The main reason for implementing IFRS17
Going through the process of implementing IFRS17 one quickly realises the vast impact this standard has on an insurer. It’s probably one of the most costly standards ever to be implemented by insurance companies. One can’t help but ask:
Why exactly are we doing this again? Is it really worth it?
Well, the IASB has been very generous with their educational material in explaining exactly the benefits or necessities for implementing IFRS17. Generally the sentiment goes as follows:
“IFRS 17 provides consistent principles for all aspects of accounting for insurance contracts. It removes existing inconsistencies and enables investors, analysts and others to meaningfully compare companies, contracts and industries.”
In a previous article, “Does the insurance community think IFRS17 is adding value“, I discussed the responses of LinkedIn connections to the questions posed above (is IFRS17 really worth it?). In this article, I’ll explore the main reasons put forth by the IASB for IFRS17 being necessary and why the benefits of implementing IFRS17 outweighs the cost as explained in the “IFRS 17 Effects Analysis” and the “IFRS 17 Fact Sheet”.
Completing the insurance accounting journey
The IASB decided to establish the accounting of insurance contracts in two phases:
- Phase 1 – The issuing of IFRS4 in 2004 which focused on enhanced disclosure of the amount, timing and uncertainty of future cash flows from insurance contracts.
- Phase 2 – The issuing of IFRS17 in 2017 which focused on measurement and presentation of insurance contracts and the development of a comprehensive IFRS standard for insurance contracts.
Thus, IFRS17 supersedes IFRS4 and completes the IASB’s project to establish a specific IFRS model for accounting for insurance contracts.
IASB’s motivation for why the benefits outweighs the cost
The following improvements were introduced to combat inconsistent accounting of insurance contracts and provide current and transparent financial information about insurance contracts.
Improvements to make information more useful, transparent and consistent:
- Updated assumptions: Companies now need to measure insurance contracts using updated assumptions and not out-of-date assumptions.
- Time value of money: Allowing for the time value of money where companies did not consider the time value of money when measuring liabilities for incurred claims (parring for simplification presented by the standard in some cases).
- Discount rates: Needing to use a discount rate which reflects the characteristics of the insurance cash flows as opposed to using a discount rate based on ‘expected return on assets held’.
- Explicit risk adjustment: IFRS17 requires a company to always include an explicit, current risk adjustment in the measurement of insurance contracts and to provide relevant disclosures, whereas the application of risk margins weren’t always explicit or consistent between insurers under IFRS4.
- Financial options and guarantees: All financial options and guarantees embedded in the insurance contracts should be included in the fulfilment cash flows, consistently with market observable prices for such options and guarantees. In some cases these weren’t recognised at all or measurement was inconsistent with relevant market prices.
- Grouping of insurance contracts at initial recognition: To make onerous contracts visible in a timely manner, achieve timely recognition of losses arising from insurance contracts and appropriately allocate profits to reporting periods.
- Consistent recognition of profits: Profits will be recognised based on how profits are released from the contractual service margin and risk adjustment over time (in line with how insurance contract services were provided in the period).
- Consistent treatment of acquisition costs: Directly attributable acquisition cash flows are included in the measurement of insurance contracts and thus a separate asset associated with this is not recognised. Complex mechanisms dealing with the deferral, amortisation and impairment of the separate asset is eliminated by IFRS17 due to any lack of recoverability of the acquisition cash flows being reflected in the measurement of the insurance contracts.
- Comparable revenue: Revenue is now based on the consideration for services on an earned basis and will exclude investment components (which represent policyholders’ investments, not consideration for services).
- Sources of profit: Consistent or complete information about the sources of profits were not provided and it will now be needed to provide information about different components of both current and future profitability.
- Expected contract profits: Expected insurance contract profits will now be provided in a comparable manner across companies and will possibly need to use fewer non-GAAP measures (such as embedded value information).
- Understandable claims and other expenses: Only items that reflect insurance service expenses are included in this line item, like incurred claims and other insurance service expenses. Repayment of deposits will not be presented as insurance expenses, but rather as settlement of liability. Furthermore, the ‘change in insurance contract liabilities’, which consists of multiple factors like new business contracts written and changes in methods and assumptions used in measuring insurance contracts, will not be included in this line item anymore.
- Consistent accounting for non-insurance components: Deposit components, goods and non-insurance services will be separated from insurance contracts if they are distinct from the insurance component and all insurers will thus use the same approach for separation.
Comparability has thus been improved:
- Among companies across countries: accounting for insurance contracts varied significantly between companies operating in different countries which will now be applied consistently.
- Among insurance contracts: some multinational companies consolidated their subsidiaries using different accounting policies for the same type of insurance contracts written in different counties and will now measure insurance contracts consistently within the group.
- Among industries: Revenue was presented as cash or deposits received which differed from other industries like banking and investment management. Revenue would now be reflected based on service provided, excluding deposit components, consistently with any other industry.
Is IFRS17 really worth it?
The IASB paints a very compelling story as to why IFRS17 is detrimental for accounting of insurance contracts. Comparing all these benefits to the costs involved of implementation is still a sore point to some insurers however, and I can’t blame them.
I personally find this standard very graceful, particularly when it comes to the recognition of profits over time and how nicely this has been matched with services provided throughout the lifetime of insurance contracts. The B120 check, which states that revenue for a group of insurance contracts should equal the amount of premiums paid to the entity adjusted for a financing effect and excluding investment components, further adds to the gracefulness of IFRS17 when converting this to a formula to check if all your disclosures pan out as they should.
I can’t help but wonder if I would have felt the same if I owned an insurance company…
To read up more on this topic, check out the following educational papers published by the IASB on the IFRS website:
Written by Andre Erasmus
IFRS17 Implementation Actuary