By Amos Kinuthia
IFRS 17, the International Financial Reporting Standard that was issued by the International Accounting Standards Board in May 2017 will replace IFRS 4 on accounting for insurance contracts and has an effective date of 1 January 2023
Here is what you need to know of the expected changes from IFRS 4 to IFRS 17
The standard introduces three separate models for accounting for Insurance contracts. These are the General Measurement Model, the Premium Allocation Approach and the Variable Fee Approach. These are discussed below.
- General Measurement Model (GMM)/ Building Block Approach (BBA) will cover long-tail contracts (those longer than 12 months). In a nutshell, GMM will require Insurance companies to measure contracts at the PV of total fulfillment cash flows, an adjustment to factor-in time value of money, an adjustment for non-financial risk and the contractual service margin (CSM). The CSM will provide the unearned income to be recorded for the insurance contract and will forms part of the liability for the remaining coverage.
- Premium Allocation Approach (PAA or simplified approach) which will mostly cover short-tailed insurance contracts with coverage of one year or less. Under this approach, there will be little change to how short-term insurance is accounted for currently. The key simplification in the PAA approach is the exemption granted from calculating and explicitly accounting for the CSM. If an entity wants to apply PAA for long-tailed contracts, they would do so on the condition that doing so would produce a reasonable approximation of the GMM model.
- The Variable Fee Approach (VFA) will work mostly for investment-focused insurance contracts.
Transitioning from IFRS 4 to IFRS 17
As noted, there will be little change in the accounting for many short-term insurance contracts under IFRS 17 and such, many general insurance companies will see minimal changes in how they record such. For other Insurance entities that issue longer-term contracts though, the implementation of IFRS 17 will result in major changes around gathering information, change to financial systems, internal procedures and governance and financial reporting.
IFRS 17 is intent on bringing consistency and transparency with how Insurance companies record and report insurance contracts.
As noted, there will be multiple changes across operations but I wanted to put into perspective the reporting aspects and list a few things that will be affected including KPIs/Metrics, changes to financial statement captions, contracts groupings and aggregation, ceded reinsurance among others.
- Changes to metrics and Key Performance Indicators (KPIs)
For a start, KPIs/ metrics are going to be significantly impacted. Many KPIs are ratios and Insurers will either have to come up with new ratios to align to the new standard or maintain dual reporting and suffer the costs of multiple reporting if they intend to maintain their ratios in the old format. This is particularly true for KPIs that use premiums, claims and expenses as denominators. With reporting changes to income statement and the balance sheet, many accounts will need to be consolidated, some absorbed and some eliminated with a goal to consistency (more on this in later paragraphs). As such, loss ratios and other combined ratios in their current formats will require some workarounds to calculate. These are easily calculated using IFRS 4 financial statements.
- Expected changes to financial statement captions (Balance Sheet and Income Statements)
Variations brought about by IFRS 17 will see changes in the recording and financial statements captioning of the following: insurance receivables, unearned premiums, deferred acquisition costs, business combination intangibles, claims payable with these amounts being included in the measurement of insurance contracts issued and reinsurance contracts held resulting in an overall simplified and consistent presentation on the balance sheet. We will no longer have the mentioned on the face of the balance sheet. For instance, there will be no Insurance Receivables.
Also, premiums written or earned will be eliminated and will not form part of the IFRS statements. This will be replaced with “insurance revenue” with a goal to separate “insurance revenue” and “investments revenue”.
- Changes to portfolio aggregation and grouping
Unlike the practice under IFRS 4, entities will need to identify and group contracts that are subject to similar risks in the same portfolio and account for these together. The portfolios will then be divided into a minimum of three groups as follows: a) Onerous contracts if any (to be recognised at inception); b) that that have remote possibility of turning onerous if any; and c) the rest that don’t fall in any of the first 2 classes.
Because IFRS 4 was vague on classification of portfolios, Insurers were under no obligation to separate profitable and non-profitable contracts and these ended up being reported together. Going forward, for periods from January 1, 2023, onerous (loss-making contracts) and profitable contracts will be grouped in separate cohorts and assessed/ accounted for separately.
- Reinsurance Ceded
On the matters Reinsurance Ceded, entities will have to factor in the following. a) Onerous/profitable contracts and the related positive/negative CSM for reinsurance, b) Risk Adjustment for the separate characteristic reinsurance contracts; and aggregation, and this is expected to change how these are reported.
The list above is not exhaustive and in addition, entities that that issue insurance contracts will need to reassess their approach to forecasts, personnel changes and compensation among other things.