The long awaited IFRS 17 on Insurance Contracts was issued by IASB on May 18th, 2017. This is the first comprehensive IFRS standard on Insurance Contracts to help investors and users of “Insurance companies” financial statements better understand insurance risk exposure, profitability and financial position. The effective date for compliance is the 1st January 2021.
The following categories of businesses are impacted by the requirements of IFRS 17
- Listed Insurance companies
- property and casualty insurers;
- Life and health insurers;
- Multi-line insurers; and
- Unlisted insurance companies using IFRS Standards, including, for example, mutual insurers.
- Banks and investment companies with significant insurance operations, such as banking groups with insurance subsidiaries, their insurance operations will be affected by IFRS 17 in the same way that insurers with the same operations will be affected.
The standard is NOT expected to significantly affect Non-Financial companies that provides insurance services.
This article attempts to highlight and summarise the practical implications of IFRS 17 compliance and is based on the authoritative “Effects & Analysis” paper issued by IASB following the release of the standard.
High Level Narratives of IFRS 17 Requirements:
- IFRS 17 sets out the requirements that a company must apply in reporting information about insurance contracts. It substantially retains the scope of IFRS 4, so, essentially, the new requirements affect the same population of contracts accounted for when applying IFRS 4. Like IFRS 4, IFRS 17 does not apply to insurance contracts in which the company is the policyholder; the only exception is when those contracts are reinsurance contracts.
- The standard applies to:
- insurance contracts issued
- reinsurance contracts held or
- investment contracts with discretionary participation features issued.
- Under some circumstances, the standard requires a compliant organisation to separate the non-insurance components from an insurance contract if a separate contract with the same features would be within the scope of another IFRS Standard, and account for those non-insurance components by applying that other IFRS Standards. (i.e. IFRS 9 & 15 where applicable).
- IFRS 17 defines recognition of “insurance contracts” from a grouping perspective. It establishes the fulfilment cash flow and contractual service margin (CSM) measurement approaches for initial and subsequent measurements of contracts. Separate measurement approach “variable fee approach” (VFA) is required for subsequent measurement of contracts with direct participation. Finally, the standard lays out specific disclosure requirements within various sections of published financial statements including Profit & Loss Account, Statement of Comprehensive Income, Balance Sheet, and Notes to Accounts.
Financial & Regulatory Reporting Impacts on Companies.
In general, IFRS 17 is expected to have a relatively minor change on the accounting and reporting for many short-term insurance contracts. E.g. Property & Casualty. In contrast, a greater change is expected in the accounting by many companies for long-term insurance contracts. E.g. Life Assurance
- Effects on the balance sheet. This can be observed at 3 levels.
- The measurement of insurance contracts;
- The presentation of insurance contracts; and
- The reported equity when first applying IFRS 17.
When IFRS 17 is first applied, it is likely that the amount recognised on the balance sheet for a company’s insurance contract assets and liabilities will change. The change for a company will depend on how different the existing accounting policies are from IFRS 17. Additionally, balance sheet effects are determined by the nature of the contracts whether it is short-term and long-term insurance contracts.
- Effects on the statement of comprehensive income. This will be evidenced at 4 levels.
- Presentation of premiums. There is a new concept of “insurance revenue” in their statement of comprehensive income. This item will replace items variously described as “premium income”, “written premiums” or “earned premiums” in their existing statement of comprehensive income. Determination & presentation of “Insurance revenue” will be consistent with the approach in IFRS 15 for the recognition of revenue from contracts with customers. Consistently with that approach, the insurance revenue recognised will reflect the amount that the company expects to receive for the services it has provided in the period (such as the provision of insurance coverage). Currently, many insurers present premiums for long-term insurance contracts separately from premiums for short-term insurance contracts. This is because they are typically accounted for using different accounting policies. In contrast, when applying IFRS 17, insurance revenue will be measured using the same approach for all types of insurance contracts. Consequently, insurers will be able to present insurance revenue in a single line in their statement of comprehensive income.
- Presentation of insurance finance expenses. For most companies that choose to present the effect of changes in discount rates in other comprehensive income, this presentation will differ from the existing presentation of such changes, if they are recognised. When applying some existing insurance accounting practices, some companies measure insurance contracts on a discounted basis using updated discount rates and present such changes in profit or loss. Others do not update the discount rates and others do not discount. When applying IFRS 17, interest accreted on insurance contracts (insurance finance expenses) will be presented together with the return on the related investments as part of a new metric called “insurance service result”.
- Recognition of the contractual service margin and of the risk adjustment. The principles applied when determining the recognition of the CSM in profit or loss and of the change in the risk adjustment will have a direct effect on the amounts recognised by a company in its statement of comprehensive income in each reporting period.
- Total amounts recognised in profit or loss. The total profit or loss of a group of insurance contracts is the difference between total cash inflows and outflows arising from the contracts. Whereas IFRS 17 does not change the total profit or loss of a group of insurance contracts recognised over the duration of the contracts, it changes the amounts recognised in each reporting period and how the components of the profitability of the contracts are disaggregated in the statement of comprehensive income.
- Effects on note disclosures; Notes provided about insurance contracts are fundamental to an understanding of:
- The amounts recognised and measured; and
- The risks arising from insurance contracts.
Although companies are required to use judgement in an equivalent way as they would in applying IFRS 4, in determining what information is material (and hence needs to be disclosed) and the level of detail necessary to satisfy the above disclosure objectives, the transition to IFRS 17 will provide a company with an opportunity to reassess the level of detail that is necessary to satisfy the disclosure objective. Some companies might conclude that, to meet the disclosure objective in IFRS 17, they need to present some of their disclosures on a more disaggregated level than they currently do. Additionally, IFRS 17 requires “transition disclosures”. These will supplement the disclosures required by IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors that apply on the application of all new IFRS Standards
- Effects on key financial metrics; As IFRS 17 is expected to increase the comparability, relevance and consistency in the financial information presented by insurers, it is likely to lead to the introduction of new financial performance measures, and to a reduction in the number of non-GAAP measures reported. Some anticipated KPI’s will include:
- Contractual Service Margin (CSM). Required disclosures on the contractual service margin initially recognised in the period will provide a measure of the value added from new contracts that might, over time, replace “new business performance” measures currently provided by some insurers.
- Combined Ratio. A key profitability measure typically reported by companies issuing short-term insurance contracts is the combined ratio (i.e. incurred claims and operating expenses expressed as a percentage of earned premiums). Since companies typically measure incurred claims on a different basis when applying IFRS 4, IFRS 17 is expected to affect this key financial ratio. It is expected that the combined ratio will continue to be a key ratio for short-term insurance contracts, but that it will be calculated using the IFRS 17 measurement for incurred claims.
- Interaction with IFRS 9. The introduction of current measurement for the accounting for insurance contracts may lead some companies to change how they manage their assets. This change may in turn change a company’s business model for managing financial assets in accordance with IFRS 9. For example, when applying IFRS 17, an insurer may need to address mismatches between the carrying amounts of assets and liabilities, by measuring some financial assets – eligible for measurement at amortised cost or at fair value through other comprehensive income – at fair value through profit or loss, using the fair value option in IFRS 9. Consequently, the transition requirements of IFRS 17 address how to deal with those potential changes. IFRS 17 enables, but does not require, insurers to reassess the classifications of their financial assets based on facts and circumstances that exist when first applying IFRS 17. Additionally, the three-year implementation period between the issuance of IFRS 17 and its effective date is expected to be adequate for companies to consider the combined effects of applying IFRS 9 and IFRS 17. A timely analysis by companies of the requirements of the two IFRS Standards is expected to allow companies sufficient time to implement changes in asset portfolios, if necessary and desired.
- Interactions with regulatory framework. There are some similarities between Solvency II and IFRS 17 requirements, such as using (a) estimates of future cash flows; (b) discount rates consistent with current rates in the financial markets; and (c) adjustments for risk. As a result, companies that have recently implemented new regulatory requirements demanding information like that needed to apply IFRS 17, such as Solvency II, are expected to have recently changed their systems and processes. Because of the investments made in new systems and processes and the potential for synergies with IFRS 17 in areas such as data collection, modelling systems and reporting lines, it is expected that companies required to comply with Solvency II requirements or other similar prudential regimes will use systems and processes already in place as the starting point for IFRS 17 implementation. Nonetheless, those systems and processes are expected to require some additional developments to meet the requirements of IFRS 17. The following elements of IFRS 17 illustrate the key differences between IFRS 17 and Solvency II: (a) the requirement to calculate and maintain a contractual service margin, except when the simplified approach is used; (b) the requirement to calculate the insurance revenue measure; and (c) the need to analyse movements in fulfilment cash flows between those that will be presented in profit or loss, those that will be presented in other comprehensive income and those that will be offset against the contractual service margin.
- Effects on the Insurance markets. IFRS 17 is not expected to affect insurance products if, in applying IFRS 4, insurers price and design contracts based on an accurate assessment of their underlying economics. However, additional information that will become available to management from applying IFRS 17 is expected to provide more insight into the profitability of insurance contracts issued and the extent to which assets and liabilities are economically matched. IFRS 17 also requires collaboration, understanding and consistency across the actuarial, risk and finance functions. Consequently, it is expected that some companies will re-examine their insurance activity because of applying IFRS 17. This may result in changes to the features of products offered. Nonetheless, these changes (if there are any) are expected to be the result of informed business decisions, rather than motivated solely by accounting outcomes.
Required Actions – Implementation Investment Considerations
To successfully implement and sustain IFRS 17 requirements on an annualised basis, companies are expected to significantly invest in project and functional resources at 2 levels.
- Level 1: Investment costs required to deliver IFRS 17 requirements for effective date (January 2021). These are expected to be primarily incurred by:
- Companies required to comply with the provisions of IFRS 17 & to a lesser extent
- Other stakeholders including Investors & Analysts as well as regulators & tax authorities.
- Level 2: On-Going delivery costs of revaluation and measurement of insurance contracts at subsequent reporting dates, by companies.
Companies Investment in IFRS 17 Implementation.
Major investments by companies to implement IFRS 17 are expected in the following areas:
- Project design and implementation. IFRS 17 implementation is expected to be carried out by project teams comprising individuals with accounting, actuarial and systems knowledge and experience. The extent of available resources is expected to affect implementation costs for companies. Those insurance companies that have used less rigorous and less sophisticated measurement techniques for management, prudential or financial reporting purposes may have a greater need to employ and develop additional people with appropriate skills.
- Systems set-up. Companies are expected to incur costs in setting up systems to obtain, store and analyse the information needed to apply IFRS 17. It is expected that companies will need to set up systems to:
- Provide & analyse data at sufficient level of granularity and to identify and maintain consistent groups of contracts.
- Track information about inception dates and the coverage period of those groups of contracts;
- Determine the CSM, accrete interest on the CSM and recognise the CSM for each group of contracts in profit or loss; and
- Store information about historical, current and future cash flows, about discount rates and about risk adjustments for each group of contracts.
Costs of implementing or modifying systems will vary depending on the type of information currently collected and produced for management, prudential or financial reporting purposes.
- Process changes. Significant process changes will be required to deliver IFRS 17 recognition, measurement and disclosure requirements. The following process changes and improvements are unavoidable:
- High level of integration between finance, actuarial and risk processes. Data extracted from source systems will typically be included in actuarial and risk systems. The resulting valuations will then be recorded in a company’s accounting system. The reason for this expected integration, is because of IFRS 17 requirement to measure insurance contracts issued to reflect probability-weighted cash flows, as well as the timing and the risk of those cash flows.
- Alignment of reporting processes with the new requirements for the balance sheet and the statement of comprehensive income. The new disclosure requirements introduced by IFRS 17 (concerning, for example, estimation approaches and risk information) are also expected to require changes to a company’s reporting processes.
- The adoption of any new process for financial reporting is expected to require the design and testing of controls and governance to ensure the quality of a company’s reporting infrastructure.
- Creation of actuarial techniques to determine: (a) probability-weighted cash flows arising from insurance contracts; (b) discount rates reflecting the characteristics of those cash flows; and (c) risk adjustments reflecting the uncertainty in timing and amount of cash flows.
The effects of IFRS 17 on a company’s finance and actuarial processes will depend on many factors, including: (a) the company’s existing reporting basis for insurance contracts; (b) the complexity and maturity of the company’s business; (c) whether the company has recently undergone a major finance transformation and (d) whether information like that required by IFRS 17 is already required to be produced (for example, for regulatory purposes).
- Alignment of accounting manuals and guidance provision to local accounting teams for multinational Insurance companies.
- Creation of an assessment process to evaluate contracts to ascertain if they meet the criteria needed for (a) insurance contracts with direct participation features, applying the “variable fee approach” or (b) use a simplified approach to measure some short-term insurance contracts.
- Education and communication.
- Companies with significant insurance operations will incur costs in educating internal stakeholders and updating internal procedures. For companies that view IFRS 17 as a fundamental change to insurance accounting practices currently applied, management & staff training is expected, to understand the new concepts of IFRS 17.
- Companies will incur costs in communicating significant changes to their reported information to external parties (for example, to the investor community). These are one-off costs when first reporting on IFRS 17 requirements.
- As with any new IFRS, when first applying IFRS 17, companies are expected to distinguish the effect of movements caused by changes in accounting policies from those related to underlying business performance in explanations to management and users of financial statements. Companies may therefore incur costs in making such a distinction.
Other Stakeholders Investment in IFRS 17 Implementation:
The extent of differences between existing insurance accounting practices and IFRS 17 is likely to affect the costs for users of financial statements. Users of financial statements will need to distinguish between:
- Changes caused by new accounting requirements as opposed to economic differences that have arisen; and
- Differential effects on different insurers, in the light of the characteristics of their insurance contracts.
Aside from these anticipated costs, the level of transparency, disclosure details and degree of accuracy required for IFRS 17 reporting, will reduce “analysts” costs of interpreting Insurance companies’ financial reports going forward.
Regulators and tax authorities are expected to incur costs relating to IFRS 17 if their respective requirements depend on financial reporting requirements. This is because they may need to consider the effect on their requirements of any change in accounting, including changes introduced by IFRS 17. Nonetheless, the use of consistent accounting policies for accounting for insurance contracts is expected to reduce the costs of analysing differences between financial reporting data and regulatory or tax reporting data of insurance companies that may be currently incurred by regulators and tax authorities.
On-Going Annualised Investments:
Ongoing costs are expected to arise from gathering the information needed to:
- Update the assumptions required to measure insurance contracts on a current basis. To achieve this companies will need to:
- Maintain data from previous periods;
- Gather actuarial information in a timely way so that assumptions are updated at each reporting date;
- Run actuarial models; and
- Analyse changes since previous periods, splitting: (i) changes related to previous and current coverage; from (ii) changes related to future coverage.
These costs of re-measuring insurance contracts will arise mainly for long-term insurance contracts. In addition, contracts with options and guarantees will be more affected than other contracts
- Adjust the contractual service margin (CSM). When applying IFRS 17, a company will typically measure the contractual service margin at a group level. This means that many companies will need to run systems to collect more granular information than they currently do, to group contracts, thereby incurring some incremental costs.
- Provide disclosures, particularly about movements in the insurance contract assets and liabilities. Once a company has set up systems to provide the disclosures required by IFRS 17, the main ongoing cost to arise from the analysis of information provided by those systems. The costs of applying the disclosure requirements in IFRS 17 will depend on:
- The characteristics of a company’s insurance contracts;
- Systems used to collect information to be disclosed; and
- Whether processing of information about insurance contracts is decentralised within subsidiaries.
Higher costs will be incurred by companies that have many groups of contracts, that do not use integrated systems on an ongoing basis and that need to collect information about insurance contracts from their subsidiaries. Companies are expected to determine which disclosures -both nature and extent – meet the needs of users of their financial statements.
Effective date and next steps
IFRS 17 takes effect for annual reporting periods beginning on or after 1 January 2021. Although IFRS 9 is effective from 1 January 2018, some insurance companies can elect to continue to apply IAS 39 (Financial Instruments: Recognition and Measurement) until 1 January 2021 and then apply IFRS 9. This is to allow the transitional arrangements of changes required by IFRS 9 to be applied at the time of IFRS 17 transitional applications.
Although 2021 seems a long way off, implementation activities may involve considerable time and effort if a company chooses to run parallel systems and processes to understand detailed differences between IFRS 17 and IFRS 4 data and perform consistency checks for a few years. To achieve this target IFRS 17 planning sessions will need to be considered effectively from 2017.
In conclusion, the financial and accounting impacts of the new standard will ensure finance departments are kept busy well ahead of 2021. Early planning is essential given the broader business impact of IFRS 17. It is also advised that specialist advise is sought where necessary.