Laura Kennedy introduces the IFRS 17 standard, explains why it's needed, and describes the path to implementation
The International Accounting Standards Board (Board) issued IFRS 17 Insurance Contracts in May 2017. IFRS 17 sets out the requirements a company should apply when reporting financial information about insurance contracts it issues and reinsurance contracts it holds.
This article provides an overview of some changes to the accounting requirements for insurance contracts and explains why these changes are needed. It also discusses the process for jurisdictions adopting the new accounting standard and how the Board is supporting implementation. The article also explains the role of the Transition Resource Group for Insurance Contracts (TRG).
Insurance accounting today
What? New accounting standard for insurance contracts
Who? It applies to all companies applying IFRS Standards that issue insurance contracts or issue or hold reinsurance contracts, with some scope exemptions
When? Mandatory for accounting periods commencing on or after 1 January 2021 with a requirement to provide comparative information for the prior year
IFRS 4 is the interim insurance contracts standard that companies currently apply. Issued in 2004, it was always intended as a 'stop-gap' measure while the Board continued to work on the development of the comprehensive standard.
IFRS 4 focuses only on enhanced disclosures and does not prescribe the measurement for insurance contracts. It instead allows companies applying IFRS 4 to continue using the existing practices of their local jurisdiction. Consequently, insurers currently use a wide range of insurance accounting practices both across jurisdictions and across product types.
In group financial statements, multinational companies are even allowed to consolidate financial information about subsidiaries in different jurisdictions that has been prepared under a number of different accounting policies.
These differences in accounting practices make it difficult for investors and analysts to understand how an insurance company is performing, and to compare insurance companies to each other. It is also difficult to compare insurance company financial statements to those from companies in other industries.
As a result of the deficiencies in insurance contracts accounting today, investors have turned to other sources of information. For example, some investors look to regulatory reporting such as that required by the EU's Solvency II Directive or alternative performance measures such as embedded value reporting. Although useful, such measures do not provide investors across the world with consistent and complete information.
Bringing insurance accounting up to scratch
Two important issues identified with some common insurance accounting practices today are:
- profit is recognised up-front; and
- assumptions, including discount rates, are out-of-date.
1. Profit is recognised up-front
Normal practice for IFRS standards is that profit from a contract is recognised as the service is provided. Conversely, for many insurance contracts today a large proportion of expected profit is recognised up-front – even when it relates to insurance services to be provided over many years in the future. Therefore, this is particularly significant for long-term contracts.
It is also common for companies to present cash received from insurance contracts as revenue. This includes cash deposits received for contracts with investment components. This is contrary to accounting applied in other industries, such as banking.
IFRS 17 requires a company to recognise profits as it delivers insurance services, rather than when it receives premiums, as well as to provide information about insurance contracts profits that the company expects to recognise in the future.
This information will provide new data that can be used to evaluate the performance of insurers and to evaluate how that performance changes over time.
2. Assumptions, including discount rates, are out-of-date
Some companies measure insurance contracts using assumptions, including discount rates (to reflect the timing of future expected cash flows), determined at the time that contracts were issued without subsequently updating these assumptions to reflect economic changes. Out-of-date assumptions do not provide useful information about expected future cash flows. This issue is most significant for long-term insurance contracts.
Some companies do not discount the expected future cash flows to present value, even when companies anticipate the cash flows to occur years later.
IFRS 17 requires a company to recognise profits as it delivers insurance services, rather than when it receives premiums, as well as to provide information about insurance contracts profits that the company expects to recognise in the future. This information will provide new data that can be used to evaluate the performance of insurers and to evaluate how that performance changes over time.
What's happening now?
Adoption of IFRS standards: As of 2017, IFRS standards are required or permitted in 138 jurisdictions worldwide. Each time the Board issues a new IFRS standard, each jurisdiction incorporates it into the requirements at a national level. Many jurisdictions, including the EU, Canada and Japan, have their own endorsement process.
EU endorsement process: In the EU, all listed companies are required to use IFRS standards as adopted by the EU. When a new standard is issued, the European Commission requests endorsement advice from its consultative body, the European Financial Reporting Advisory Group (Efrag). Based on this advice, the EU Accounting Regulatory Committee votes on the endorsement of the new standard.
Efrag plans to issue its draft endorsement advice for IFRS 17 in the third quarter of 2018. As part of the endorsement consultation process, European insurance companies have been invited to participate in a case study that will include consideration of discussions held by Efrag's Insurance Accounting Working Group.
Implementation support: The effective date of 1 January 2021 gives companies three and a half years to implement IFRS 17. To set the implementation period, the Board carefully balanced insurers' need for time to implement the standard with investors' desire to get better information.
The Board is supporting companies with implementation in a number of ways, including by establishing a Transition Resource Group (TRG).
Transition Resource Group: The purpose of the TRG for Insurance Contracts is to provide a public forum for stakeholders to follow the discussion of implementation questions.
Key cost reliefs
IFRS 17 includes simplifications and practical expedients to provide cost relief for companies both when they first apply IFRS 17 and on afterwards, including:
- excluding some contracts from the requirements (product warranties, financial guarantees and fixed-fee service contracts);
- allowing insurance contracts to be grouped for measurement;
- providing an optional simplified approach for short-term contracts; and
- providing transition reliefs.
For more information: IFRS 17 Insurance Contracts Effects Analysis, Key cost reliefs, p.67-70
The TRG comprises 15 participating members, three members with observer status and three Board members. The TRG members have a wide breadth of expertise in a variety of insurance product types sold in different parts of the world.
The discussions of the TRG will be based on implementation questions submitted by companies, their auditors, etc. Anyone can submit an implementation question by completing the submission form available on the IFRS Foundation website.
The first TRG meeting will take place in February 2018. All meetings, agenda papers and meeting summaries will be public.
Implementation tools: The Board supports implementation by publishing educational materials, including webcasts that provide a step-by-step introduction to IFRS 17.
Further materials will be developed throughout the implementation period. The Board will remain flexible in the development of new materials with the aim to provide support on key areas of interest or concern for companies as they arise.
Keep up to date: To stay up to date with the latest IFRS 17 developments and materials, including the TRG, visit the dedicated IFRS 17 implementation page on the IFRS Foundation website (www.ifrs.org)
Laura Kennedy is a staff member of the International Accounting Standards Board