The pace of the accounting change decisions impacting insurers on both the asset and the liability side has recently accelerated.
At a time when the IASB is sharpening the pencil to write a new Insurance Contracts standard (IFRS 4 Phase 2), and the industry is looking to accommodate the different effective dates between this standard and the new standard for Financial Instruments (IFRS 9), the industry reaction in Asia is quite heterogeneous.
For instance, most Singaporean undertakings have not yet analysed the financial impacts of these two major accounting changes, but Hong Kong’s leading companies are being more proactive, currently evaluating spreadsheet models and plans for production. There is, however, an urgent need to get a more holistic view of the impacts, including on strategy and future investor stories, as well as of the operational and finance considerations.
In December 2015, the IASB issued an Exposure Draft (ED) to amend the current IFRS 4 standard in order to address the concerns of the insurance industry around the difference in effective dates between the first implementation of IFRS 9 (1 January 2018) and the application of IFRS 4 Phase 2.
This ED presents two options to insurers: the first option allows insurers to exclude from profit and loss the impact of the new classification for financial assets backing insurance contracts; the second option offers insurers the opportunity to defer the implementation of IFRS 9 until the sooner of 2021 and the first application of the future Insurance Contracts standard (IFRS 4 Phase 2).
Even though this decision has been welcomed by the market, it still includes some conditions that could push a number of insurers to apply IFRS 9 as soon as 2018.
During its January 2016 meeting, the IASB cleared two critical outstanding issues of IFRS 4 Phase 2, with respect to the level of aggregation of contracts and to the effect of discretion on participating contracts. These two decisions should be positively perceived by the industry.
Following this, the Board was asked to review the due process steps taken in developing the model over the last two years and requested permission to begin drafting the new Insurance Contracts standard in February. Permission was granted at a meeting on the 16th of February, meaning that there will be no further exposure drafts, and the final standard is now expected by the end of the year or early next year.
EY recently invited staff from the finance functions of insurers in Hong Kong and Singapore to breakfast seminars on the future IFRS 4 and the implementation of IFRS 9.
Hot topics included different effective dates of IFRS 4 Phase 2 and IFRS 9, treatment of participating contracts, the unit of account and transitional arrangements.
Singapore insurers adopted a “wait and see” approach
Insurers in Singapore have generally taken a “wait and see” approach to the new standard. Over 40% of participants indicated that they do not know when they intend to start implementation, and over 25% of participants would wait for the IASB’s final decision to address the different effective dates of IFRS 4 Phase 2 and IFRS 9.
When asked for opinions on which areas will be affected by the new standard, participants believe reporting (including Key Performance Indicators), and actuarial modelling are the two areas where they foresee most changes happening. This is consistent with our view that IFRS 4 Phase 2 will require insurers to fundamentally re-assess how they report their financial results.
Interestingly though, no participants thought product development and sales would be impacted by the new Insurance Contracts standard. This is an area insurers should investigate in more depth once they have started the implementation process and better understand the effects of this new standard on running and managing their business.
During the EY session in Singapore, over 35% of participants did not have a view on whether the “deferral” solution on different effective dates for IFRS 9 and IFRS 4 Phase 2 proposed by the IASB for insurers was suitable, while 30% of participants thought it was a suitable solution but that the insurance predominance threshold to qualify for deferral should be lower.
The worldwide industry reaction is in line with this latter position. Undertakings are also pushing to get a test at the entity level rather than at the reporting level to accommodate the position of bancassurers.
Several Hong Kong insurers have begun preparations
Some participants in Hong Kong thought the predominance test should be further refined, while others suggested a qualitative approach be introduced in addition to a quantitative test.
In Hong Kong, several of the large insurers have begun planning and prototyping in advance of the release of the final standard. These companies have small teams in place, and are intending to ramp up their activities throughout 2016.
Although they are further ahead in planning on the technical issues, it is still currently seen as a predominantly actuarial and financial reporting project. We expect this to change in the coming months, with wider involvement, including input from the IT function, and more interest from senior management.
It was also of interest to hear that some companies with regional offices in Hong Kong are expecting the local businesses to drive the bulk of the implementation work. This is in contrast to Solvency II programmes run by some of the same companies, which were primarily managed from head offices.
Practical implementation issues
There will be a number of practical difficulties in implementing the new Insurance Contracts standard for Asian insurers.
For European insurers that are expected to leverage the investment in Solvency II solutions, there are already some important differences such as the Contractual Service Margin (CSM), locked-in discount rate requiring data storage or presentation, and disclosure requirements that will require extra work to fully address. Insurers that have not previously invested in Solvency II capabilities must expect to:
• enhance IT systems for data storage due to finer granularity;
• implement integrated reporting processes across finance, actuarial, tax, risk and IT, taking into account local IFRS, group reporting and local statutory financial statements;
• develop new models including stochastic capabilities to measure cost of options and guarantees; and
• structure training to develop experience and expertise on the new standard.
Total cost of implementation is expected to be in the millions of US dollars.
The transition exercise will be very specific to individual firms, depending on the capacity of the company to trace back historical data to build a full retrospective valuation. This will be key since the CSM at transition date will represent the future income of the company on the inforce business.
Where to start
We expect that the IASB will be aiming to finalise the new Insurance Contracts standard towards the end of 2016 with a potential effective date no earlier than 2020. This means that insurers will have to produce at least one year of comparative results on that effective date. Insurers are running with a very tight timeline given the level of changes needed within their organisations. The Board of directors or the analysts will ask about the impact of such changes and the cost of implementation very soon.
There are many advantages for insurers to act early. Identifying strategic and operational impacts of IFRS 4 Phase 2 will enable insurers to develop primary and contingency plans for the most critical issues, eg data collection, model development and refinements, robust and auditable closing processes and investor communication.
An effective implementation plan will also help insurers to manage overall costs and to set out efficient processes and system solutions for the new reporting cycle. Finally, the undertakings can already start gathering all necessary data on newly issued contracts and build up this information over the next four years for the transition period.
We recommend that the industry follows what we are already seeing in Europe: companies are starting with a small but comprehensive exercise, running gap analysis projects to fully measure the operational and financial impacts and to assess the cost to deliver overall. For those involved in the drafting of the IFRS standards, the process has been a marathon. For insurers themselves, the final sprint to the finish line will start this year.
Mr Patrick Menard is Financial Services, Partner, Mr Phil Joubert is Actuarial and Insurance Advisory, Director and Ms Vanessa Lou is Advisory Services, Associate Director 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.