The International Accounting Standard Board (IASB) yesterday issued a new insurance contracts standard, International Financial Reporting Standards (IFRS) 17 Insurance Contracts, the most significant change to insurance accounting requirements in 20 years. IASB says that the standard will help investors and others better understand insurers' risk exposure, profitability and financial position. Challenges, however, exist in its implementation.
IFRS 17 solves comparison problems by requiring all insurance contracts to be accounted for in a consistent manner, benefiting both investors and insurance companies. Insurance obligations will be accounted for using current values – instead of historical cost. The information will be updated regularly, providing more useful information to users of financial statements.
International professional services company EY finds that IFRS17 will trigger a landmark shift in the financial reporting of insurers under IFRS, and marks a fundamental change to current practice across the industry. Insurers providing long-term contracts will be most affected.
The new standard will require insurers to provide a balance sheet valuation of their insurance liabilities that combines a measurement of the expected probability weighted future cash flows based on updated assumptions, with the recognition of profit over the period that services are provided under the contract, says EY.
Mr Martin Bradley, EY Global Insurance Finance, Risk & Actuarial Leader, said: “These changes will coincide with other changes to the reporting for financial assets under IFRS 9 Financial Instruments, and will potentially bring more volatility in reported profit.”
Preparation should start soon
The effective implementation date of 1 January 2021 will give insurers a transition period of around three and a half years after issuance of the standard. While the IASB has stated that the implementation period is relatively long compared with other standards, the complexity of IFRS 17 will be such that companies will need to start preparing for implementation very soon, as insurers will be required to estimate historical amounts when transitioning to the new standard, says EY in a statement.
Mr Kevin Griffith, EY Global IFRS 17 Accounting Change Lead, said: “While the standard will not become effective for a few years, the impact is likely to be felt much sooner by insurers. Investors are likely to ask for expected impacts ahead of the implementation date, and the decisions made by insurers at the date of transition to the new standard will have a significant impact on future profitability.
“New systems and processes will have to be built to produce and report the numbers, and metrics for steering the business will change. Ultimately, the implications of IFRS 17 will go well beyond the reporting function and affect many parts of the organisation.”
Separately, Willis Towers Watson, the leading global advisory, broking and solutions company, warns that implementation will be a major challenge for insurers and investors.
Mr John Nicholls, Senior Consultant and Willis Towers Watson’s lead on IFRS for insurers in Asia Pacific, said: “IFRS 17 is more than ‘just’ an accounting change, and will have a wide and significant impact on insurers’ operations.”
He said: “Four years may seem like a long time, but adequately preparing for the new complexity of IFRS 17 will be a challenge, particularly in Asia where there is a diversity of current accounting practices.” The additional complexity will also affect communication with investors.
Analysis by Willis Towers Watson notes that some of the biggest challenges for insurers include:
- Interpretation and judgement: IFRS 17 is truly principles-based, which in most cases will mean it is the insurer’s responsibility to ensure policies and disclosures comply with the standard’s requirements, rather than it being able to rely on prescriptive and detailed rules.
- Dealing with volatility in profits: The hybrid model proposed will increase volatility compared to existing models, particularly those based on locked-in assumptions.
- Managing stakeholder expectations: Explaining IFRS 17’s impact on profits and equity, and the variances to current GAAP and reporting under applicable regulatory regimes will require robust processes, a keen grasp of the individual differences and a transparent communication strategy. This may affect dividend paying capacity, management bonuses and market-wide performance metrics.
Impact on ratings
Meanwhile, Fitch Ratings says that IFRS17 will not trigger any immediate rating changes when it comes into force.
“New accounting standards have no immediate impact on an insurer's credit profile as they do not change the economic substance of its balance sheet. The assets held and the financial commitments to customers and creditors are unaffected - it is only their presentation in the accounts that changes,” said the international rating agency.
In the medium term, accounting standards may influence insurers' business models, which could affect their credit profile. In particular, the timing and profile of profit recognition under an accounting system may make certain products more or less attractive. The sensitivity of accounting metrics to interest rates and financial markets may influence the design and mix of products that insurers offer, their asset-liability management, and their hedging and dividend policies.