IFRS 17 will present many challenges for insurance companies. Dermot O’Hara FCCA outlines some of the issues facing companies in preparing for the new standard
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This article was first published in the January 2018 Africa edition of Accounting and Business magazine.
The new accounting standard for insurers, published in May last year, establishes principles for recognition, measurement, presentation and disclosure for insurance and reinsurance contracts, and investment contracts with discretionary participation features provided the entity also issues insurance contracts.
IFRS 17, Insurance Contracts, is a significant change to accounting requirements and will require companies to change their financial reporting processes and systems, actuarial models, financial statements, and business planning and forecasting models.
The key to a successful transition involves engaging with all stakeholders, putting a project implementation plan in place and developing an early understanding of the key issues.
First, you need to understand your insurance contracts. The general consensus is that the project will be more complex for life insurance and life reinsurance companies than non-life companies, as non-life companies will typically be able to apply the premium-allocation approach. However, this will not be the case universally.
To understand the impact on your company you will need to review all of your existing contracts, their terms and conditions, and economic substance. For example, certain participating contracts may fall into the variable-fee approach, but others may be classified as indirect participating contracts and require the building-block approach.
If contracts have separate insurance components (such as embedded derivatives and investment components), then these will need to be unbundled. You will also need to assess contract boundaries. The definition of contract boundaries under IFRS 17 generally starts with the earlier of the start of the coverage period or the first premium payment and continues until the contract expires.
Solvency II defines contract boundaries as the point where an insurer can terminate the contract, refuse to accept a premium or amend the benefit or premium without limit. As a result, some non-life insurance contracts, for example, are potentially recognised as 13-month contracts under Solvency II, but as 12-month contracts under IFRS 17.
Groupings and data
The contract grouping in IFRS 17 is different from the current standard. While companies will continue to group contracts into portfolios with similar risks that are managed together, there are additional requirements in IFRS 17. These are that contracts should be grouped into those that are issued in the same 12-month period and should be split into a minimum of three separate profitability groups (onerous at recognition, no significant possibility of becoming onerous when assessed at recognition, and remaining contracts).
This enhanced contract grouping presents big challenges for life insurance companies. Life insurers have complex actuarial models for projecting forward expected future cashflows, using assumptions for future expected experience (eg investment returns and mortality rates) and discounting the cashflows to current terms to calculate the liability. The data used in these models is typically not currently split using the 12-month grouping requirement.
Companies may therefore need to change the way their historical data is aggregated and potentially change their data capture and analysis going forward to ensure that they meet the contract grouping requirements.
Their projection models may also need to be enhanced and potentially be rewritten. A detailed review of assumptions may be required to ensure that assumptions are available and applied within projection models at the new contract grouping level.
The successful implementation of IFRS 17 will require close collaboration between finance, actuarial and IT functions within the company.
Once new models have been built, tested and reviewed, companies will be in a position to determine the expected impact of IFRS 17 on their financial statements.
One of the key impacts of IFRS 17 is that profit will be recognised over the term of the contract. On transition, this could potentially lead to the creation of an additional liability for future expected profits, which could in turn lead to a reduction in shareholder funds on transition. Companies should consider this potential impact when making decisions around dividends and capital during the implementation period.
Early implementation of IFRS 17 will enable companies to apply the new accounting standard to their financial planning cycle, which will provide valuable insight into their projected profit and financial position before 2021.
Depending on the impact, companies may have to consider redesigning the features of some of their products. They should also consider any potential taxation impacts on transition and the interaction with IFRS 9, Financial Instruments. Early engagement with the company’s auditor on approaches adopted is essential to achieve a successful implementation.
IFRS 17 introduces a number of changes to the language of insurance accounting. The income statement will be very different from what stakeholders are used to. Revenue will include items such as changes in the contractual service margin, and this will make comparisons with historical accounts difficult. Companies will have to invest substantial time educating and preparing their stakeholders for these changes.
IFRS 17 is effective for annual periods beginning on or after 1 January 2021. For European Union (EU)-listed entities there is uncertainty as to when the standard will be endorsed. The European Financial Reporting Advisory Group (EFRAG) needs firstly to issue endorsement advice, currently expected in Q3 2018. Other EU bodies will then decide on endorsement and final publication; however, this can take substantial time.
Dermot O’Hara FCCA, director of actuarial services, Mazars, UK
"Its successful implementation will require close collaboration between finance, actuarial and IT functions"