Macro hedge accounting: A viable option for insurers hedging liabilities under IFRS 17

This article was written by Eva de Leon, Hedge Accounting Product Manager at Bloomberg.

Interplay between the economic and accounting impact of new International Financial Reporting Standards (IFRS 17 Insurance Contracts and IFRS 9 Financial Instruments) is challenging the asset and liability management (ALM) models of many insurance firms – along with the assumptions and methodologies underpinning them.

The interaction – sometimes conflicting – between IFRS 17’s impact on liabilities and IFRS 9’s impact on assets means insurance firms face complex choices on how best to adopt these standards.

Both standards – IFRS 17 Insurance contracts and IFRS 9 Financial Instruments–will challenge some firm’s ALM models and the underlying assumptions and methodologies underpinning them. To reflect the interplay between the economic and accounting impact, the challenge would be on how to extend or overlay it with accounting measurements.

Accounting elections should ideally reflect the firm’s ALM or business strategies, i.e. accounting treatments should reflect the economics of the business and its performance reflected in P&L (or OCI) depending on their IFRS 17 and IFRS 9 adoption.

Benefits of hedge accounting

Hedge accounting can help firms mitigate the accounting impact of IFRS 17 by addressing or reducing mismatches in accounting measurements. For general hedge accounting, insurers have a choice between IAS 39 and IFRS 9.

There are several advantages to adopting IFRS 9, as its main objective is to closely align hedge accounting with risk management. IFRS 9 addresses a number of issues with the previous IAS 39 standard, broadening the scope of eligible hedge strategies and introducing a ‘cost of hedging’ concept that can lessen P&L volatility for certain hedge types.

Regardless of whether a firm adopts IFRS 9 or IAS 39 for general hedge accounting, they can still use IAS 39 as the basis for macro hedge accounting – a viable option for insurers when adopting IFRS 17 for insurance liabilities.

Insurers tend to implement a dynamic hedging programme on a portfolio basis when hedging their interest rate exposure, due to the nature of insurance contracts, which are highly sensitive to behavioural assumptions and estimates (e.g. policyholder actions such as decision to lapse contracts) and new additions on an ongoing basis.

IAS 39’s macro hedge accounting model caters to this use case, enabling firms to hedge a portfolio of interest rate hedges against an exposure that is subject to behavioural risks and assumptions (similar to the way in which a bank applies macro hedge accounting to pre-payable loans and mortgage assets).

Challenges to implementation

IFRS 17 and IFRS 9 are complex standards with a variety of different pressure points. Firms implementing a macro hedge accounting model face a number of challenges, including:

• Modelling the exposure (e.g. time buckets) on a prospective and retrospective basis
• Accounting for effective and ineffective basis on a portfolio and dynamic (or frequent) basis
• Applying or optimising a dynamic hedge allocation
• Implementing an appropriate hedge effectiveness methodology
• Monitoring and tracking amortisation amounts and balances

A May 2021 survey by Bloomberg and Regulation Asia found that 61% of respondents planned to increase, maintain or begin hedge accounting in their derivatives trading activities, making this a key focus area as insurers gear up to implement IFRS 17 and IFRS 9.

How Bloomberg can help

Bloomberg’s Multi-Asset Risk System (MARS) is a comprehensive suite of risk management tools that enables front office, risk and finance professionals analyze their trading and investment portfolios, manage and mitigate their exposure, and ready themselves for any turn of events.

MARS Hedge Accounting helps users comply with the fair value measurement, revenue and cost recognition, reporting and disclosure requirements of hedge accounting standards. Bloomberg helps financial and non-financial corporations alike to ensure compliance with hedge accounting and financial instrument standards across four key areas: automation and transparency, reporting and documentation, quantitative effectiveness testing and controls framework.

MARS Front Office includes a powerful solution to value portfolios and understand key risks across all cash and derivative products powered with high-quality underlying market data and analytics. It also offers a highly customizable ALM solution that enables a unified view of assets, derivatives and liabilities, duration analysis, cashflow analysis, bespoke dashboard creation using APIs and workflows for discounting assets and liabilities.

For research content and analysis, Bloomberg Financial Accounting combines the full text of IFRS standards with news and analysis to keep accounting departments up to speed on the evolving IFRS 9 and IFRS 17 standards.