Value of New Business, or VNB, is a common measure to evaluate the expected profitability of business at time of issue. As IFRS 17 is now in effect, many feel that VNB will no longer be as useful a measure as it was previously, since the combination of the Contractual Service Margin (CSM) and Risk Adjustment (RA) will sufficiently inform users of the profitability of the business; however, there are many reasons why VNB will remain relevant in the IFRS 17 era — perhaps becoming even more relevant.
While the CSM and RA inform the users of the unearned profits at time of issue, they do not capture the time value of those profits at a company’s internal hurdle rate or target return on equity. A dollar of income today is more valuable than a dollar of income in ten years, and we know that for certain products, such as Universal Life, the release of CSM and RA into income can stretch many years into the future.
The CSM and RA do not measure the cost of holding regulatory capital. Long-duration contracts tend to have higher capital requirements, and that capital tends to be released back into shareholder equity over a very long period. This capital is not fungible but rather represents opportunity cost for pursuing other business. While in Canada the regulator permits both the CSM and RA to count as available capital, required capital remains, along with the cost of holding it. And it is the capital rules which determine remittances to shareholders.
Recent indications from the four largest public insurers in Canada suggest that new business CSM growth will be a significant performance indicator under IFRS 17.
Other elements of IFRS 17 need to be considered:
Strategically, VNB can be used to compare profitability across various product groups or lines, and this information is very helpful in decisions on capital allocations.
VNB is also a common measure for incentive compensation. In Canada, public company disclosures indicate that VNB forms in excess of 30% of annual incentive compensation. VNB is an unbiased way to put a number on the accretive value to an organization of adding new business.
We at WTW would be happy to discuss how we can assist you in developing a VNB tool for your new business to help inform management and to monitor and drive both performance and compensation. Please contact us.
