MILLIMAN REPORT
Impact of IFRS 17 on insurance 4 May 2020
product pricing and design
3.1 BASIC VALUATION METHODOLOGY FOR PRODUCT DESIGN AND PRICING
To be able to address these questions with appropriate quantitative analysis we define a basic valuation
methodology for use in this paper as follows:
New business value (NBV) = probability-weighted discounted value of real-world distributable profits
where:
Distributable profit in period = change in distributable NAV over period (adjusted for any capital movements)
and where:
Distributable NAV = excess of available capital over required capital (in line with local solvency rules and
target solvency ratio)
Discount rate = shareholders’ required rate of return
Probability-weighted = best-estimate assumptions on future experience
By “real-world” distributable profits we mean that the projection of distributable profits will use real-world (as
opposed to risk-neutral) investment returns. This is a key point as, given that the shareholders’ required return is
used as the discount rate, the difference between projected investment returns and discount rate will mean that
the NBV is sensitive to the timing of the emergence of profit.
This in turn is important as the total profit to emerge will be the same under all measurement approaches, with
each approach only varying the timing of when distributable profit emerges.
We note that this can be one reason why a market-consistent new business value (MCNBV) is sometimes not
seen as being aligned with management’s view of the business and the insight they require for decision-making:
this type of new business value is essentially insensitive to changes in the timing of how distributable profits emerge
(due to projected returns and discount rate being the same). However, we note that some companies are still
using market-consistent embedded value (MCEV) as a key valuation metric.
This is an important point for participating savings business in particular, whose viability often depends on real-
world investment profits, given that in a calculation of MCNBV these real-world “uplifts”, and the associated cost
of capital for market risks, are effectively ignored. Hence in this case it is not just the timing of the projected future
profit stream that is different but also the assumed size of the stream (although as the uplifts emerge over time
the actual profits will eventually align with those projected under a real-world approach).
Therefore our approach will be based on the premise that new business profitability is being judged based on its
impact on real-world distributable profits, and the focus of our analysis will be on showing how the introduction of
IFRS 17 may impact this measure.
3.2 SUMMARY OF OUR APPROACH
The analysis of this paper is therefore based on the following two premises:
a. In performing product design and pricing, companies will often use a methodology involving a new
business value that is sensitive to the pattern of emergence of distributable profit.
b. Local legislation and accounting rules can impose constraints that influence the pattern of profit
distribution. Even without legal constraints there can be various other factors that exert similar
restrictions on distribution (e.g., investor views, expectations of shareholders or the board on profitability),
or simply management sensitivity to the timing of profits (e.g., due to managers’ bonus targets).
The main question addressed in this paper is therefore whether IFRS 17 will alter the expected pattern of profit
distribution (b.) and hence impact product design and pricing (a.). We also investigate the form and extent of
any such impact.
We note that for companies where a. is not the case, and/or situations where b. does not hold, then the introduction
of IFRS 17 may be expected to have no major impact on product design and pricing. Of course, it may still be the
case that there is concern about the timing of profits even when it does not impact dividend capacity directly.
However, our analysis will demonstrate that, even in the common case where a. and b. are both satisfied, then,
for specific types of product, the impact on product design and pricing of IFRS 17 may be rather less than might
be assumed.