Risk adjustment under IFRS 17: An adaptation of Solvency 2 one-year aggregation into an ultimate view framework

The standard IFRS 17 introduces a risk adjustment (RA) to reflect the compensation the insurance entity requires for bearing the uncertainty associated with nonfinancial risks. The risk adjustment is one of the main components in IFRS 17 disclosures and is a factor that impacts strongly IFRS 17 P&L and balance sheet as well as their evolution over a time horizon. IFRS 17 does not prescribe any specific techniques for calculation methodologies; insurance entities are free to adopt their own assessment while meeting several qualitative rules to ensure their consistency. This paper focuses on the recommendations of paragraph §B88 stating that the risk adjustment is required to reflect the diversification benefit of bearing the risk. We suggest a method for aggregating elementary RA (per risk and/or per Line of Business) based on the Solvency 2 elliptic aggregation. We introduce the concept of ultimate correlation as opposed to Solvency 2 one-year correlation and provide a theoretical bridge between both depending on a time diversification parameter. We explore correlation structures involving this time diversification and discuss analytical properties in terms of possible correlations values and the resulting impact on the aggregated RA features