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Mar 2021

IFRS 4 amendments to address the different effective dates of IFRS 9 and IFRS 17: What you need to know

Source: Asia Insurance Review | Nov 2016

Mr Jonathan Zhao and Mr Phil Joubert of EY explain the two alternative options – temporary exemption and the overlay approach – for entities issuing contracts within the scope of IFRS 4. 
  • The IASB amended IFRS 4 to address potential issues arising from the different effective dates of IFRS 9 and IFRS 17; 
  • The two options – a temporary exemption and the overlay approach – have extensive systems and process implications; and
  • Neither option gives insurers a way to significantly defer the investment needed to handle the new reporting regime.
Insurers reporting under IFRS are faced with two big accounting projects over the next few years: IFRS 9, which will mostly affect the asset side of the balance sheet, and IFRS 17 (previously referred to as IFRS 4 Phase II), which will mostly affect the liability side. 
   IFRS 9 will go into effect in January 2018. However, the IASB are still finalising IFRS 17. The result is that IFRS 17 will have a later implementation date, probably January 2020 or 2021.
   Insurers have raised three concerns about this timeline:
  1. Accounting mismatches and temporary volatility in Profit and Loss (P&L) could occur if they apply IFRS 9 before IFRS 17.
  2. Classification and measurement of financial assets under IFRS 9 might have to be revisited when adopting IFRS 17 to minimise accounting mismatches.
  3. Two sets of major accounting changes in a short space of time will result in significant cost and effort for both users and preparers of financial statements.
   The IASB agrees that these are valid concerns, and decided to amend the existing IFRS 4 to address them. 
   EY’s latest Insurance Accounting Alert “IASB issues amendments to IFRS 4 to address the different effective dates of IFRS 9 and IFRS 17” has an in-depth description and analysis of the changes.
What you need to know
  • The IASB amended IFRS 4 to address issues arising from the different effective dates of IFRS 9 and the upcoming new insurance contracts standard IFRS 17. Entities issuing insurance contracts will still be able to adopt IFRS 9 on 1 January 2018.
  • The amendments set out two alternative options for entities issuing contracts within the scope of IFRS 4: a temporary exemption, and an overlay approach.
  • The temporary exemption lets some eligible entities delay the implementation date of IFRS 9 if they are “predominantly” insurers. (see below) 
  • The overlay approach allows an entity applying IFRS 9 to remove the effects of some of the accounting mismatches by introducing a line item in the P&L which transfers elements to Other Comprehensive Income (OCI). (see below) 
  • Both options have extensive systems and process implications.
  • The changes are largely in line with discussions held at IASB meetings over the past 12 months.
Temporary exemption
The temporary exemption can only be applied by a reporting entity if its activities are predominantly connected with insurance. To assess predominance, the entity must sum the values of:
  • Its liabilities from contracts within the scope of IFRS 4 -including deposit and unbundled components, and
  • Non-derivative investment contract liabilities measured at fair value through P&L, and
  • “Liabilities that arise because the insurer issues, or fulfils, obligations arising from the contracts...above”.
   The ratio of this sum to total liabilities is called the Predominance Ratio (PR). Entities with a PR greater than 90% can apply the exemption. Entities with a ratio of 80% or less cannot. Entities which fall in between can apply the exemption, if they do not engage in a “significant activity unconnected with insurance”. 
   The amendments give some guidance for assessing whether or not this is the case, as well as guidance on which liabilities can be counted in the third category above, but leave final interpretation open to discussion between the company, its auditors and its advisors. 
   The amendments also list a number of disclosures that companies will need to make when applying the exemption. They include the details of the PR calculation, and the values of the assets the insurer holds. Assets must be split into categories defined by IFRS 9 concepts, including “solely payments of principal and interest” (SPPI) and low credit risk.
   Preparing for the disclosures under the temporary exemption will require significant effort. For example, insurers will need to implement processes and systems for the SPPI test and for determining which assets do not have low credit risk. 
   Insurers who are confident of qualifying for the exemption should not assume that this means they can defer related implementation projects.
Overlay approach
The overlay approach allows an insurer to exclude from P&L certain effects of IFRS 9, by introducing an “overlay adjustment” which reclassifies some amounts to OCI. 
   The insurer can elect to apply the overlay approach on an instrument-by-instrument basis. Eligible instruments are those which are measured at FVPL under IFRS 9 but not under IAS 39, and assets held in respect of insurance business. The exact wording of the amendments excludes assets held by a banking subsidiary and certain other cases.
   The entity then applies IFRS 9 to the balance sheet and Statement of Comprehensive Income (SCI), but calculates the overlay adjustment to transfer the difference between the IAS 39 values and the IFRS 9 values from P&L to OCI for the chosen instruments.
   As for the temporary exemption, the revised standard requires the entity to disclose the details of the overlay adjustment.
   The overlay approach does not have a predominance threshold, so entities not qualifying for the temporary exemption could still make use of the overlay approach. However, the application of the overlay approach, and the systems required to implement it, are likely to be complex. 
The IASB has produced a compromise set of options to address concerns about the different implementation dates of the two largest ever changes to insurance accounting. The details of the two options are complex, and some decisions will come down to negotiation between companies and their auditors.
   However, concerns remain about the size of the changes and the resources needed to implement them. The reality is that neither option gives insurers a way to defer investment in systems, processes and people to handle the new reporting regime.
   The effective date of IFRS 9 (1 January 2018) is approaching rapidly, so insurers need to decide which approach they will take towards applying IFRS 9 together with IFRS 17 as soon as possible, and start implementation without delay.
Mr Jonathan Zhao is Asia-Pacific Insurance Leader and Mr Phil Joubert is a director in Actuarial and Insurance Advisory, both at EY.
This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Member firms of the global EY organisation cannot accept responsibility for loss to any person relying on this article.
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