New Standards in the Insurance Industry "Crossing the River in Deep Water": How the Difference of Billions in Profits Arises During the Same Period

The timing of the switch between old and new accounting standards has made the financial reports of insurance companies, which were already "hazy," even more confusing.

In the recent two periodic reports from China Everbright Life, the net profits for the first three quarters were 1.111 billion yuan and -1.087 billion yuan, with a staggering difference of 2.198 billion yuan between the two;

Coincidentally, in the two reports from PICC Life Insurance, the net profit difference during the same period reached 13.119 billion yuan.

The starkly different results stem from the transition between the old and new accounting standards.

At the request of the Ministry of Finance, listed insurance companies have switched to the new standards starting in 2023, while non-listed insurance companies will implement them starting in 2026; currently, some non-listed insurance companies represented by "banking systems" have already adopted the new standards ahead of schedule.

The new standards consist of accounting standards related to financial instruments aligned with IFRS 9 (hereinafter referred to as "instrument standards") and the "Enterprise Accounting Standards No. 25 - Insurance Contracts" aligned with IFRS 17 (hereinafter referred to as "contract standards").

Analysts have indicated that "switching to the new standards is exceptionally complex, simultaneously altering liabilities and assets, with numerous items needing reclassification."

The profit gap of up to tens of billions under different accounting standards is the most intuitive slice of the situation.

"We are also learning in many areas," the analyst pointed out, "how premiums are accounted for, how assets are classified, including reserves, contract liabilities, expenses, and other aspects are all affected."

In the long run, the new standards will not only reconstruct the way performance is presented. The reclassification of asset and liability items will subtly change the investment preferences and product tendencies of insurance companies.

Transition Period Shockwaves

In the solvency report, China Everbright Life reported insurance business income and net profit of 16.499 billion yuan and 1.111 billion yuan, respectively, for the first three quarters.

In the third-quarter report, its insurance business income remained at 16.499 billion yuan, but the net profit showed a loss of 1.087 billion yuan.

The profit difference is directly related to accounting standards.

In the solvency report, China Everbright Life prepared net profit and insurance contract liabilities according to the new standards; other data still used the old standards.

China Everbright Life did not provide an explanation for the differences in standards; however, given that the new standards involve numerous items, it is not uncommon for significant adjustments to occur during the transition period.

Even listed insurance companies that have fully switched to the new standards have reported "two sets of performance."

In the third-quarter report prepared under the new standards and the solvency report prepared under the old standards, PICC Life Insurance reported net profits of 15.582 billion yuan and 2.463 billion yuan, respectively; PICC Property and Casualty and PICC Health also showed some differences.

Previously, China Life Insurance also experienced a profit difference of over 20 billion yuan under both the new and old standards in 2023.

The switch to the new standards aims to fully reveal the sources of profit, making the income of insurance companies more comparable among themselves and with other industries However, the friction during the transition period seems unavoidable.

The significant differences in the "two performance reports" mentioned above highlight the enormous changes in insurance companies' profits under the old and new standards.

Due to varying transition times and degrees, along with the optional restatement of last year's performance, some insurance companies experience drastic profit fluctuations, making comparisons between peers and even within the same company difficult and often untraceable.

For example, China Post Life Insurance reported a net loss of 10 billion yuan in 2023 under the old standards, but a net profit of 10 billion yuan in the first three quarters of 2024 under the new standards;

After switching to the new standards, New China Life Insurance saw a year-on-year decline of 10% in net profit in 2023; however, if the 2022 data were simulated under the new standards, the resulting decline for the following year would exceed 40%.

To ensure a smooth transition, some insurance companies have adjusted HTM (Held-to-Maturity assets) to AFS (Available-for-Sale financial assets) based on the old standards.

This change has affected the solvency of several insurance companies.

For instance, after the asset reclassification, CITIC Prudential Life Insurance saw its core capital and actual capital increase by 6 billion yuan and 9 billion yuan, respectively, leading to a rise in core and comprehensive solvency adequacy ratios by 25.92 and 38.32 percentage points, respectively.

This has also made the comparability of various indicators during the transition period even more ambiguous.

How to Open the "Black Box"

The reserve account, which accounts for about 80% of total liabilities of insurance companies, is often referred to as the "black box."

The nature of insurance operations involves long liability cycles, with income and expenses separated by several years; however, accounting must adhere to the accrual basis, requiring current income and expenses to match.

Amidst these contradictions, the insurance industry has formed a highly uncertain "reserve" account that encompasses all business cash flows and unrealized profits during the contract duration, making it difficult for the market to dissect its profits.

Under the new standards, the contract standards regulate the recognition, measurement, and presentation of accounting elements; at the same time, they dismantle the "black box" by linking reserves to different items in the income statement.

For example, the income recognition method removes the investment component and presents it by source; the income recognition period is extended from the "payment period" to the "coverage period."

Taking New China Life Insurance as an example.

In the first three quarters of 2024, premiums increased by about 8 billion yuan compared to the same period in 2022; however, after removing the investment component and extending the income recognition period, the "insurance service income" presented in the financial report decreased by 70% compared to the "insurance business income" in 2022.

The insurance contract liabilities in the financial report will require more detailed disclosures in the notes.

This includes the amounts of incurred claims liabilities and unexpired risk liabilities, both loss and non-loss amounts; disclosures of the present value of future cash flows, non-financial risk adjustments, and contract service margins will make the operations of insurance companies more transparent.

The discount rate also brings changes.

Under the old standards, the discount rate was based on the 750 curve (750-day moving average of government bond yields).

As government bond rates continue to decline, many life insurance companies face profit pressures. For instance, China Post Life Insurance significantly increased its reserves in 2023 due to large fluctuations in the discount rate, resulting in a loss of billions on the profit statement.

Under the new standards, the 750 curve is replaced by the spot yield.

However, regarding the reserve provisions caused by interest rate changes, the new standards have set up an OCI option, allowing insurance companies to allocate the changes in liabilities due to the discount rate across various periods' profits and losses, transferring the fluctuations in net profit to fluctuations in net assets and smoothing the impact In addition, insurance companies have a large amount of bonds on the asset side. When interest rates decline, not only will reserves increase, but the fair value of bond investments will also rise, which is conducive to facilitating asset-liability matching.

Against this backdrop, China Post Life Insurance has switched to new standards starting in 2024.

The new standards have improved the objectivity of asset classification and the consistency of accounting treatment, adjusting financial assets from "four categories" to "three categories."

Under the old standards, financial assets were divided into four categories: FVTPL (financial assets measured at fair value with changes recognized in profit or loss), L&R (loans and receivables), HTM (held-to-maturity investments), and AFS (available-for-sale financial assets).

The new standards classify financial assets into three categories based on measurement methods: AC (financial assets measured at amortized cost), FVTPL (financial assets measured at fair value with changes recognized in profit or loss), and FVOCI (financial assets measured at fair value with changes recognized in other comprehensive income).

The market price changes of FVTPL assets are directly included in the company's profit and loss statement, while FVOCI assets do not have an impact on the current period.

This classification of assets is clearer, but given that insurance companies have a large amount of assets expected to be classified as TPL, performance fluctuations will also be more pronounced.

Driving Dividend Investment

The impact of the new standards on the industry goes far beyond the superficial presentation of profits.

The most direct manifestation is the high-frequency increase in dividend assets by insurance capital during the transition period.

To smooth out balance sheet fluctuations, insurance companies prefer long-term and allocation-oriented assets that are likely to be classified as FVOCI, which is related to the recent two rounds of "stock acquisition frenzy."

Since 2020, listed insurance companies such as China Life and CPIC, which entered the transition period early, have begun to layout dividend assets, acquiring stakes in high-dividend assets such as China Fortune Land Development, Agricultural Bank of China, China Jinmao, and Industrial and Commercial Bank of China.

At the performance meeting that year, Zhang Di, the investment head of China Life, stated that the company's stock selection criteria include growth, value, and dividends.

As of November 28, 2024, a new batch of small and medium-sized insurance companies entering the transition period, such as Great Wall Life and China Post Life, have completed 15 stock acquisitions within the year, similarly focusing on dividend assets.

Xu Kang, chief analyst at Huachuang Securities, pointed out that stocks with a holding ratio of 5-10% by insurance capital align perfectly with the OCI "long-term holding" logic and are expected to be included in this category.

In addition to promoting the allocation of dividend assets, the new standards may also subtly influence insurance companies' product preferences on the liability side.

For example, the new standards require policy grouping based on profitability, reducing subsidies between profitable and loss-making contracts.

In this context, insurance companies may pay more attention to product profitability and risk management.

Wang Guojun, a professor at the School of Insurance at the University of International Business and Economics, believes that after the switch in standards, insurance products will place greater emphasis on balancing protection and investment attributes.

"It is necessary to consider the measurement of different assets and liabilities, as well as accounting changes, and their impact on overall profits and finances," Wang Guojun stated.

Overall, asset-liability matching will continue to optimize.

Wang Guojun indicated that in the future, insurance companies will adjust pricing based on the accounting characteristics of liabilities with different maturities. "They will increase the allocation of assets that are stable in measurement and can match the cash flow of liabilities, reducing fluctuations caused by fair value changes and other factors."

Rising Demand for Information

Currently, insurance companies switching to new standards are still dominated by leading firms and larger "bank-affiliated" companies.

A staff member from a large accounting firm, Li Hua (pseudonym), revealed that for small and medium-sized insurance companies, switching to the new standards presents "numerous challenges."

"Many companies have opaque financials," Li Hua stated. "Different departments and different quarters may use varying metrics to beautify performance. We are also very troubled by this."

According to Li Hua, some insurance companies have even hidden assets that should have entered the risk disposal phase under previously vague accounting data.

To open the "black box" of reserves under the new standards, a highly complex information system is required.

This includes building new data platforms, measurement platforms, accounting engines, and transforming various core business systems, cost allocation systems, and financial reporting systems.

Research results from Tao Rui Hui Yue show that the average planned cost for implementing IFRS 17 among the 24 largest multinational insurance companies in the world in 2021 was approximately USD 175-200 million; the cost for the remaining 288 insurance companies was about USD 20 million.

Wang Qing, who has served as the chief actuary for several domestic life insurance companies, revealed in a signed article at the end of 2023 that a Hong Kong insurance group has invested USD 150 million in the IFRS 17 project, "but still feels it is not sufficiently complete."

"Many insurance companies in China have not yet initiated projects," Wang Qing stated. "Completing the IFRS 17 system in the next two years with minimal costs is extremely difficult, and the consulting teams from the Big Four accounting firms do not have enough manpower to take on this."

Wang Qing pointed out, "Many small companies have a budget of only 10 million, and the only solution is to use packaged software provided by consulting firms, but there are currently no successful cases."