IFRS 4 to IFRS 17: How the Combined Ratio Actually Changes

The combined ratio is the single most-watched profitability metric for short-term insurance. Boards look at it, analysts model it, and internal performance targets are usually expressed in combined-ratio terms. The transition from IFRS 4 to IFRS 17 changes how the number is built — not dramatically in formula, but substantially in what each component represents.

Most of the IFRS 17 conversation has focused on the balance sheet: CSM, risk adjustment, LRC/LIC split. The income-statement mechanics have had less attention, and the combined ratio sits squarely in that less-examined territory.

1. The IFRS 4 Combined Ratio

Under IFRS 4, the combined ratio that most management teams and analysts used was the net ratio:

Combined Ratio (IFRS 4) = (Net Claims + Net Expenses) / Net Earned Premium

All three components sit net of reinsurance. Net claims equals gross claims less reinsurance recoveries; net earned premium equals gross earned premium less reinsurance ceded; net expenses equals gross expenses less reinsurance commissions received.

The appeal of the net construction is that it tracks the insurer’s retained economic position directly. A 92% net combined ratio is a clean statement: after reinsurance, the insurer’s retained book produced 8 cents of underwriting profit per Rand of retained premium.

The limitation is that the net construction obscures gross-book dynamics. Two insurers with identical 92% net ratios can have very different gross books, very different reinsurance structures, and very different sensitivity to reinsurance market cycles.

2. The IFRS 17 Combined Ratio

Under IFRS 17, the combined ratio Ageas and other large European short-term writers adopted is built as:

Combined Ratio (IFRS 17) = (Gross Claims + Gross Expenses + Reinsurance Result) / Insurance Revenue

Three components replace three components, but the construction is deeper:

• Gross claims is now the claims component of insurance service expenses on an IFRS 17 recognition basis — past-service claims in the LIC, plus the claims element of LRC movements.
• Gross expenses is the directly-attributable insurance expenses. Acquisition costs are spread across the coverage period under IFRS 17; they no longer hit the income statement all at once.
• Reinsurance result captures the net effect of outwards reinsurance — ceded premium allocation, recoveries, and the reinsurance equivalent of LIC/LRC movements — as a single line.
• Insurance revenue replaces earned premium. It is the release of expected premium receipts for services provided, adjusted for the release of risk adjustment and CSM as appropriate.

3. Worked Example

Take a short-term insurer with the following IFRS 4 income statement (simplified, in R millions):

IFRS 4 Line	Amount
Gross earned premium	1,000
Less: Reinsurance ceded	(200)
Net earned premium	800
Gross claims incurred	650
Less: Reinsurance recoveries	(130)
Net claims	520
Gross expenses	260
Less: Reinsurance commissions	(44)
Net expenses	216
Net combined ratio	(520+216)/800 = 92.0%

Restating the same portfolio under IFRS 17, assuming PAA eligibility and no material CSM movement on this book:

IFRS 17 Line	Amount
Insurance revenue	1,000
Gross claims (service expense)	650
Gross expenses (attributable)	260
Reinsurance result (net outflow)	26
IFRS 17 combined ratio	(650+260+26)/1,000 = 93.6%

The number moves from 92.0% to 93.6%. The underlying economics have not changed. What has changed is:

• Denominator shifts from net to gross. Moving from a denominator of 800 to 1,000 makes every percentage point of ratio a larger Rand number.
• Reinsurance recognition is symmetric. Under IFRS 4 the reinsurance-to-gross relationship was implicit in the netting. Under IFRS 17 it is an explicit reinsurance result line, and the net effect (here 26) is the sum of ceded premium allocation, recoveries and any asset/liability movement.
• Acquisition cost profile differs. For a growing book, IFRS 17’s coverage-period spreading of acquisition costs produces a lower claims-and-expenses numerator than IFRS 4’s upfront recognition, all else equal — but the effect reverses as the book stabilises.

4. Why Management Targets Need to Be Re-Baselined

A 92% target under IFRS 4 is not a 92% target under IFRS 17. The ratios are measuring different things against different denominators, and the differences are not a simple additive offset — they depend on:

• Reinsurance structure. Heavier use of proportional reinsurance widens the gap between IFRS 4 net ratios and IFRS 17 gross-equivalent ratios, because the denominator change is bigger.
• Growth trajectory. Rapidly growing books see a timing benefit from IFRS 17 acquisition-cost spreading that rapidly-shrinking books do not.
• Onerous contract recognition. Groups identified as onerous at initial recognition under IFRS 17 produce a loss component that affects the combined ratio differently than the IFRS 4 treatment of the same loss.

The practical implication is that any KPI expressed as a combined-ratio threshold — a board bonus target, a rating-agency trigger, a reinsurance placement benchmark — has to be re-expressed on the IFRS 17 basis with an explicit walk showing the reconciliation. Quietly carrying the old target forward without restatement is the failure mode. Analysts will spot it and ask why.

5. Sector-Level Insights That Become Possible

There is a second, more interesting consequence of the IFRS 17 combined-ratio construction. Because every insurer now discloses insurance revenue, gross claims, gross expenses and reinsurance result on the same basis, cross-firm comparison becomes possible in ways it was not under IFRS 4.

Under IFRS 4 the “net ratio” for insurer A and insurer B could differ for structural reasons that had nothing to do with underwriting quality — different retention ratios, different commission structures, different definitions of attributable expense. Analysts spent real time trying to normalise these differences and usually gave up.

Under IFRS 17, the disclosed gross-basis components make normalisation much easier. Sector aggregates begin to carry meaning. The effective loss ratio on primary underwriting, the absolute Rand cost of reinsurance, the directly-attributable expense ratio — each is now comparable across firms in the same market.

For the South African short-term market, that means the next few years of annual-report reading will expose variances that were hidden inside IFRS 4 net ratios. Those variances are not surprises in the economic sense — they were always there — but their visibility will change how boards and regulators engage with the sector.

6. What to Do

Three items sit on the finance-function checklist for the first full year of IFRS 17 combined-ratio reporting:

1. Build the reconciliation once. The walk from the old IFRS 4 net combined ratio to the new IFRS 17 combined ratio is the most-asked question from boards and analysts. Build it once, well, and include it in every investor pack and internal MI.
2. Re-baseline every downstream target. Bonus plans, reinsurance placement thresholds, rating-agency triggers. The basis change affects all of them.
3. Track the sector. The disclosure harmonisation IFRS 17 forces will change the competitive analysis. Firms that read the sector data well will gain a commercial advantage; firms that stick with the old metrics will miss it.

The combined ratio is not harder under IFRS 17. It is different. The firms that handled the transition well are the ones that treated the ratio change as a management-reporting event in its own right, rather than as a by-product of the balance-sheet restatement.