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What Global Insurance Businesses Need to Know about IFRS 17

Interview with Charles Rumbold

Managing Principal, Financial Services Consulting, EPAM UK
Interview
  • Financial Services

As the International Accounting Standards Board (IASB) continues to roll out new standards for companies in the EU and other countries to follow, it’s difficult to balance reaching compliance with business goals. If you’re committed to following the latest accounting standards from IASB, however, you’ll need to get started on implementing International Financial Reporting Standard (IFRS) 17 sooner than later.

For a quick rundown of what you need to know before getting started, here’s an interview with Charles Rumbold, EPAM’s Managing Principal of Financial Consulting for the UK.

What is IFRS 17?

IFRS 17 Insurance Contracts is a new accounting standard covering financial reporting on insurance business. It essentially defines new principles for accounting for companies that have insurance business and comes into effect for reporting periods starting on or after January 1, 2021.

Why has it been published?

The main reason is to bring uniformity to the accounting treatment of insurance contracts. IFRS 4, the current standard which was issued in March 2004, generally permits companies to continue with previous accounting treatment for insurance contracts but enhanced the disclosure requirements. The accounting treatment for insurance contracts varies significantly between different countries and different companies, making the comparison of company performance very difficult. There was controversy when IFRS 4 was issued that it did not include accounting policy changes. IFRS 17 now brings forward a defined accounting treatment for insurance contracts in addition to revised disclosure requirements.

What is the new accounting treatment?

Generally, the insurance contract liabilities will be valued at the present value of future expected cash flows with a provision for risk. The discount rate should reflect current interest rates. A gain (meaning the present value of premiums is greater than the present value of expected liabilities and expenses) measured at day one requires the creation of an offsetting Contractual Service Margin (CSM). The CSM is then amortized over the life of the contract. Short duration contracts (generally less than a year) may use a simplified unearned premium liability model, and where contracts are linked to underlying items the liability value can reflect that linkage.

IFRS 17 defines three measurement approaches:

  1. Building Block Approach (BBA), or General Model, for most long-term contracts
  2. Premium Allocation Approach (PAA) optional for most short-term contracts
  3. Variable Fee Approach (VFA) for contracts with direct participation features

If a contract does not meet the defined requirements for PAA or VFA, then BBA should be used.

So, what is the impact on companies?

Aside from the actual complexity of implementation, the main impact will be on the long-term contracts, such as life, health, pension or savings in the general market and re-insurance contracts. Businesses will see:

  1. Additional complexity in the valuation process, data requirements and modelling & assumptions
  2. Income recognition change, which may result in more volatility
  3. An increase in the frequency of loss recognition
  4. Additional disclosures of business data and increased transparency and comparability of performance

The change to using current interest rates instead of, for example, average investment return is likely to be significant, and this should be regarded as a feature of the standard. According to Hans Hoogervorst, IASB chairman, "The devastating impact of the current low-interest-rate environment on long-term obligations is not nearly as visible in the insurance industry as it is in the defined benefit pension schemes of many companies.” He continued to say that current discount rates would "increase comparability between insurance companies and between insurance and other parts of the financial industry, such as banks and asset management." [1]

What is the implementation challenge?

For most insurance companies, this will be one of the largest finance and technology change projects over the next three years, which is longer than most budget cycles. Most insurance companies currently use accounting policies which are quite different from the new standard. The bulk of the change will be related to the long-term contracts. Unlike many changes from other IFRS standards, which can be handled at the reporting level, the insurance BBA requires analysis and tracking at the contract level and is therefore likely to be part of the contract creation process. The new valuation approach is also likely to require new valuation processes combined with new current and historical data requirements.

From a technology perspective, I would expect to see a new calculation process to implement the BBA approach for contract valuation combined with a new accounting process for implementing the correct account treatment of contracts and record keeping. A significant amount of project work will be focused on the sourcing and integration of transaction data. There will also be changes to internal and external reporting to support the new disclosure requirements.

When do we start?

Now! No, really – although January 1, 2021, seems a long time away, the change is huge and, with a significant amount of work to be done, that time will evaporate quickly. The standard has a principles-based approach, which necessitates those principles for accounting be understood and applied to the current business processes. For technology (and technology is usually the driver of the change project), this means that detailed requirements will not yet be established and will take some months to begin to be defined. Looking forward, the project structure needs to accommodate emerging detailed requirements alongside the design and build of the solutions.

For more on standard accounting practices, check out HawkEye, EPAM’s accounting treatment solution for hedge accounting and control under IFRS 9. You can also explore more of our thinking on IFRS 9 in the blog ‘How the New Financial Regulatory Environment Will Impact Business Models.’

Sources:

[1] https://www.accountancydaily.co/iasb-commits-ifrs-17-release-combat-accounting-anarchy

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