InsuranceERM gets the lowdown from the industry on what it means for the sector" />

This site uses cookies. By continuing to browse the site you are agreeing to our use of cookies. Find out more here

IFRS 17 compliance: a task comparable with Solvency II?

Published in: Risk, Risk management, Solvency II, IFRS 17

Companies: International Accounting Standards Board, EY, Deloitte, Willis Towers Watson, Grant Thornton, FIS, PwC, Milliman

IFRS 17 has been described as a "landmark shift" in insurer accounting and some are saying that implementation could require more work than was needed for Solvency II. InsuranceERM gets the lowdown from the industry on what it means for the sector

The International Accounting Standards Board (IASB) has published the IFRS 17 standard on accounting for insurance contracts today (18 May), giving underwriters around three and a half years to deal with a revolution in accounting practices.

“This standard represents the most significant change to insurance accounting requirements in 20 years,” says Martin Bradley, risk and actuarial leader at consultancy EY.

IFRS 17 aims to provide a single standard for accounting that will be useful to investors and insurers alike. It replaces the IFRS 4 standard that allowed a “myriad of accounting practices”, according to IASB chairman Hans Hoogervorst.

But the industry is fearful of the cost required to implement the new standard and some are comparing the challenge to that presented by Solvency II. The IASB has not attempted to quantify the cost, but asserts that the benefits of the transition, in terms of improved reporting, are expected to outweigh the expenditure.

InsuranceERM has prepared this Q&A to explain the changes ahead.

Who will be affected?

More than 120 countries use IFRS standards and insurers in Asia and Europe will be most impacted. This includes large listed insurers, which must report under IFRS, as well as many more that do so voluntarily.

The big exception is the US, which will remain under US GAAP accounting

According to IASB analysis, it will affect at least 449 listed insurers with $13.3trn of assets, and a further 46 unlisted insurers.

The scope also extends to other financial services, such as banks with equity release contracts.

The IASB is not a regulator, so it’s up to each country to endorse the approach. The changes may also filter down into local generally agreed accounting principles (GAAP) standards.

The big exception is the US, which will remain under US GAAP accounting.

So what exactly will change?

IFRS 17 will change the measure of profit and equity in insurers’ accounts, and change how the accounts are presented.

Profits will be earned as insurers serve the customer, rather than the current practice of earning profits as the product is sold.

This means that insurers will need to calculate carefully how cash-flows emerge from contracts over their lifetime and, at the point of sale, measure the expected profits in the so-called contractual service margin (CSM).

The profit calculated at the point of sale will be adjusted on a regular basis to account for updated assumptions on risks, interest rates, etc.

“The accounting around the CSM is perhaps the most important element of IFRS 17,” explains Francesco Nagari, global IFRS insurance leader at Deloitte.

Will some insurers be affected more than others?

Life insurers are going to find the transition harder than non-life firms, because contracts of one year or shorter can use a simplified approach. Any business longer than a year has to calculate the CSM.

Life insurers are going to find the transition harder than non-life firms, because contracts of one year or shorter can use a simplified approach

The degree of impact will also depend on where firms are starting from. The standard can be considered a hybrid between book-value accounting, common in continental Europe and Asia, and the more forward-looking accounting measure used in the UK and other jurisdictions, according to Kamran Foroughi, a director at consultancy Willis Towers Watson. “This sort of model is fairly untested globally, but it’s not that different from the model that operates in Australia.”

What are the biggest challenges facing insurers?

First, IFRS 17 is principles-based, so insurers will have to interpret and make judgements on the rules.

But many expect the biggest challenges to be around systems and processes to deal with the new calculations, which require a much more detailed level of information on contracts, and will need updated frequently as assumptions change.

“There is going to be a lot of work around systems, data and processes, particularly in order to track the CSM,” explains Simon Perry, principal, IFRS 17 lead at accounting firm Grant Thornton.

Insurers with business written over a number of years will need to go back and figure out the CSM when the contracts were first written. “Companies potentially won’t have the systems to do that,” he notes.

Martin Sarjeant, global risk solutions leader at software vendor FIS says that IFRS 17 “brings insurers’ actuarial models and calculations into the heart of their financial reporting function” and means teams will have to collaborate more effectively, and ensure actuarial systems are well governed and connect with finance systems.

“The actuarial calculations for IFRS 17 will now effectively drive a company’s profits, tying the function much more closely to the whole financial reporting process. For some insurers, particularly those not yet subject to Solvency II or its regional equivalents, there will need to be a complete step change to governance levels,” Sarjeant says.

"The actuarial calculations for IFRS 17 will now effectively drive a company's profits, tying the function much more closely to the whole financial reporting process."

Finally, there are stakeholder expectations to manage. The change in profits and equity compared with existing regimes will need explaining, as will the comparison to other metrics such as Solvency II and embedded value.

Some are expecting IFRS 17 to result in more volatile results for insurers, and the new standard may also affect the ability of companies to pay dividends, and even impact on executive bonuses.

“Whilst ultimate profits will not change, the emergence of those profits can change significantly. Both insurers and their analysts will need to assess the full impact in terms of telling the performance story of their companies,” says Alex Bertolotti, global IFRS insurance leader at PwC.

Will it be as big a challenge as Solvency II?

For some firms it won’t be, for others it may be worse. The scope of IFRS 17 is certainly narrower than Solvency II, but the practical challenges of delivering the correct numbers on time are similar.

“Talking to clients, you hear a whole range of estimates as to what this might cost, which is anywhere between 25% of Solvency II to 200% of Solvency II. It’s a big range and it will depend on each company. The general view is, it’s not going to be small,” says Perry at Grant Thornton.

According to European Commission estimates, the cost of implementing Solvency II in the EU was €3bn-4bn ($3.4-4.5bn).

“I think IFRS 17 implementations will take a similar amount of effort to Solvency II, says Sarjeant at FIS. “However, the standard is likely to affect different areas and focus spending more on governance and the streamlining of reporting than on modelling.”

Firms that have already implemented Solvency II should be in a better position than most, because their governance will be up to scratch and they will be able to re-use work on modelling.

"Unlike with Solvency II, there are no impact studies to complete or regulators creating interim deadlines. So it’s up to insurers to come up with realistic plans"

Foroughi at WTW notes the huge impact that Solvency II had on certain markets and posed challenges for insurers on how they managed their business in the post-Solvency II world.

“There may well be similar effects on markets and products, and questions about managing the business in [the] post-IFRS world, so on that level it’s a similar challenge,” he says.

How long does the industry have to prepare?

IFRS 17 is to be implemented on 1 January 2021, giving firms three-and-a-half years from now – probably the longest period ever given to prepare for a new IFRS standard.

Insurers will need to produce IFRS 17 accounts for the 2020 year-end to give themselves a prior-year comparison come 2021.

“Unlike with Solvency II, there are no impact studies to complete or regulators creating interim deadlines. So it’s up to insurers to come up with realistic plans,” says WTW’s Kamran Foroughi.

Is the industry well prepared?

Some firms have been very engaged and worked on estimates of the financial and operational impacts, while other have done little if anything so far.

Henny Verheugen, principal and consulting actuary at Milliman, says the consulting firm recently surveyed 100 insurers worldwide, and about 70% were following developments and doing some early-stage interpretation "but haven't done much more than that. The other 30% are in the process of doing gap analysis, all sorts of field testing, and doing some test runs."

“Levels of preparedness can certainly vary between regions and according to their levels of financial and actuarial governance. The size of company and whether it is a life or non-life insurer can also make a difference,” says FIS’s Sarjeant.

Observers have noted a reluctance to spend money on IFRS 17 until insurers knew it was definitely happening – a view that may change now.

The Transition Resource Group can force a change in wording, if the industry successfully argues its case

Though 2021 seems a long way off, Perry at Grant Thornton says the preparation work is going to be demanding. “The time is going quickly. Those companies that haven’t done anything yet are probably going to find out they have a lot of work to do over the coming months and years,” he says.

Does the publication of the final text today contain any surprises?

The final text will be considerably different from the previous exposure draft, but the changes have been openly discussed at IASB meetings and though the industry would have liked to have viewed the final text ahead of today’s publication, anyone closely following the progress is unlikely to be shocked.

Deloitte’s Nagari says in his initial reading of the standard this morning: “We have not found anything different to what we were expecting. The IASB has been transparent in the development of the standard, and every decision has been discussed publicly. We haven’t seen anything surprising today.”

Will there be any more amendments to IFRS 17?

Full implementation may reveal difficulties and impracticalities for insurers, and the IASB could be open to quite significant changes in the run up to 2021. The board is establishing a Transition Resource Group (TRG) to support implementation and the TRG can force a change in wording, if the industry successfully argues its case.

In the past such TRGs have wielded considerable power: in the case of IFRS 9, the corresponding group won a one-year delay to the implementation date and a major change to the standard.

How long has it taken to develop IFRS 17?

Practically 20 years. The official kick-off was the publication of the first draft statement of principles in 2001, but the first discussions on the standard began in 1997.

A discussion paper was published in 2007, followed by the first and second exposure drafts in 2010 and 2013 respectively.

What about IFRS 9?

Insurers have won special dispensation to implement IFRS 9, the accounting standard covering financial instruments, at the same time as IFRS 17 (i.e. 1 January 2021), whereas the rest of commerce has a deadline of 1 January 2018.

Nonetheless, IFRS 9 may bring more unwanted volatility in reported profit.

 

Christopher Cundy