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This article was first published in the September 2017 Singapore edition of Accounting and Business magazine.

The profound changes to the accounting practices of Singapore insurers required by the new standard for insurance contracts make early mobilisation imperative

Although IFRS 17, Insurance Contracts, is not due to come into force until 2021, the insurance industry in Singapore has no time to lose to start preparing for its adoption.

In May, the International Accounting Standards Board (IASB) issued IFRS 17, the first truly international standard for insurance contracts. It will replace the current IFRS 4 as of 2021. Set to profoundly change the accounting practices of most insurers, the three-and-half-year timeline for implementation reflects the complexities the insurance industry will face to adopt this new standard.

The more robust standard is needed because IFRS 4 currently permits a wide variety of accounting policies, making it difficult to compare insurers’ financial performances around the world and with companies in other sectors. IFRS 17 aims to solve the comparison problems by requiring all insurance contracts to be accounted for in a consistent manner, which will benefit both investors and insurance companies.

IASB chairman Hans Hoogervorst says: ‘An insurance company will have to use updated information as opposed to historical information, and for that reason it will give investors a much more realistic insight where the insurance company stands, how it performs and what the risks are.’

Among its key changes, IFRS 17 requires a company to report earnings that reflect the service provided (rather than when it receives premiums) and to provide information about insurance contract profits that the company expects to recognise in the future. As such, estimates of future cashflows will be based on current assumptions rather than historic ‘locked-in’ assumptions.

Companies will need to distinguish between groups of contracts expected to be profit-making and those expected to be loss-making. Expected losses must be accounted for as soon as the company determines losses are to be expected.

Contract measurement

Singapore insurers have always used current information when measuring insurance contracts, but IFRS 17’s valuation method and profit recognition will be new, says Sumit Narayanan, partner at EY Singapore.

While some proposed disclosures are similar to current approaches, the valuation details, such as the discount rate and risk adjustment, may be different from what insurers in Singapore are using under the current risk-based capital framework, he adds.

Singapore insurers currently measure insurance contracts based on the value of their investment portfolios only if the investment component is distinctly separated from the insurance contract. The measurement of insurance contracts is always based on the obligations created by these contracts; sometimes, investment may be one component (for example, in the case of an investment-linked product).

While insurers currently have the option to voluntarily unbundle deposit components, it will be a requirement under IFRS 17, while new components have been added. The new standard requires embedded derivatives to be separated if they meet certain specified criteria, and there are distinct performance obligations to provide non-insurance goods and services. An investment component is deemed to be distinct if a contract with equivalent terms is (or could be) sold separately but not if the investment and insurance components are highly interrelated.

There is also currently no consistent requirement to provide information about the sources of profit recognised from insurance contracts. Not all companies currently provide alternative (non-GAAP) performance measures to supplement IFRS 4 information, such as embedded value information. ‘Typically only the largest ones publish embedded value information,’ Narayanan says.

Calculating the discount rate and risk adjustment will require new methodologies and considerable judgment on how to apply each one.

The three models

IFRS 17 offers three measurement models: a core measurement model, called the general model (also referred to as building block approach), the premium allocation approach (for contracts of less than one year), and the variable fee approach (for contracts with direct participation features).

The general model will be a challenge for Singapore insurers as it differs considerably from the current gross premium valuation method. The contractual service margin (a key metric for profitability and performance going forward) as well as the determination, and application of the discount rate on future cashflows may also be new concepts to Singapore insurers. Life insurers in Singapore have traditionally used the risk-free rate and there has been no requirement for general insurers to apply discounting.

‘In particular, insurers will have to spend significant amounts of time and effort assessing the impact from contractual service margins,’ Narayanan says. ‘The measurement of contractual service margin will be performed at cohort level rather than policy level. The insurer will apply professional judgment in defining the cohorts, which will have a direct impact on the profit pattern of the insurer’s profit and loss statement.

‘The key issue for insurers will be to define discount rates that reflect the characteristics of liability cashflows. It is difficult to find instruments that fully reflect insurance cashflows.’

While the premium allocation approach is similar to existing approaches for non-life insurance products, defining the contract boundary will be critical to analysing whether an insurer can use it for some contracts. Narayanan says: ‘Contract boundary is important because it will define the measurement model being used. A long-term contract means profits are smoothed and recognised over the lifetime of the policy whereas a short-term contract means profits are recognised in one year. The challenge for insurers is in products that exhibit both short-term and long-term features, which are typically seen in medical and hospital contracts.’

The implementation date of 1 January 2021 may seem a long way off, but the timescale will be a challenge for many, in particular because IFRS 17 will need to be applied retrospectively for all contracts in force at the transition date. Insurers will have to review their contracts and products in terms of product design (for contract boundary), cohort definition and profitability, Narayanan warns.

Even the bigger players might need until 2021 to get ready for the changes, to review contracts, quantify the impact and make accounting decisions before they get round to deciding on the tweaks required to their current systems.

Sonia Kolesnikov-Jessop, journalist