Introduction
The implementation of IFRS 17 has fundamentally transformed how life insurers approach asset liability management (ALM), particularly with respect to the contractual service margin (CSM) under the global accounting standard. As Canadian insurers navigate this new landscape, a critical strategic question has emerged: Should the CSM be supported by growth assets—typically measured at fair value through profit or loss (FVPL)—that maximize long-term returns but introduce short-term volatility and higher capital requirements, or by fixed-income assets managed under amortized cost or fair value through other comprehensive income (FVOCI) measurement, which provide earnings stability and generally lower capital consumption at the expense of yield?
This question is far from academic. With major Canadian insurers holding tens of billions of dollars in the CSM—representing deferred profits from insurance contracts—the choice of backing assets directly affects earnings volatility, capital usage, return on equity and, ultimately, shareholder value creation.
Throughout this article, references to assets “backing” CSM are economic and notional in nature. IFRS 17 does not require formal asset tagging or segregation. Instead, the discussion reflects management intent and balance-sheet sensitivities within an integrated portfolio framework.
A Dual Management Framework
An effective ALM framework under IFRS 17 can be viewed as operating through two complementary management approaches, each serving a distinct objective.
ALM optimization for fulfilment cash flows. Assets notionally supporting fulfilment cash flows are managed primarily to control interest rate risk that drives net income or other comprehensive income (OCI) volatility. Depending on the insurer’s accounting policy election, changes in discount rates affecting fulfilment cash flows are recognized either through profit and loss or through OCI. Regardless of classification, the core objective is to manage interest rate exposure efficiently while preserving overall financial performance.
Strategic asset allocation for capital and CSM. Assets notionally supporting capital and the CSM are managed predominantly through strategic asset allocation (SAA) decisions that address market risk rather than interestrate hedging. Interest rate-sensitive assets allocated to this bucket are typically classified as amortized cost or FVOCI to avoid introducing profit and loss volatility from interest rate movements. This allows management to focus on maximizing risk-adjusted returns and capital efficiency while maintaining accounting stability.
Together, these two lenses enable targeted risk management while supporting optimization across accounting, regulatory and economic measurement bases.
Backing CSM with Growth Assets: Accepting Volatility for Long‑Term Returns
The case for supporting the CSM with growth assets rests on a fundamental observation: the CSM represents deferred profits with long investment horizons. These profits are discounted using locked‑in rates set at contract inception and, as a result, are not directly exposed to interest rate risk. From an economic perspective, the CSM can therefore behave as patient capital.
Over long horizons, growth assets have historically delivered materially higher expected returns than traditional amortized-cost fixed-income portfolios, albeit with greater short‑term volatility and higher capital requirements. For insurers with large and stable CSM balances, this return differential can translate into meaningful improvements in long‑term return on investment and value creation, even after allowing for additional capital consumption.
The growth-asset universe spans public equities, private equity, real estate equity, infrastructure equity, and other alternatives such as hedge funds or insurance-linked securities. Each offers a distinct risk-return profile, liquidity characteristic and capital treatment. While outcomes vary across market regimes, these asset classes are commonly viewed as well-suited to long-duration capital that can tolerate interim volatility.
In practice, many large insurers already maintain significant exposures to such assets at the total balance-sheet level. While these holdings are not explicitly designated as CSM backing assets, they illustrate how long-horizon investment strategies can coexist with insurance liabilities. Internationally, some insurers explicitly discuss the notional support of the CSM by growth assets and emphasize normalized or underlying earnings measures to help investors look through short‑term market movements.
The principal trade-off is earnings volatility. Growth assets are generally measured at fair value through profit and loss, while the CSM remains valued with locked-in interest rates. This accounting asymmetry requires clear communication and disciplined risk governance, but experience suggests that markets can accept this volatility when the strategic rationale is clearly articulated.
Backing CSM with Amortized-Cost or FVOCI Assets: Stability and Predictability
An alternative strategy prioritizes earnings stability by supporting the CSM with amortized-cost or FVOCI assets. Under this approach, fair value movements driven by interest rate changes do not flow through net income, resulting in more predictable quarterly results.
The amortized-cost-asset universe for Canadian insurers typically includes government and high-quality corporate bonds held to maturity, private placements, corporate loans, commercial mortgages, policy loans, and certain forms of infrastructure debt. These assets generally provide lower expected returns than growth assets but offer stable income profiles and reduced earnings volatility.
Many Canadian insurers already hold large portfolios of such assets, particularly commercial mortgages and private placements, demonstrating that this approach is operationally scalable. Although these assets are not formally matched to the CSM, they can be viewed as economically aligned with long-duration capital objectives.
This strategy is often favored by organizations with a strong preference for earnings predictability, whether driven by investor expectations, internal risk appetite or regulatory considerations. The trade-off is opportunity cost: Foregone upside in exchange for stability.
Portfolio Evolution and Reinvestment Considerations
As the CSM amortizes over time and new business is written, insurers must actively manage reinvestment and portfolio composition to preserve their intended risk-return profile. Although IFRS 17 does not impose asset segmentation, changes in interest rate levels, business mix, and liquidity needs can influence realized outcomes.
Maintaining flexibility and forward-looking coordination between ALM and investment strategy is therefore essential to avoid unintended reinvestment drag or realized losses during portfolio rebalancing.
Capital Considerations
From a capital perspective, assets notionally supporting capital and the CSM introduce important trade-offs. Holding cash or very short-duration fixed-income assets is generally the most capital-efficient approach, as it minimizes both interest rate and market risk charges. Extending duration introduces interest rate risk capital requirements, while allocating to non‑fixed-income assets introduces market risk capital requirements.
As a result, strategies that reduce earnings volatility through longer-dated fixed-income assets may still increase capital usage, while strategies that enhance returns through growth assets increase both earnings volatility and market risk capital. These trade-offs should be explicitly analyzed and understood within the insurer’s stated financial objectives and risk limits.
Aggregate versus Separate Management of In‑Force and New Business
While IFRS 17 requires cohort-level measurement, insurers retain flexibility in how they design ALM and SAA processes. Some analyze in‑force and new business CSM separately to enhance transparency, while others manage them in aggregate to smooth results.
Aggregate management remains common, particularly where new business inflows offset in‑force runoff. The choice is operational rather than accounting-driven and is generally secondary to the broader dual ALM management framework.
Strategic Priorities
The appropriate CSM backing strategy depends on organizational priorities. In practice, these priorities are often evaluated in the following order:
- First, maximize financial performance across accounting, regulatory and economic measurement bases through integrated, forward-looking analysis.
- Second, optimize interest rate risk within approved risk limits, particularly where interest rate movements affect profit and loss.
- Third, optimize strategic asset allocation for assets notionally supporting capital and CSM, distinct from assets primarily used for interest rate risk management.
- Finally, where earnings stability is paramount, limit exposure to FVPL assets and emphasize amortized-cost or FVOCI assets consistent with the insurer’s business model under IFRS 9.
Conclusion
There is no unique solution for backing the CSM under IFRS 17. Growth-asset strategies and amortized-cost or FVOCI strategies can both be successful when they are aligned with an insurer’s risk appetite, reporting philosophy and stakeholder expectations.
Growth-asset approaches accept short-term volatility in pursuit of superior long-term returns. Amortized-cost approaches prioritize stability and predictability, trading upside for reduced volatility. FVOCI classification can serve as a hybrid, balancing transparency with income stability.
IFRS 17 enables clearer conceptual separation between fulfilment cash flow hedging and the management of capital and the CSM. Insurers that make deliberate, well-communicated choices within this framework—and that understand the associated trade-offs across earnings, capital and economic value—will be best positioned to create long-term value in the IFRS 17 environment.
This article reflects the opinion of the authors and does not represent an official statement of the CIA. This article is provided for informational and educational purposes only. Neither the Society of Actuaries nor the respective authors’ employers make any endorsement, representation or guarantee with regard to any content, and disclaim any liability in connection with the use or misuse of any information provided herein. This article should not be construed as professional or financial advice. Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers
Charles L. Gilbert, FSA, FCIA, CFA, CERA, is president of Nexus Risk Management. Charles can be contacted at charles.gilbert@nexusrisk.com.
Hélène Baril, FSA, FCIA, executive vice president of Nexus Risk Management. Hélène can be contacted at helene.baril@nexusrisk.com.