The new insurance contracts accounting standard brings a dramatic shift in accounting and actuarial practices, and insurers should be prepared for implementation challenges, as Kamran Foroughi explains
IFRS 17 is a major milestone in what has been a long journey from the commencement of the Insurance Contracts Project. For those still recovering from Solvency II, the new standard is going to be a huge implementation project. It will fundamentally change insurers' profit reporting and has actuarial principles at its core.
The International Accounting Standards Board published on 18 May 2017 the final version of International Financial Reporting Standard 17 Insurance Contracts (IFRS 17), effective for reporting periods commencing on or after 1 January 2021. It is the first ever global accounting standard for insurance to be applied consistently across most of the world. The existing standard, IFRS 4, is not really a standard – it allows local GAAP approaches to be used in each country, which means that there is little consistency across countries and indeed within multinationals.
The big change under IFRS 17 will be more transparency, giving investors a clearer picture of the returns they realistically expect on their investment and the risks to those expected returns. As a consequence, this may help the industry attract a wider generalist investor pool that struggles today to understand disparate insurance accounting, although in the early days of adoption new communication challenges will arise.
Four years may seem like a long time, but adequately preparing for the new complexity of IFRS 17 will be a challenge. The new standard will impact profit, equity and volatility, as well as reserving and financial reporting processes, actuarial models, IT systems, and potentially executive remuneration, so insurance companies should not underestimate the work required.
Central to IFRS 17 is the General Measurement Model which insurance companies will apply to determine the liabilities for their insurance contracts. The key elements of the General Measurement Model are summarised below, together with two alternatives permitted under IFRS 17: the Variable Fee Approach and the Premium Allocation Approach.
IFRS 17 – The General Measurement Model
The Insurance Contract Liability will consist of a fulfilment cash flow element and an unearned profit element (the Contractual Service Margin, or CSM). The value of the fulfilment cash flows will be a current amount at any point in time, reflecting economic conditions at – and expectations of future experience from – the time of the valuation.
Alternative approaches:
Variable Fee Approach: The Variable Fee Approach is a variation of the General Measurement Model in which the CSM can be adjusted in particular in response to investment return variations, so investment return variations will not immediately affect profit or loss. This will be applicable to with-profits contracts.
Premium Allocation Approach: An unearned premium type approach (i.e. using the premium less acquisition costs as the liability on day one, then running it off simply over time) will be permitted (with an onerous contracts test) for remaining coverage, where the coverage period is one year or less, providing a simpler alternative for many Property / Casualty and some Life contracts.
Why is implementation likely to be challenging?
The issues insurers face will vary, depending on the nature of the insurance liabilities, current insurance accounting and existing systems, models and processes.
- Interpretation and judgement: IFRS 17 is truly principles-based, which in most cases will mean it is the insurer's responsibility to ensure policies and disclosures comply with the standard's requirements, rather than it being able to rely on prescriptive and detailed rules.
- Dealing with volatility in profits: The hybrid model proposed will increase volatility compared to existing models, particularly those based on locked-in assumptions.
- Managing stakeholder expectations: Explaining IFRS 17's impact on profits and equity, and the variances to current GAAP and reporting under applicable regulatory regimes will require robust processes, a keen grasp of the individual differences and a transparent communication strategy. This may affect dividend-paying capacity, management bonuses and market-wide performance metrics.
For all insurers, there will also be significant additional disclosure requirements. This includes a new income statement which will take time to get used to.
More widely, until the introduction of Solvency II in the EU, the technical provisions under national GAAP, IFRS 4 and local regulatory reporting were similar within each country, although varying between countries. This link has been broken by Solvency II, causing investor communication challenges, and will be further fragmented by IFRS 17. It will be interesting to see how the EU reconciles the three reporting bases – insurers must hope that the three will re-align in the medium term.
How can insurers contribute to the process?
It will take some time for best practices to emerge. Both actuaries and risk professionals should be at the forefront of developments, leading discussion and debate on how IFRS 17 should be applied. There are many topics which should be subject to debate, including practical ways to quantify the risk adjustment, how to derive the discount curves and appropriate methodology for the roll forward of the CSM, to note just a few.
It should be noted that the IFRS 17 standard may not be fully "final". The IASB is setting up a Transition Resource Group later this year that will advise the IASB on implementation issues, and it is possible that some changes are made to the standard as a result, before 2021. Engagement by the actuarial and risk professions will really help the industry make the most of IFRS 17.
Kamran Foroughi is a Director at Willis Towers Watson