Transforming FP&A Practices Post-LDTI and IFRS 17
By Sahreen Moti, Vance Forrest and Casey Tan
International News, May 2024
Editors’ note: This article is adapted from an original report, published by Deloitte. The full report can be found here.
Financial planning and analysis (FP&A) is one of the most important functions of an insurance company, yet one of the most chronically underfunded. It is tasked to provide strategic business insights and help the company plan, forecast, and budget while also performing the ongoing assessment of the company’s financial health based on key benchmarks and performance metrics. Due to the long-duration nature of life insurance and annuity products, such benchmarks and metrics are often tied to one or more valuation and accounting bases; hence, any changes to the relevant basis would have an impact on FP&A activities.
Changes in accounting regimes across the globe have accelerated the long-overdue need for insurance companies to update outdated valuation systems and models. Companies across the globe have collectively invested more than a billion dollars to implement solutions and adapt to the wave of the largest changes in insurance accounting history, such as USGAAP Long-Duration Targeted Improvements (LDTI) and International Financial Reporting Standard (IFRS) 17. Adopters as of Jan. 1, 2023, have finally shifted their focus away from compliance as the implementation journey is behind them and now have the time and resources to process the profound impact the new accounting regimes have on financial storytelling, performance measurement, and management, thus posing challenges as well as opportunities, especially for the FP&A function in a post-LDTI/IFRS 17 world.
Before we discuss the potential implications of new accounting regimes, let’s refresh on how an FP&A team performs financial assessment by answering three foundation questions. Can the FP&A team identify what happened? Can the FP&A team link the outcome to key drivers? What was our expectation, and what would be the revised outlook if certain conditions changed?
The FP&A team should strive to answer these questions with respect to three key considerations: accuracy, speed, and modifications. How accurate can we get in our explanation, and do we have a high-quality, reliable data source and the right process in place? How fast can we determine a conclusion and how much time do we need to get within a reasonable answer? Modifications lean into what-if scenario analysis and are critical to forming any revised outlooks. What if this happens again, and what if its conditions were more extreme?
The first two considerations are reactive in nature by looking backward, and oftentimes, the FP&A team is actively working to put out a fire. Considerable time is spent and lost just gathering the right data to answer the first two considerations, while not enough time and resources are spent on the third consideration. Cumbersome processes and disconnected data sources are always evolving. Regulatory changes are modernizing operations that the FP&A department can leverage as well to enhance its objective. The FP&A team can incorporate modernization efforts to spend less time gathering data trying to figure out what happened and pivot toward being proactive, anticipating the next step, and driving insights to position the company for success.
A recent Deloitte survey (Deloitte FP&A and Actuarial Study) of L&A insurance companies found that many insurers struggle to integrate their FP&A and actuarial processes, which can negatively affect their ability to manage enterprise performance. Companies consistently cited a lack of connected solutions to enable collaboration and information-sharing between FP&A and other functions. Sitting as a key connection point between strategy, operations, reporting, and valuation, if the right level of collaboration and the right toolsets are put in place, the FP&A function would be uniquely positioned to deliver true and timely business insights to drive value creation.
With LDTI and IFRS 17 being effective, there is an amplified need for collaboration with valuation and reporting, and this presents an urgency for the FP&A teams that have not been closely following along the LDTI/IFRS 17 implementation journey. To some extent, the FP&A team may view itself as just the consumer of financial reporting results and lack the time to become immersed in the implementation of new accounting regimes. However, when it comes to creating a multiyear financial plan and forecasting performance metrics for different business scenarios, FP&A would need to catch up on the new accounting requirements and heavily rely upon the valuation and reporting team to understand how the future Profit and Loss (P&L) would unfold, especially given that financial results under are more dynamic and less predictable than years prior.
For example, FP&A leaders may have a routine FP&A activity to set an expense plan. Without an appreciation of how attributable versus non-attributable expenses are treated under IFRS 17 valuation and how they respectively flow into profit, it would be an impossible task to set a meaningful three-year plan for IFRS 17 operating profit. As the first sets of financial statements under LDTI and IFRS 17 were made available in 2023, internal and external stakeholders have been busy analyzing and digesting the financial stories behind the changes in equity positions from transitioning from the old accounting bases and new P&L trends indicated from the limited data points. Projecting into the future with confidence is currently a challenge, but being a strategic partner, the FP&A team has unique opportunities to take on.
New accounting regimes have brought about new key performance indicators (KPIs), and the drivers of earnings are changing. New disclosures offer a great deal amount of information and insights that did not exist before. For metrics used by the FP&A function that are tied to an accounting basis, it is critical for the FP&A team to understand the new dynamics of emerging earnings and how best to integrate with the financial reporting process to generate such KPIs and messaging in a timely fashion.
For example, LDTI has prompted insurers to revisit adjusted earnings. For blocks of business with significant SOP 03-1 balances prior to LDTI that are now accounted for as Market Risk Benefits (MRB), changes in MRB liability may be excluded from adjusted earnings, given the nature of the fair value calculation. In general, LDTI has changed the volatility in P&L resulting from Deferred Acquisition Costs (DAC) and liability roll-forward, and the source of earnings has changed depending on the facts and circumstances of the insurer.
In comparison, IFRS 17 has changed the valuation of insurance liabilities and the financial presentation of balances and P&L. New concepts such as Contractual Service Margin (CSM), Risk Adjustment (RA), and Insurance Revenue have triggered new KPIs and the desire for stakeholders to understand the walk from old KPIs to new ones. For example, some insurers are defining new business profit margin as the new business CSM plus RA over the present value of new business premium (PVNBP). This is akin to the Value of New Business (VNB) over PVNBP that many insurers currently look at when analyzing new business profitability. Another example is the implied in-force profit margin from the IFRS 17 statement of profit or loss, which is the ratio of insurance service results over insurance revenue.
Also, in the case of reinsurance transactions, LDTI and IFRS 17 may result in a certain level of accounting mismatch between direct and ceded business, causing P&L to emerge in a way that is not perfectly aligned with real-world economics. Understanding how the accounting mismatch unfolds and how the resulting P&L should impact performance metrics have continued to be a topic of consideration for the FP&A function.
Due to the requirements for enhanced disclosures and granular valuation under LDTI and IFRS 17, companies are now sitting on top of a “gold mine” comprising insurance financial data that is significantly more detailed and voluminous than ever. This is evidenced by the rising popularity of insurance sub-ledger solutions across the globe. There are tons of insights that did not exist before, and it would be a waste for that amount of data to be generated and thrown away just for accounting compliance purposes. There is an opportunity to modernize the usage, accessibility, and storage of insurance data. It is in FP&A leaders’ best interest to capitalize on the momentum from accounting compliance and turn it into something lasting and real by leveraging what has been achieved and building into a future state of value-driven finance function. It would allow for more reliable and timelier what-if analysis if the insurer possesses the capability to bring together operational and financial data and marry investment and liability data. With access to a wealth of insurance data, FP&A leaders could also investigate solutions with generative AI and machine learning features to enhance their financial forecast capabilities.
FP&A is expected to proactively provide financial forecasts and real-time analysis to inform business decisions. However, unanticipated results from the financial close often result in FP&A scrambling and reacting post-close to modify the full-year forecast, which is exacerbated by the less predictable financial results of new accounting requirements. FP&A will need to fully appreciate the accounting changes and be equipped with the right tools to perform forecasts in a more automated and streamlined fashion.
The FP&A process has always been connected with other functions and is continuous in nature, requiring flexibility for updates and changes. Historically, manual Excel-based processes hinder the FP&A team’s ability to produce valuable and timely insights. FP&A could benefit from stronger integration with operational data and financial reporting data, enabled by technology for real-time connectivity to actuals, comparison between plan and forecast, and timely updates. The FP&A should also adapt and evolve to improve financial projections by leveraging advances in the FP&A technology space.
There are also a few considerations to revisit. It’s important to determine how often plans and forecasts should be refreshed to accommodate the less static and less predictable nature of financial results and establish timetable refresh cycles that align with financial quarter-end or year-end close cycles, as well as any pre-close or post-close activities. There’s a need to determine the desired level of granularity for FP&A analysis, whether it be by business level, issue year cohort, or even more granular levels. It’s also important to assess if there are any additional reports, KPI dashboards, or visuals to produce, and what sensitivities are there to run in addition to the baseline scenario to form a spectrum of results that allow FP&A to be more nimble and agile in reacting to what-if type of scenario requests from business partners.
As FP&A leaders adapt to the impact of new accounting regimes, it is also important to rethink the modeling approach. More actuarial involvement is expected, given the less predictable nature of financial results and a stronger need for drivers of earnings analysis and sensitivity runs. Trade-offs between speed and accuracy and simplicity and granularity must be evaluated, especially considering the significant technology investment in financial reporting that could be leveraged for FP&A and the increased granularity and detailed data available under LDTI and IFRS 17.
As the compliance and implementation efforts for accounting changes conclude, several great opportunities are presented to the insurance FP&A function across the globe to make the best of the current momentum. The FP&A function could capitalize on the investment in technology and talent over the past few years and take the opportunity to strengthen integration with other functions to enable a truly connected and continuous planning process. It is critical for an FP&A leader to be equipped with the tools and ability to assess the financial health of the company in a timely manner, analyze complex business scenarios and propose alternatives, articulate financial results in a meaningful way, and forecast the future with confidence. Companies that remain committed to their slow, inefficient, and cumbersome processes will lack the ability to produce actionable insight and foresee upcoming road bumps that could hinder capital deployment and won’t empower their executives to articulate a compelling story about the benefits of their new business mix. Strong FP&A capabilities are what sets one organization apart in terms of improving business decisions and driving business performance to better position the company to achieve success.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.
Sahreen Moti, ASA, is a senior manager at Deloitte. She can be reached at smoti@deloitte.com.
Vance Forrest, FSA, MAAA, is a manager at Deloitte. He can be reached at vforrest@deloitte.com.
Casey Tan, ASA, is a consultant at Deloitte. She can be reached at casetan@deloitte.com.