Shenwan Hongyuan Group: How to understand the changes in the insurance industry's new accounting standards?

Shenwan Hongyuan Group released a research report stating that the insurance sector has undergone a phase of adjustment recently, mainly influenced by the amplification of the sector's beta attribute under the trend of increasing market attention, and the mid-term outlook remains positive for the improvement of asset-liability dual-way dynamics. After the formation of a consensus expectation for public offering regulations, insurance capital entering the market, and a bull market, the attention on the significantly underweight insurance sector continues to increase. Some institutions have positioned themselves as "aggressively attacking" insurance, which has amplified the sector's beta attribute in the face of market volatility. The firm sees a systematic revaluation opportunity for the mid-term value of the insurance sector. Key viewpoints from Shenwan Hongyuan Group include: Profound impact of the implementation of new accounting standards for the insurance industry In order to enhance comparability of performance and profit transparency, listed insurance companies will implement the new financial instrument standard (IFRS 9) and new insurance contract standard (IFRS 17) in 2023, while non-listed insurance companies are expected to implement them by January 1, 2026. The new standards overturn the recognition and measurement rules of the original standards, resulting in profound impacts on the accounting practices, business management, and valuation logic of insurance companies. IFRS 9: Asset classification "Four Changes Three," increase in proportion of fair value measurement assets 1) The classification of financial assets is changed to a three-category method based on the objective business model for managing financial assets and the cash flow characteristics of financial assets - AC/FVOCI/FVTPL. Looking at specific assets, i) Stocks: can choose to be included in FVTPL or FVOCI; when included in FVOCI, there are limitations on holding period, dividends are included in the income statement, fair value changes are included in other comprehensive income, and fair value changes upon sale go directly into the balance sheet without affecting profits. ii) Bonds: classified based on the business model and cash flow characteristics, can choose to be included in AC, FVTPL, or FVOCI; when included in FVOCI, interest is included in the income statement, fair value changes are included in other comprehensive income, and fair value changes upon sale are included in the income statement. iii) Funds: currently all funds are classified as FVTPL. 2) Impairment losses are accounted for using the "expected loss method" instead of the "incurred loss method." It measures the impairment reserves that should be recognized on the current balance sheet date based on the expected value of future default events, accurately reflecting the true value of financial assets. IFRS 17: Reshaping financial statement logic for clearer profit sources 1) Premium recognition principle transitions from the cash basis to the accrual basis, only recognizing revenue corresponding to services provided in the current period, while excluding the "investment component" from contracts; 2) Splitting and measuring insurance contracts focus more on the essence of the contract. Under the new standard, insurance contract groups are the only unit of measurement for financial models, providing new allocation methods for participating-insurance, loss contracts, and short-term insurance to adapt to their unique characteristics. 3) The sensitivity of insurance contract liabilities to spot rates significantly increases, with insurance companies focusing more on asset-liability matching in a fluctuating interest rate environment; a new item - Contractual Service Margin (CSM) is introduced, representing the potential profits or unearned profits from services provided in the future under an insurance contract, gradually recognized as actual profits within the insurance period as services are continuously provided to customers, which is the most important source of underwriting profits for the current period, highly relevant to the profitability performance of insurance companies. Risk warning: Declining long-term interest rates, significant fluctuations in equity markets, frequent large-scale disasters, regulatory policy impacts exceeding expectations.