IN FOCUS6-8 min read

IFRS 9 and 17: goodbye CALM…and carry on

Tier 1_Business


Patrick O’Sullivan
Solutions Manager
Ruolin Wang
Solutions Manager
Ryan Mostafa, CFA
Portfolio Manager

In an earlier article we saw that for insurers reporting under International Financial Reporting Standards (IFRS), the accounting balance sheet is moving to an economic measurement of both assets and liabilities. For Canadian life insurers, this represents not only an accounting change but also a regulatory change. Effective from 1 January 2024, the latest Life Insurance Capital Adequacy Test (LICAT) represents a move from the previous Canadian Asset Liability Method (CALM)-based framework towards IFRS 17 and 9 principles, maintaining the consistency between the country’s life insurance capital regime and its accounting standards.

As we will see below, insurance liabilities under IFRS 17 are valued based on a yield curve that is effectively1 decoupled from the insurer’s assets. This is a marked change from CALM, where the value of liabilities is directly linked to the value of the supporting assets, and calls for a rethink of asset-liability management (ALM) for Canadian insurers. The IFRS framework incentivises insurers to take an economic approach and immunise their balance sheets from interest rate risk across the curve. With the alignment between IFRS and LICAT, this can protect life insurers from volatility in their accounting as well as solvency positions. The more economic approach also affords insurers more flexibility to optimise and manage their portfolios to maximise yield without negatively impacting their accounting positions.

Market changes over the past year or so are a further cue for insurers to review their investment strategies and make sure that these are still fit-for-purpose. For instance, now that investors are able to achieve non-trivial returns from government bonds, how should insurers think about the relative attractiveness of credit allocations?

Figure 1: Government bond yields have risen since 2021

608778_Chart images for ContentStack_01

Source: Schroders, Refinitv. Based on ICE BofA Canada Government Index. As at May 31, 2023. Current performance trends may not continue and should not be relied upon to predict future results. 608778

Asset-liability management

Asset-liability management is the practice of making the two sides of the balance sheet work together to manage risk, capital requirements, and to inform investment strategy. The reporting lenses of IFRS 9 and 17 can help firms position assets to reduce the volatility of their balance sheets and, depending on their specific accounting policies (see our previous article, IFRS 9 and 17: a guide to insurance asset management, for a reminder of these), the volatility of their profit or loss (P&L) and/or other comprehensive income (OCI).

Sound ALM practices will also benefit life insurers from a capital perspective. Under the LICAT guidelines, the interest rate shock parameters at the short-to-medium end of the curve2 are proportional to the square root of current interest rates. In other words, as rates rise, so too do the absolute sizes of the interest rate shocks, increasing the capital cost of any duration or curve (key rate duration3) mismatch. Asset and liability matching can mitigate adverse reactions to rate stress and from a regulatory perspective, reduce capital and improve solvency positions.

Using a proxy cash flow profile with approximately 15-year duration as an example, consider the LICAT scenario 1 interest rate requirement on the insurers’ liabilities (i.e. without considering assets). Under scenario 1, interest rates are decreased across the term structure, and this scenario leads to the largest increase in liabilities on a standalone basis.

The liability-only interest rate requirement under scenario 1 has increased significantly compared to what it would have been at the end of 2021. In other words, any asset-liability mismatch now comes at a higher cost not just in terms of economic and accounting sensitivity, but also in terms of solvency capital.

The cost of ALM mismatches has risen


Duration (year)

Scenario 1: Interest rate requirement

December 2021



May 2023






Source: Schroders, Aladdin, OSFI. Based on CAD yield curves constructed using market government and corporate yield data. As at May 31, 2023. 608778

Under an economic framework, the key to ALM practice is to construct and maintain asset portfolios that match the liabilities they are backing. This can be done to various degrees of exactitude: duration matching, key rate duration matching, or cash flow matching. These, in turn, would provide various degrees of protection against interest rate level and curve risks.

While it is possible to duration-match by allocating to a series of fixed income funds, this is likely to leave the insurer exposed to curve risk. Key rate duration or cash flow matching are more robust approaches to rate risk management, but require portfolios that are more tailored to insurers’ liabilities, and these are more practical to construct and manage through a segregated investment portfolio (rather than through funds).

Concretely, such key rate duration or cash flow matching requirements can be translated into a series of targets and restrictions in the portfolio’s investment guidelines, which can then be reviewed on a regular basis as the liability profile evolves.

With the move to IFRS 9, many insurers are already choosing to invest through segregated portfolios in place of mutual funds4. The possibility for more tailored asset-liability management is a natural advantage of this approach.

IFRS 17 and the case for credit

What should insurers’ fixed income portfolios consist of? Credit spreads have proven volatile over the last year. During the spread hike of autumn 2022, insurers who had close partnerships with asset managers would have been best poised to take advantage of the market conditions. For the rest, it is never too early to establish relationships with asset managers close to the market, and who can take advantage of investment opportunities.

Figure 2: US corporate bond spreads

608778_Chart images for ContentStack_02

Source: Schroders, Refinitv. As at May 31, 2023. Based on ICE Bof A indices. Shown for illustrative purposes only and should not be interpreted as investment guidance. 608778

For insurers with illiquid (for example annuity) liabilities, the case for credit is particularly strong under IFRS 17’s discounting methodology. IFRS 17 requires account preparers to construct discount curves which are consistent with ‘observable current market prices’. Much has been written about potential ways to implement the so-called ‘bottom-up’ or ‘top-down’ approaches, but in essence (and in theory5), they should both result in a yield curve composed of:

Risk-free rate + Illiquidity premium.

The ‘illiquidity’ here refers to the characteristics of the liabilities, not the assets. IFRS 17 makes no requirement that either approach should refer to the actual assets backing the liabilities being discounted, although this is possible under a top-down approach. A simplified bottom-up approach for Canadian insurers could be to take the LICAT yield curve construction of risk-free rates plus 90% of market spreads, adjusting the level of market spread included for the liquidity of the liabilities. Other approaches exist. For firms with illiquid liabilities, the case is strong to allow for a significant illiquidity premium in the liabilities’ corresponding discount rates, thereby improving the insurer’s accounting and solvency positions.

If firms can uplift their IFRS yield curves by an illiquidity premium without even the need to show that it can be earned on their assets, does this effectively give insurers an accounting illiquidity premium ‘for free’?

No. Although assets and liabilities are no longer linked directly as under CALM, consistency between the discount rate and firms’ asset portfolios is still an important part of asset-liability management. Using a portfolio of assets which do not earn the illiquidity premium implied by the liability discount curve would create inadequate reserves. In other words: the illiquidity premium gives firms an additional lever to manage their IFRS balance sheets, but the only responsible way to use it is to earn it.

Where can insurers find these illiquidity premia?

To take advantage of the opportunities on offer in the evolving fixed income marketplace, Canadian insurers should not shy away from globalising their portfolios. By being open to credit opportunities in USD, for example, investment grade (IG) investors can increase their accessible market size by more than tenfold.

Figure 3: IG corporate bond market sizes by market value

608778_Chart images for ContentStack_03

Source: Schroders, Refinitiv. As at May 31, 2023. Based on ICE BofA indices. Shown for illustrative purposes only and should not be interpreted as a recommendation to buy or sell. 608778

This wider market access provides not only greater opportunities to harvest attractive yields, but also greater sector and issuer diversification. The CAD investment grade corporate bond market offers around 200 issuers, for example, while the USD market boasts well over 1,5006. In addition, while the CAD investment grade corporate bond market is relatively concentrated, with the top five sectors making up almost three-quarters of the market, the USD market is much more diversified between sectors.

Figure 4: Sector Diversification: CAD IG Corporate Bonds

608778_Chart images for ContentStack_04

Source: Schroders, Aladdin. Based on BofA Merrill Lynch Global Broad Market Index. Sectors based on Barclays definitions. Includes investment grade CAD and US corporate bonds only. As at May 31, 2023. Diversification cannot ensure profits or protect against loss of principal. 608778

Figure 5: Sector Diversification: USD IG Corporate Bonds

608778_Chart images for ContentStack_05

Source: Schroders, Aladdin. Based on BofA Merrill Lynch Global Broad Market Index. Sectors based on Barclays definitions. Includes investment grade CAD and US corporate bonds only. As at May 31, 2023. Diversification cannot ensure profits or protect against loss of principal. 608778

For insurers, a foreign- or multi-currency bond portfolio can be effectively managed with FX hedging to match domestic liability currency (where required), and to reduce or eliminate LICAT currency risk charges. With IFRS 9 and IFRS 17 coming into effect, hedge accounting is also more economic and simpler to apply than under the previous IAS 39. Indeed, the Group Chief Executive of AIA called out the updated accounting treatment of derivatives used to hedge its liabilities as a major positive driver behind its 2022 results7. With robust risk management practices and adequate documentation, there is really no reason to forego global opportunities.

Assessing the landscape

As we have seen in the past, there can be unforeseen events or rapid deterioration in the outlook of a particular issuer or industry that can lead to sharp and unexpected deterioration in credit quality and downward ratings migration. It is important, in our view, to have dedicated credit analysts assessing the changing dynamics of issuers under their coverage to properly mitigate downside risks throughout the cycle and especially during these periods of heightened stress.

Such an active approach to credit risk management is now even more important on an accounting basis due to the introduction, under IFRS 9, of the ‘Expected Credit Loss’ (ECL) provision. For bonds measured at Amortised Cost or Fair Value through OCI (FVTOCI), firms must now hold a provision which represents the bond’s 12-month or lifetime expected loss due to credit risk. The standards set out the following three-stage, principles-based framework for determining the time horizon covered by the ECL. The exact definition for terms such as ‘significant increase in credit risk’ and ‘credit-impaired’ would need to be specified by firms’ accounting policies.

ECL staging for financial assets not purchased or originated credit-impaired

608778_Chart images for ContentStack_06

Source: Schroders, IASB. 608778

Any changes in the ECL, for example due to a ‘significant increase in credit risk from initial recognition”, would be reflected in the insurer’s P&L. The impact of this could be sizeable. Take for example a BBB-rated bond with 10 years remaining to maturity, currently with a 12-month ECL. If downgraded to BB, and if this were deemed a ‘significant increase in credit risk’ under the insurer’s accounting policy, its ECL would change from reflecting a ~0.2% one-year probability of default associated with a BBB-rated bond to reflecting a ~16% 10-year probability of default for a BBrated bond.8 This would be in addition to the asset’s market value change if measured under FVTOCI.

The market is currently late cycle. Leading economic indicators and tightening lending point to at least a sharp contraction in economic growth and a likely recession. At the same time, spread dispersion is still relatively low, not reflecting these risks fully in our view.

Credit quality improvements since 2021 have shielded U.S. investment-grade firms from ratings downgrades and spread blow-ups typical of turns in the economic cycle. The net upgrade bias of the US Investment Grade index, an indicator compiled from the ‘watch’ and ‘outlook’ designations of the three major credit rating agencies, has fallen to 13-month lows, as the pipeline of future upgrades can’t keep pace with a heavy flow of realised upgrades, and the slate of downgrade candidates is becoming more entrenched. As growth continues to soften and a downgrade cycle materialises, so too will risks to rating-sensitive portfolios. And with this, having thorough and dedicated coverage of issuers and industries in scope will take on added importance.

1Where insurers choose to use a ‘top-down’ method to determine their IFRS 17 discount rates, there can still be linkage between assets and liability discount rates, although not in the same way as under CALM.

2In other words, all but the shocks to the ultimate interest rate.

3Key rate durations measure the sensitivity of an asset or liability to specific points on the yield curve.


5Although, as the IFRS 17 standards recognise, not always in practice.

6Bloomberg Barclays Global Agg Credit index.


8Source: Moody’s default study, 1920–2021.

Important Information

The views and opinions contained herein are those of the individuals to whom they are attributed and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. Issued in June 2023.

These views and opinions are subject to change. Companies/issuers/ sectors mentioned are for illustrative purposes only and should not be viewed as a recommendation to buy/sell.

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Patrick O’Sullivan
Solutions Manager
Ruolin Wang
Solutions Manager
Ryan Mostafa, CFA
Portfolio Manager


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