IFRS 17 discount rates (bottom-up and top-down)

An insurer discounts a liability of 1,000 payable in ten years: at 2.8% it is worth 759, at 3.2% 729. The 30 difference goes straight into profit or into equity, depending on the option chosen. IFRS 17 does not give the curve, it sets the characteristics it must have, in paragraphs 36 and B72 to B85: reflect the time value of money, the characteristics of the cash flows and their liquidity, be consistent with observable market prices, and exclude factors that do not affect those flows. Two methods are open to the entity. The bottom-up approach starts from a liquid risk-free curve, such as swaps, and adds an illiquidity premium reflecting the illiquid nature of the insurance liability. The top-down approach starts from the expected yield on a reference portfolio of assets and removes what does not concern the liability, credit risk and other elements. In principle, the two converge. In practice they give different curves, and judgment decides between them. Life insurers, who have the Solvency II curve and its volatility adjustment to hand, often take it as a starting point, but the standard has no ultimate forward rate or volatility adjustment: extrapolation beyond liquid maturities is for the entity's judgment, and two insurers with the same regulatory curve may discount differently under IFRS 17.