On 18 May 2017, the International Accounting Standards Board (IASB) issued IFRS 17: Insurance Contracts, a long awaited standard for insurers. Mr Raj Juta from Deloitte gives an in-depth view of this new insurance contracts standard which will be applicable for annual reporting periods beginning on or after 1 January 2021.
The International Accounting Standards Committee, IASB’s predecessor, had started the International Financial Reporting Standard (IFRS) project in April 1997 and Phase I was completed by the IASB when IFRS 4 was issued in March 2004.
However, IFRS 4 was deemed to be an interim solution only as it allowed insurers to use wide variety of accounting practices, as IASB continues to work on a comprehensive standard. Investors and analysts find it difficult to understand and compare insurers’ financial position, performance and risk exposures due to the differences in accounting practices across jurisdictions and products. Phase II of this project which resulted in IFRS 17 replacing IFRS 4, address these concerns.
Objective
The main objective of this new standard was to make sure that the issuer provides relevant information that faithfully represents rights and obligations from insurance contracts it issues.
In order to achieve this and eliminate inconsistencies and weaknesses in existing accounting practices, the IASB developed a single principle-based framework to account for all types of insurance including reinsurance contracts that the insurer has entered into. IFRS 17 also enhances comparability between insurers by specifying presentation and disclosure requirements.
Impact
The standard will impact what constitutes revenue and profit in an insurance company and introduces the important concepts of contractual service margin and risk adjustment. The insurer’s target operating model will change including key processes and systems.
The impact on Asia-based insurance organisations are significant given that, unlike European insurers, Asian insurers would not be able to leverage their IFRS 17 solution from the technical alignment between IFRS and the new Solvency II regime that went live on 1 January 2016 across the European Union.
Asian insurers will therefore have a different starting point in the absence of similar requirements by their respective regulators and the need to factor into the cost the ability to report between local statutory reporting and the more complex IFRS 17 requirements.
Six group of stakeholders will be affected and insurers need to manage these relationships effectively to ensure the overall market impact is beneficial (See Figure 1).
Scope
An entity shall apply IFRS 17 to issued insurance contracts including reinsurance contracts it issued, reinsurance contracts held, and also investments contracts with discretionary participation feature (DPF) it issues, provided the entity also issues insurance contracts.
Level of aggregation
An entity shall identify portfolios of insurance contracts. A portfolio comprises contracts that are subject to similar risks and are managed together. For all issued insurance contracts in a portfolio, the entity shall divide it into:
- a group of contracts that are onerous at initial recognition, if any;
- a group of contracts at initial recognition have no significant of becoming onerous, if any, and
- a group of remaining contracts in the portfolio, if any.
Recognition
An entity shall recognise the group of insurance contracts it issues from the earliest of (a) the beginning of the coverage period; (b) the date when the first payment from a policyholder becomes due; and (c) when the group becomes onerous.
Measurement
General Model (Building Block Approach)
For entities using the general model, on initial recognition, they shall measure a group of contracts at the total of the amount of fulfilment cashflows (FCF) and the contractual service margins (CSM).
Premium Allocation Approach (PAA)
An entity may simplify the measurement of the liability for remaining coverage of a group of insurance contracts using the PAA on the condition that:
- doing so would produce a measurement that would not differ materially from the one that would be produced applying the requirements of the general model; or
- the coverage period of the insurance contract (including coverage arising from all premiums within the contract boundary) is one year or less.
Variable Fee Approach (VFA)
Many insurance contract allow policyholders to participate in investment returns with the insurer, in addition to compensation for losses from insured risk. Not all participating contracts meet the definition of direct par insurance contracts, which need to satisfy all three of the following criteria:
- The contractual terms specify that the policyholder participates in a defined share of a clearly identified pool of underlying items;
- The entity expects to pay to the policyholder an amount equal to a substantial share of the returns from the underlying items; and
- A substantial proportion of the cash flows that the entity expects to pay to the policyholder should be expected to vary with the cash flows from the underlying items.
Recognition and presentation in the financial statements
Carrying amount of groups of insurance contracts that are assets and/or liabilities as well as reinsurance contracts held that are as assets and/or liabilities shall be separately presented, by the entity, in the Statement of financial position.
In addition, new disclosures, such as best estimate liability (BEL), Risk Adjustment (RA), and CSM roll forwards, will be required. Most disclosures will also require explicit separate disclosure of direct business and reinsurance amounts. Reinsurance lines will have to be separately presented whenever they are material to the reporting entity.
Disclosure
An entity shall disclose qualitative and quantitative information about (a) the amounts recognised in its financial statements that arise from insurance contracts; (b) the significant judgments, and changes in those judgments; and (c) the nature and extent of the risks that arise from insurance contracts.
Effective date and transition
The standard is applicable for annual reporting periods beginning on or after 1 January 2021. For the purpose of the transition requirements, the date of initial application is the start of the annual reporting period in which the entity first applies the Standard, and the transition date refers to the beginning of the period immediately preceding the date of initial application.
An entity shall apply the Standard retrospectively unless impracticable, in which case entities have the option using either the modified approach or the fair value approach. A
Mr Raj Juta is Insurance Sector Leader from Deloitte Southeast Asia.