The new international accounting framework for insurance companies has been some time in the making. IFRS 17 supersedes IFRS 4 which, due to its lack of clarity over fair value of insurance contracts, has only ever been considered an interim solution since its publication in 2004.
The update process began in earnest in 2007, with accounting bodies around the world stating a commitment to incorporating a fair value measure suitable for all carriers. Fast forward over a decade, and work to implement the completely new set of standards, calculations and criteria is underway, with insurers across the globe re-evaluating the input needed to transition from the old frameworks.
The headline implementation challenges will affect many areas of an insurer's business; from adapting internal capabilities to managing the complexity and disruption that the new rules will bring about, IFRS 17 will induce an increase in balance sheet volatility and a need to attain accurate information with the necessary level of detail.
In addition to these wide-ranging and difficult tasks, there is a considerable challenge posed by companies in different countries being at varying stages of readiness, which in itself could lead to more costly implementations.
Insurance companies struggling to implement the new standard have since welcomed the deferral of the effective date by two years, which the International Accounting Standards Board (IASB) said it hoped would allow time for an orderly and simultaneous adoption of the standard around the world.
IFRS 17 is effective for annual reporting periods beginning on or after 1 January 2023 (with earlier application permitted as long as IFRS 9 is also applied).
The IASB states that the new standard first and foremost sets out to 'combine current measurement of future cash flows' with the recognition of profit over the period that services are provided under an insurance contract.
It also presents insurance service results (including presentation of insurance revenue) separately from insurance finance income or expenses; and requires an entity to make an accounting policy choice of whether to recognise all insurance finance income or expenses in profit or loss or to recognise some of that income or expenses in other comprehensive income. Its key principles include that an entity:
- Identifies as insurance contracts those contracts under which the entity accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder
- Separates specified embedded derivatives, distinct investment components and distinct performance obligations from the insurance contracts
- Divides the contracts into groups recognised and measured in accordance with profitability, risk nature, reporting period, and/or management decision
- Recognises and measures groups of insurance contracts at: i) a risk-adjusted present value of the future cash flows (the fulfilment cash flows) that incorporates all of the available information about the fulfilment cash flows in a way that is consistent with observable market information; plus (if this value is a liability) or minus (if this value is an asset); and ii) an amount representing the unearned profit in the group of contracts (the contractual service margin)
- Recognises the profit from a group of insurance contracts over the period the entity provides insurance contract services, and as the entity is released from risk. If a group of contracts is or becomes loss-making, an entity recognises the loss immediately
- Presents separately insurance revenue (that excludes the receipt of any investment component), insurance service expenses (that excludes the repayment of any investment components) and insurance finance income or expenses
- Discloses information to enable users of financial statements to assess the effect that contracts within the scope of IFRS 17 have on the financial position, financial performance and cash flows of an entity.
IFRS 17 includes an optional simplified measurement approach, or premium allocation approach, for simpler insurance contracts.
Facing the challenge
Whilst primarily regarded as an accounting standard, IFRS 17 requires significant input from actuarial cash flow models and a great deal of work is already underway to assess the capabilities of current models and to establish what developments or enhancements they need to ready them.
This pressure on the actuarial function to do more with less continues to add to the strain of regulatory reporting requirements, which have been increasing steadily for years. With little to no additional time or resources available to them, having the ability to complete all these extra tasks (and having the confidence in the models and calculations) is critical.
IFRS 17 is not just about day-to-day reporting; it also requires insurers to be proactive and have forward-looking systems in place that are fit for large volumes of calculations. This can represent a challenge for certain IT infrastructures, which are at risk of buckling under the computational pressure. Legacy systems add a further layer of challenge. By their very definition, they are resistant to change and evolution. They can prove to be a considerable sticking point for forward-looking insurers looking to keep pace with change in the ever-evolving world of actuarial and financial consulting.
Getting IT done
Notwithstanding the recent extension to the IFRS 17 deadline, insurers are at varying stages of implementation, with the question of ownership for the standard still in debate. Technically, it is an accounting regulation but arguably the bulk of the work is actuarial.
Wherever they stand on the debate of ownership, insurers should be making the most of the implementation delay to ensure they completely understand the calculations and that they are completely satisfied with the mechanisms they have in place – beyond the physical processes of running the models.
For those that have not yet started at all – time really is of the essence, as the full complexity of the new requirements, resources and time it takes to implement them may not be fully appreciated.
Alex Tsai, head of Greater China at RNA Analytics, notes a curiosity in the market about how "other companies" are carving up ownership. He sees the implementation of IFRS 17 as a golden opportunity for insurers to achieve new levels of communication across the various business functions, and to better understand the driving factors for change in the business.
"Actuarial, accounting, finance, HR and IT departments need to get together right now to face this challenge. The accounts department must have an understanding of the needs of HR; IT needs to understand the requirements of the recognises actuarial and the financial functions – and I mean really understand what they are talking about! This brings all these disparate functions closer and closer," he explains.
"Depending on your outlook, the standard can either be seen as onerous, or as something which can have quite a positive impact, whilst as the same time getting everybody on the same page before IFRS 17 comes into play."
Considering the standard in this context, that is, as an enabler, could in itself give insurers a major advantage over competitors when it comes to implementation. Indeed, as René Doff observes in the second edition of Risk Management for Insurers (Risk Books, 2011), contemporary supervisory requirements for insurers are in fact already closely aligned with the internal risk management activities they have in place.
This, she points out, is efficient not only because it presents companies with an opportunity to reduce duplication, but also because "a company that follows its internal risk management principles will automatically reach supervisory objectives. Regulatory arbitrage will be avoided".
No two are alike
Whilst there is much talk a lot about implementing IFRS 17 'across the insurance industry', no two insurers are alike, and a great deal of time needs to be spent applying unique circumstances and transactions when carrying out such a crucially important piece of work within our sector. In adapting their strategies for IFRS 17, insurance executives must address five distinct challenges, according to a report published by McKinsey:
- Increased balance-sheet volatility. Valuations of assets and liabilities will now be based on market value, not book or historic value
- Risk of lower profits. Insurers need to make a trade-off between post-implementation profitability and balance-sheet strength.
- Short and uncertain timelines. This could risk doubling expenditures, according to analysts.
- Increased pressure and potentially more questions from investors.
- Internal capabilities. Teams need the right capabilities to manage their function's performance under the new rules.
Failure to manage these, it says, risks a dramatic decrease in transparency around financial performance and extensive cost overruns.
Asia in focus
When considering the current state of progress with implementation worldwide, the picture is mixed. In Hong Kong, despite a prolonged period of civil unrest and more recently Covid 19-related disruption, there is evidence of steady progress. Hong Kong is working to the global schedule, leaving insurers there with a two-year window until 2023.
For global companies there with headquarters in Europe, preparations are thought to be going well. The same may not be said for local insurers, however, where a sense of urgency has not yet become apparent.
In Taiwan, meanwhile, implementation has been observed to be somewhat varied, with many insurers looking for a three-year extension until 2026 and regulators keeping a watchful eye on progress among local insurance organisations. Right now, firms are beginning to formulate implementation plans, which is itself a requirement of the local regulator as part of the monitoring process. In terms of its own deadline, therefore, progress seems positive.
In Mainland China, a local version of the standard will be released by the end of this year, despite some initial concerns about its adoption. Though the schedule for that is not yet firm, the industry is scaling up to have the resources to head it up both internally and externally.
Part of a cautious approach in the region has been to look at every detail of IFRS 17, as well as to learn from other countries. In the case of both China and Taiwan, they are looking to Korea (which is working to the global schedule). In that sense, these two countries are far from behind, and this efficient approach will save them time and resources in the long run.
IFRS 17 is set to have a considerable impact on revenue recognition and capital structure, something that many insurance companies in Taiwan and China have been conscious of for almost two years, in anticipation of the new standards. With much of the Asia-Pacific region set to delay implementation by up to three years, there will of course be more time to think about the role that technology may play.
Many life and non-life insurers are showing a keen interest in all the latest developments in technology development for the arena, including a broader interest in the changing role of the actuary.
IFRS 17 – The RNA way
We have already touched upon the concept of turning implementation programmes into an opportunity to improve understanding across the relevant functions of the business. At the heart of this are actuarial calculations, so using the IFRS 17 model to run these calculations is really about improving automation, operational risk management and process governance. From a practical perspective, there's the added benefit of increased efficiency in the running of the end-to-end process.
The R³S IFRS 17 Package incorporates the standard code, and, whether starting best-estimate liability (BEL) calculations from the beginning, or making use of an existing BEL process, our IFRS 17 reporting model is designed to enable rapid compliance.
The IFRS 17 standard code provides an out-of-the-box solution to the portfolio-level calculations of balance sheet and profit and loss values required under the new standard. They use a defined set of cash flow model inputs which can be taken from any underlying source for maximum automation.
Our IFRS 17 model can be used for the initial recognition calculation, subsequent measurement reporting over various approaches, BBA/VFA/PAA alike, and one-off transition calculations.
Regulatory demands have a substantial impact on required IT infrastructure and necessarily on budgets. The hardware used to run models can have a significant effect on their performance, so scaling the hardware to the model requirements is critical. In some cases, it may be appropriate to take a close look at the design process with solution experts. This would start with an assessment of the suitability of a particular IT environment in achieving desired targets.
The volume of data required to run models and output generated from them is increasing significantly as companies need to understand and analyse their results. The complexity of the data needing to be stored is increasing under IFRS 17, defining information and results that need to be maintained at more granular levels than previously.
Through rigorous testing and research, RNA's technical consultants are already helping clients across the world successfully implement flexible and resilient IFRS 17 packages, such as the R³S IFRS 17 package provides an out-of-the-box solution to the portfolio-level calculations of balance-sheet and profit-and-loss values required under IFRS 17.
RNA's teams are skilled in analysing target storage requirements to help architect an optimal data structure strategy, regardless of company scale or readiness for the impending regulatory changes – which will be even better strengthened by the company's imminent end-to-end IFRS cloud-based solution planned to be launched 2021.
The goal of RNA Analytics' actuarial consulting team is to educate users and review models and processes to ensure the latest knowledge and functionality is known about and used where it should be. Coupled with this is a focus on ensuring the models and processes access the hardware efficiently to help ensure compliance.
The consulting elements around IFRS 17 are currently focused on assistance with determining how the example IFRS 17 process model can be expanded and integrated into existing processes; enhancing current base models to ensure compliance; and providing consultancy to ensure a full end-to-end implementation.
To ensure a model is performing efficiently in terms of coding, process and IT infrastructure, a combined team of technical and actuarial consultants with worldwide expertise can assist in profiling and amending the models and processes.
The breadth of RNA's client base means the team is exposed to a range of global regulatory environments including Asia, Europe and the US – giving them a unique insight into the way different regimes and regions approach similar situations. This insight can help users optimise their actuarial modeling environment, making it easier to maintain and manage into the future – both practically and from a cost/budget perspective.
RNA Analytics ensures all its consultants are trained and educated to the highest standards – just providing access to more than just sector resources, but instead, a team of professionals working on the entirety of end-to-end requirements within risk and actuarial model processing.
For today's life and non-life insurers, RNA Analytics has the consultancy expertise, the global reach and the ability to deliver bespoke, and scalable software solutions that help organisations overcome the challenges of IFRS 17. With a reach that extends from the UK across Europe and into South Korea, Taiwan, China, Japan and Hong Kong, our actuarial teams are poised and ready to support your transition to IFRS 17.
As it currently stands, with countries and companies at different stages of preparation, there is much work to do before the original purpose of the new standard can be fulfilled and utilised to its full potential.
In the meantime, such inconsistent levels of progress with implementation makes reconciling numbers and providing investors with clear financial statements a very difficult task, both for insurers and investors – more difficult indeed than implementation itself needs to be.
To find out more about RNA Analytics' products and solutions, or to download our white paper titled The Modernization of the Actuarial Function, visit our website www.rnaanalytics.com