IFRS17

In May 2017, the International Accounting Standards Board (IASB) finished its long-standing project to develop a new international accounting standard for insurance contracts.

The new standard, IFRS 17, replaces IFRS 4, which permits a wide variety of accounting practices in different jurisdictions.1 IFRS 17 will become effective from 1 January 2021, with prior-year comparative reporting required, although some countries have chosen not to adopt it. Most notably, the US Financial Accounting Standards Board will instead make targeted improvements to its existing US GAAP.

The key features of IFRS17 are broadly as set out in earlier consultation drafts. In particular, the framework involves measuring insurance liabilities based on expected cash flows adjusted for the compensation an insurer requires for bearing uncertainty about the amount and timing of these cash flows as it fulfils the contract. In addition, any insurance liability includes a contractual service margin (CSM), which represents the unearned profit on the policy. Liabilities are re-measured in each reporting period and valuation changes are reflected in published financial statements.

In a departure from the draft proposals, however, premiums written will no longer drive the top line: investment elements of insurance contracts will not be considered revenue. Amounts that the policyholder will always receive regardless of whether an insured event happens will not feature in the income statement but instead be recognized as liabilities directly in the balance sheet. This aligns the presentation of insurers' revenue with firms in other industries: income is allocated to periods in proportion to the value of expected coverage and other services provided in that period, and claims are presented when incurred.

IFRS 17 is a major departure from current accounting practice. While it is principle-based and allows discretion in how to calibrate and allocate valuation changes, the reform will likely increase volatility in reported equity capital and profits.2 Economic mismatches between assets and liabilities will become more visible. For example, movements in long-term insurance liabilities will reflect not only current market interest rates but also the impact of embedded policyholder guarantees, obligations which may not be adequately matched by corresponding assets.

Implementing IFRS 17 will create challenges for many insurers. From an operational perspective, it will likely require significant investment in new data capture, systems and processes. For international insurers with overseas subsidiaries, the added complexity of having to prepare financial statements under various valuation frameworks – GAAP, Solvency II, IFRS etc. – will only add to the operational challenges.3 According to a recent global survey, over 60% of insurers plan to invest in both new accounting and actuarial systems to meet the demands of the new framework, although only 15% have actually started implementation projects.4 The increased volatility in their financial results will put increased emphasis on insurers to better communicate their underlying business performance including the sources of income and balance sheet volatility. This will help ensure that insurers' costs of capital are not unduly driven higher by investors who misinterpret period-to-period swings in reported financial results.

Read and download the full insurance review and outlook report.

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References

1. IFRS 17 applies to insurance contracts issued, to all reinsurance contracts, and to investment contracts with discretionary participating features if an entity also issues insurance contracts.

2. Under IFRS 17, entities can choose to recognise the impact of changes in discount rates and other assumptions that relate to financial risks either in profit or loss or in other comprehensive income ("OCI"). The OCI option for insurance liabilities reduces volatility in profit or loss for insurers where financial assets are measured at amortized cost or fair value through OCI under IFRS 9.

3. To address some of these challenges, Swiss Re in partnerships with Deloitte, KPMG and IFB has recently developed the Baseline Delta Approach which facilitates parallel construction of financial statements under multiple valuation methods in a simple, effective way. See […]

4. IFRS 17 preparedness: 2017 survey feedback, Milliman, June 2017.The new standard, IFRS 17, replaces IFRS 4, which permits a wide variety of accounting practices in different jurisdictions.1 IFRS 17 will become effective from 1 January 2021, with prior-year comparative reporting required, although some countries have chosen not to adopt it. Most notably, the US Financial Accounting Standards Board will instead make targeted improvements to its existing US GAAP.

The key features of IFRS17 are broadly as set out in earlier consultation drafts. In particular, the framework involves measuring insurance liabilities based on expected cash flows adjusted for the compensation an insurer requires for bearing uncertainty about the amount and timing of these cash flows as it fulfils the contract. In addition, any insurance liability includes a contractual service margin (CSM), which represents the unearned profit on the policy. Liabilities are re-measured in each reporting period and valuation changes are reflected in published financial statements.

In a departure from the draft proposals, however, premiums written will no longer drive the top line: investment elements of insurance contracts will not be considered revenue. Amounts that the policyholder will always receive regardless of whether an insured event happens will not feature in the income statement but instead be recognized as liabilities directly in the balance sheet. This aligns the presentation of insurers' revenue with firms in other industries: income is allocated to periods in proportion to the value of expected coverage and other services provided in that period, and claims are presented when incurred.

IFRS 17 is a major departure from current accounting practice. While it is principle-based and allows discretion in how to calibrate and allocate valuation changes, the reform will likely increase volatility in reported equity capital and profits.2 Economic mismatches between assets and liabilities will become more visible. For example, movements in long-term insurance liabilities will reflect not only current market interest rates but also the impact of embedded policyholder guarantees, obligations which may not be adequately matched by corresponding assets.

Implementing IFRS 17 will create challenges for many insurers. From an operational perspective, it will likely require significant investment in new data capture, systems and processes. For international insurers with overseas subsidiaries, the added complexity of having to prepare financial statements under various valuation frameworks – GAAP, Solvency II, IFRS etc. – will only add to the operational challenges.3 According to a recent global survey, over 60% of insurers plan to invest in both new accounting and actuarial systems to meet the demands of the new framework, although only 15% have actually started implementation projects.4 The increased volatility in their financial results will put increased emphasis on insurers to better communicate their underlying business performance including the sources of income and balance sheet volatility. This will help ensure that insurers' costs of capital are not unduly driven higher by investors who misinterpret period-to-period swings in reported financial results.

Read and download the full insurance review and outlook report.

References

1. IFRS 17 applies to insurance contracts issued, to all reinsurance contracts, and to investment contracts with discretionary participating features if an entity also issues insurance contracts.

2. Under IFRS 17, entities can choose to recognise the impact of changes in discount rates and other assumptions that relate to financial risks either in profit or loss or in other comprehensive income ("OCI"). The OCI option for insurance liabilities reduces volatility in profit or loss for insurers where financial assets are measured at amortized cost or fair value through OCI under IFRS 9.

3. To address some of these challenges, Swiss Re in partnerships with Deloitte, KPMG and IFB has recently developed the Baseline Delta Approach which facilitates parallel construction of financial statements under multiple valuation methods in a simple, effective way. See […]

4. IFRS 17 preparedness: 2017 survey feedback, Milliman, June 2017.

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