We’re almost at the finish line. Sooner or later, we will succeed.”

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2022 by the Society of Actuaries, Schaumburg, Illinois.