Notes to Financial Statements

Study guides: Exam 6C, Exam 6U

The Notes to Financial Statements are the narrative and tabular disclosures accompanying an insurer's primary statements. Under IFRS 17 they carry an unusually heavy load: the standard's measurement is judgement-intensive and entity-specific, so the notes are where a reader learns what the numbers mean and whether two insurers' figures are comparable at all.

• The IFRS 17 disclosures that matter most, and which candidates should be able to list:
  • Reconciliations of the LRC, the Loss Component and the LIC from opening to closing balance, and of the CSM where one exists.
  • The risk adjustment's confidence level, and the level at which diversification is recognised.
  • The discount rate methodology (bottom-up or top-down) and the yield curves used.
  • The Coverage Units driver and the acquisition cash flow policy election.
  • Claims development tables, showing how each accident year's estimate has moved.
  • The transition approach and a reconciliation of the CSM by approach.
• Risk disclosures under IFRS 7 and IFRS 17: insurance risk concentration, sensitivity analyses to key assumptions, credit exposure by reinsurer rating, liquidity maturity profiles, and market risk sensitivities.
• Why the notes are not optional reading. The risk adjustment, discount rate and coverage-unit choices are all levers on reported profit and equity. Two insurers with identical portfolios can report materially different results, and only the notes reveal which choices were made.
• Materiality governs. Disclosure is required where it is material to a user's understanding — see Materiality. An insurer cannot bury a significant judgement in boilerplate, and the External Auditor and the regulator both test this.
• The Appointed Actuary's work underlies several notes directly — the liability reconciliations, the risk adjustment confidence level, the development tables and the sensitivity analyses — so the actuary is responsible for far more of the notes than of the primary statements.

Comparing Two Insurers Through the Notes Two P&C insurers report similar books and similar equity. Their notes disclose:

• Insurer A: risk adjustment at the 85\text{th} percentile, diversification recognised at entity level; discount rate bottom-up with a 70 basis point illiquidity premium.
• Insurer B: risk adjustment at the 65\text{th} percentile, diversification at group level; discount rate top-down.

What does an analyst conclude?

Answer The reported figures are not comparable as they stand, and the notes say by how much.

• Insurer A is more conservative on the risk adjustment. An 85\text{th} percentile carries a materially larger margin than a 65\text{th} — on a heavy-tailed liability, plausibly twice as large. A holds a bigger liability, reports lower equity, and will release more into future profit as risk expires. It is not less profitable; it is more prudently stated.
• Diversification level compounds it. B recognises diversification at group level, which produces a smaller risk adjustment than entity-level recognition for the same portfolio. So B's margin is lower for two reasons, not one.
• Discount rate method. A's 70 basis point illiquidity premium is disclosed and can be judged. B's top-down rate depends on its asset portfolio's yield less credit adjustments, which is harder to benchmark — the analyst should look for the resulting rate itself in the note, not just the method.

The adjustment an analyst would make: restate B's risk adjustment to an 85\text{th}-percentile equivalent before comparing equity, and compare the two discount curves at similar durations. Both restatements are possible only because the confidence level and the method are required disclosures — which is precisely why IFRS 17 requires them rather than prescribing a single margin.