Monday, July 28th, 2025
IFRS 17 · Insurance Liabilities · Actuarial Practice
The methodology choices companies make when setting discount rates under IFRS 17 carry material consequences for reported liabilities, P&L volatility, and long-term comparability across the industry.
By Michael Winkler, Actuary (SAA/DAV), Shasat Consulting | Sunil Kansal, Head of Consulting, Shasat | 28 July 2025
| 42% of insurers use same or similar rate as EIOPA |
58% use a higher discount rate than Solvency II |
30 yrs typical EUR last liquid point used in practice |
Bottom-Up dominant methodology used by most insurers |
A sum of money currently available has a greater value than the same sum to be paid in the future — due to its earnings potential in the interim. This so-called “Time Value of Money” is a core principle of finance which is also reflected in IFRS 17. The concept of discounting future cash flows was not consistently applied under previous standards — many non-life insurers deliberately avoided discounting claims reserves to include a conservative margin. IFRS 17 changes this fundamentally: discounting is now consistently required for all long-term cash flows.
According to IFRS 17, appropriate discount rates shall reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts. They must be consistent with observable current market prices for financial instruments with comparable characteristics, and must exclude any factors influencing market prices that do not affect the future cash flows of the insurance contracts.
Under Solvency II, the Matching Adjustment enables insurers to adjust the risk-free interest rate used for discounting specific long-term insurance liabilities, incorporating the illiquidity premium associated with holding less liquid assets aligned with liability cash flows. In contrast, IFRS 17 does not impose explicit restrictions on the selection of the reference portfolio — insurers have the flexibility to utilise their own asset portfolios, provided the resulting discount rates appropriately reflect the characteristics of the insurance contracts and are consistent with observable market data.
Similar to the Volatility Adjustment in Solvency II, discount rates can also be derived by starting from risk-free rates and adding an allowance for illiquidity. This gives rise to two primary approaches.
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Approach 1 Top-Down Based on a yield curve that reflects current market rates of return implicit in a fair value measurement of a reference portfolio of assets, adjusted to eliminate any factors not relevant to the insurance contracts. Starting from a portfolio yield (e.g. 5.5%), credit risk adjustments are deducted to arrive at the discount rate (~4.0%). |
Approach 2 Bottom-Up Based on adjusting a liquid risk-free yield curve to reflect the differences between the liquidity characteristics of financial instruments underlying risk-free market rates and those of the insurance contracts. Starting from the risk-free rate (e.g. 3.25%), a liquidity premium (e.g. 0.5%) is added (~3.75%). |
Most companies use the bottom-up approach — in many cases very closely aligned to the Volatility Adjustment used in Solvency II. However, there are notable exceptions. Aegon has generalised both approaches into one unified direct discounting technique where discount rates equal the risk-free rate plus a percentage of the product-specific illiquidity premium. Aviva and Phoenix (UK) use the top-down approach for annuities, where they also apply the Matching Adjustment under Solvency II.
Cash flows that vary based on the returns on any financial underlying items — for example, when applying the Variable Fee Approach (VFA) for direct participating business — shall be either discounted using rates that reflect that variability, or adjusted for the effect of that variability and discounted at a rate that reflects the adjustment made.
The first option is analogous to a real-world valuation framework, using asset-based discount rates that reflect the rates of return on the underlying items. The second option permits a risk-neutral framework where risk-free rates are used both to project the underlying items and to discount the cash flows — relying on mathematical relationships within and among financial instruments.
A notable challenge faced by many insurers is the duration and yield mismatch between own portfolios and market-referenced portfolios, where long-dated liabilities are paired with medium-term matching assets. The application of a liquidity premium based on the entity’s own portfolio can lead to meaningfully different outcomes depending on the nature of the assets held.
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Scenario 1 Illiquid High-Yield Assets If the insurer holds highly illiquid assets with long-term horizons, these typically offer yields and coupons significantly above market averages. The discount rate applied to insurance liabilities would be higher, leading to lower reported liabilities. |
Scenario 2 Low-Yield Assets If the insurer has invested in low-yield assets in a high-interest-rate environment, the discount rate would be lower, resulting in higher reported liabilities. Currency and term mismatches amplify this further in annuity and whole-of-life portfolios. |
The Canadian Institute of Actuaries has issued an Educational Note on how to derive IFRS 17 discount rates in practice.1 The process involves four key stages: establishing the last observable point on the yield curve using quoted prices from active markets; setting the ultimate risk-free rate with more weight on long-term estimates than short-term fluctuations; setting the liquidity premium to reflect the characteristics of the insurance contracts; and determining discount rates for products where cash flows vary with an underlying item.
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Desirable Characteristics of the Long-Term Discount Curve Stability — The ultimate interest rate should be more stable over time, with long-term rates expected to show lower variability than short-term rates. Smoothness — Interpolated rates should follow a smooth path from the last observable point to the ultimate long-term rate, avoiding artificial jumps. Simplicity — The approach should be straightforward to understand, audit, and implement consistently across reporting periods. |
Setting the liquidity premium is not straightforward. Market-based techniques use the spread difference between covered bonds and risk-free bonds in the same currency. However, due to missing liquidity and longer-term durations, this approach may not be feasible in many markets. Most European companies base their IFRS 17 discount rates on Solvency II discount rates, using Euro market rates up to 30 years — in contrast to EIOPA rates where extrapolation to the ultimate forward rate starts much earlier.
In many developing markets, companies struggle entirely. Risk-free rates may not exist, and the longest available duration may be a few years or less. The only viable reference point is the long-term investment return the company can achieve, with a deduction for unexpected losses. Countries whose currency is pegged to the USD are an exception — companies there typically use those rates as a starting point.
For each accounting period, discount rates must be updated in line with market movements, as IFRS 17 requires the use of current assumptions. For long-term liabilities, this can have a significant impact on the time value of money and on the fulfilment cash flows. Companies can determine in their accounting policy whether the effect of changes in market discount rates is recognised in P&L or in Other Comprehensive Income (OCI) — in the latter case with interest accrued to P&L at the discount rate locked in at inception.
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“At first glance, OCI seems the better choice, as discount rate volatility should not distort the P&L. However, the change in fair value of some assets — particularly those used for interest rate hedging — always flows through P&L. A careful analysis is essential before making this election.” |
In the Solvency II environment, EIOPA-published discount rates are a natural reference point. According to an EIOPA survey, 42% of respondents reported using the same or almost the same rates, with the remaining 58% using — in most cases — a higher discount rate than Solvency II.2 58.5% use the same risk-free rate as Solvency II; for those not, the most relevant differences are a more remote last liquid point (e.g. 30 years for EUR) and a different ultimate forward rate.
Analysis of 2024 annual reports reveals consistent patterns. In developing markets with local currencies pegged to USD, companies normally use USD rates with a particular uplift. Many companies vary discount rates by product type — rates for annuities in payment are typically significantly higher than those derived from the backing asset portfolio yield. Many companies use different rates for the General Measurement Model and the VFA, with VFA rates being more conservative. EUR spreads over EIOPA risk-free rates are broadly constant across durations but drop beyond 20 years — an artefact of extrapolation methods rather than genuine market signals. USD spreads tend to increase with duration across most companies.
Some companies chose initially to use average rates for their interest-sensitive business that were not accurately reflecting the actual pricing rates for the various cohorts. This appeared to be a reasonable simplification given the administrative burden of maintaining multiple yield curves. However, many found that a significant number of cohorts turned onerous despite having reasonable pricing margins in reality.
We would therefore highly recommend analysing the quantitative impact of any simplifications at the earliest possible stage — before they become embedded in reporting processes and create downstream compliance and restatement risk.
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Michael Winkler Actuary (SAA/DAV) at Shasat Consulting. Previously in leading actuarial positions at Swiss Re, Munich Re/New Re, and Winterthur Group. |
Sunil Kansal Head of Consulting at Shasat. Chartered Accountant and Fellow of the Institute of Chartered Accountants in England and Wales (ICAEW). |
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1 Canadian Institute of Actuaries: Draft Educational Note / IFRS 17 Discount Rates for Life and Health Insurance Contracts, June 2020 2 EIOPA: “IFRS 17 – Insurance contracts report”, April 2024 |
Tags: IFRS 17 · Discounting · Insurance Liabilities · Actuarial Practice · Solvency II · Risk Adjustment · OCI Election · Shasat
