Preparing for IFRS 17 Standard: Insurance Contracts

The IFRS 17 Standard, “Insurance Contracts,” represents a fundamental change in how insurance companies account for insurance contracts and is the culmination of a project that spanned more than two decades. The IFRS 17 Standard replaces the interim IFRS 4, “Insurance Contracts,” and provides a more comprehensive and consistent accounting model that aims to improve the quality, transparency, reliability, and comparability of financial information related to insurance contracts. In this article, we will provide a guide to preparing for the IFRS 17 Standard, discuss its objectives, scope, and key requirements, focusing on the new measurement model, the expected challenges in implementation, and the steps necessary for a smooth transition to this standard.

What is the IFRS 17 Standard: Insurance Contracts?

The IFRS 17 Standard is a comprehensive international accounting standard that specifies how to recognize, measure, present, and disclose insurance contracts in the financial statements of insurance companies. This standard applies to all types of insurance contracts (including reinsurance contracts) that an entity issues, to reinsurance contracts that it holds, and to certain investment contracts with discretionary participation features.

Objectives of the IFRS 17 Standard:

• Provide a Comprehensive Accounting Model for Insurance Contracts: It aims to provide a comprehensive and consistent accounting framework for all types of insurance contracts, regardless of the type of contract or the issuer.
• Improve the Quality of Financial Information: The IFRS 17 Standard provides more accurate and reliable information about the obligations and profitability of insurance companies, thereby enhancing the quality of financial reporting.
• Increase Transparency and Comparability: It helps increase the transparency of financial information related to insurance contracts and improves the comparability of financial statements of insurance companies globally.
• Provide Better Information for Decision-Making: It provides more useful information to users of financial statements, such as investors and analysts, helping them better assess the performance of insurance companies and make informed investment decisions.
• Keep Pace with Developments in the Insurance Industry: This standard addresses the shortcomings of IFRS 4 and provides an accounting model that is more suitable for the complexities of modern insurance products.

Scope of the IFRS 17 Standard:

This standard applies to:

• Insurance contracts that the entity issues.
• Reinsurance contracts that the entity holds.
• Investment contracts with discretionary participation features issued by the entity, provided that the entity also issues insurance contracts.

The IFRS 17 Standard excludes from its scope:

• Financial guarantee contracts (covered by IFRS 9).
• Employee benefit plans (covered by IAS 19).
• Contractual rights and obligations contingent on the future use of, or right to use, a non-financial item (such as some leases and royalty payments) (covered by their respective standard).
• Certain guarantees related to the sale of goods (covered by the IFRS 15 Standard).
• Loan guarantee contracts (unless the issuer has previously explicitly asserted that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts).

Key Requirements of the IFRS 17 Standard:

The IFRS 17 Standard introduces a new accounting model for insurance contracts based on three main measurement models:

1. General Model (Building Block Approach – BBA):
   • This is the basic model for measuring insurance contracts under the IFRS 17 Standard.
   • It consists of four building blocks:
     • Estimates of Future Cash Flows: The company must estimate the expected inflows and outflows of cash from insurance contracts, including premiums, claims, and contract administration expenses.
     • Discount Rate: Future cash flows are discounted using a discount rate that reflects the time value of money and the characteristics of the cash flows.
     • Risk Adjustment: Represents compensation for bearing the risk of uncertainty related to future cash flows.
     • Contractual Service Margin (CSM): Represents the unearned profit of the insurance contract and is recognized as revenue over the coverage period.
2. Premium Allocation Approach (PAA):
   • This is a simplified model for measuring short-term insurance contracts (usually 12 months or less).
   • It can be used if it provides a measurement of the liability for remaining coverage that is not materially different from the building block approach.
   • Premiums are recognized as revenue over the coverage period.
3. Variable Fee Approach (VFA):
   • This is a specific model for measuring insurance contracts that include direct participation in investment returns.
   • The contractual service margin is adjusted to reflect changes in the fair value of the investments.

Steps for Applying the Building Block Approach (BBA):

1. Identify Groups of Insurance Contracts: Insurance contracts must be aggregated into portfolios consisting of contracts with similar risks that are managed together. Within each portfolio, contracts are divided into groups based on their profitability (profitable contracts, non-profitable contracts, contracts that may become profitable).
2. Estimate Future Cash Flows: Expected cash inflows and outflows must be estimated for each group of insurance contracts, taking into account all available and reasonable information.
3. Determine the Discount Rate: A discount rate must be determined that is appropriate for the characteristics of the expected cash flows and reflects the time value of money.
4. Calculate the Risk Adjustment: A risk adjustment must be calculated for each group of insurance contracts, representing compensation for bearing the risk of uncertainty related to future cash flows.
5. Calculate the Contractual Service Margin (CSM): At initial recognition, the contractual service margin is calculated for each group of insurance contracts so that no profit is recognized at the beginning of the contract.
6. Recognize Profit over the Coverage Period: The contractual service margin is recognized as revenue over the coverage period, reflecting the pattern of service provision under the insurance contract.

Recognition and Measurement under the IFRS 17 Standard:

• Recognition: Insurance contracts are recognized in the financial statements at their inception, i.e., when the entity becomes a party to the contract.
• Measurement: Insurance liabilities are measured using the building block approach (or the premium allocation approach in some cases) at the reporting date.

Impact of the IFRS 17 Standard on Financial Statements:

• Statement of Financial Position: The application of the IFRS 17 Standard is expected to lead to significant changes in how insurance liabilities are measured and presented in the statement of financial position.
• Statement of Profit or Loss: The IFRS 17 Standard will affect the timing of profit recognition from insurance contracts, as profit will be recognized over the coverage period instead of being recognized upfront.
• Disclosures: The IFRS 17 Standard imposes comprehensive disclosure requirements aimed at enabling users of financial statements to understand the nature and impact of insurance contracts on an entity’s financial position, financial performance, and cash flows.

Challenges in Applying the IFRS 17 Standard:

• Complexity of the Standard: The IFRS 17 Standard is a complex standard that requires a deep understanding of the new measurement model and its requirements.
• Need for Detailed Data: Applying this standard requires the availability of detailed historical and future data on cash flows related to insurance contracts.
• Changing Systems and Processes: Applying the IFRS 17 Standard may require significant changes in the accounting systems and processes of insurance companies.
• Need for Specialized Expertise: Insurance companies may need to rely on experts specializing in International Financial Reporting Standards, especially in the areas of valuation and actuarial science.
• Cost of Implementation: Applying the IFRS 17 Standard can be costly, especially in the early stages of implementation.

Preparing for the IFRS 17 Standard:

Insurance companies must prepare well for the IFRS 17 Standard to ensure a smooth transition to the new standard. The steps to prepare for the IFRS 17 Standard include:

• Understand the Requirements of the New Standard: Insurance companies must carefully study the IFRS 17 Standard and understand its requirements comprehensively.
• Assess the Impact of the IFRS 17 Standard on the Company: Companies should assess the impact of applying this standard on their financial statements, systems, and processes.
• Develop an Implementation Plan: Companies should develop a detailed plan for implementing the IFRS 17 Standard, including the implementation timeline, required resources, and key responsibilities.
• Update Accounting Systems and Processes: Companies may need to update their accounting systems and processes to be able to collect the necessary data and apply the new measurement model.
• Train Employees: Companies must train their employees on the requirements of the IFRS 17 Standard to ensure they understand and apply the standard correctly.
• Communicate with Stakeholders: Companies should communicate with stakeholders, such as investors and analysts, to explain the impact of the IFRS 17 Standard on their financial statements.

Role of Technology in Applying the IFRS 17 Standard:

Accounting software and Enterprise Resource Planning (ERP) systems help in applying the IFRS 17 Standard more efficiently and accurately through:

• Automating complex calculations.
• Managing data related to insurance contracts.
• Performing the analyses necessary to assess the impact of the IFRS 17 Standard.
• Generating the reports necessary to comply with disclosure requirements.
• Improving the accuracy and comprehensiveness of financial information related to insurance contracts.

Conclusion

The IFRS 17 Standard represents a milestone in the history of insurance accounting, as it provides a new accounting model that aims at improving the quality, transparency, reliability, and comparability of financial information for insurance contracts. Applying this standard requires the insurance companies to be well prepared for IFRS 17 Standard, completely understand its requirements, and make changes to their accounting systems and processes. Early and effective preparation for IFRS 17 Standard will help insurance companies seamlessly transition to the new standards, comply with their requirements, and enhance the confidence of investors and other stakeholders.

Understanding the IFRS 17 Standard and their impact on the financial statement is essential for accountants, auditors, investors, and anyone trying to understand the insurance business.