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Jul 2020

PwC: Gearing up for a paradigm shift

Source: Asia Insurance Review | Jul 2017

Global Asia Regulation

The issuance of IFRS 17 by the International Accounting Standard Board (IASB) recently was the most significant change to insurance accounting requirements in 20 years. Ms Woo Shea Leen and Ms Ang Sock Sun, both from PwC Singapore, share how insurers can gear up for this paradigm shift in reporting standard. 
With IFRS 17, the new insurance contract standard looming over the horizon, it is imperative for insurance companies to recognise that the new standard is a lot more than just an accounting change. Beyond its obvious impact on profitability and market-wide performance metrics, insurers will find a whole new challenge in implementing the standard from an operational and systems perspective. 
   The difficulty of this project will also depend on the specific circumstances of each insurer at the time of implementation. For example, countries like Australia and China have adopted accounting standards with principles similar to IFRS 17 and insurers from these countries may find the introduction of this standard less daunting.
System architecture
The IT systems of many insurers were put in place in the 1980’s and 1990’s. To cater for the challenges over the years, many have either upgraded existing systems or put in place new ones but very few have completely swapped out or modernised their systems over the last five to 10 years. This now makes a systems refresh or change both very challenging and likely to be very costly.
   A lot of the difficulty in applying IFRS 17 centres around the ability of systems to obtain, store and analyse data. Examples of this include: -
  1. Analysing data with sufficient granularity to identify and “aggregate” insurance contracts into appropriate portfolios or groups;
  2. Monitoring inception dates and coverage periods of the abovementioned portfolio or group of insurance contracts;
  3. Being able to store information about historical, current and future cash flows, discount rates and risk adjustments for each portfolio or group of insurance contracts; and
  4. Determining the contractual service margin, accrete interest on the contractual service margin and recognising the contractual service margin for each portfolio or group of insurance contracts in profit or loss. This is widely recognised at the largest cost driver across IFRS 17.
   The degree of difficulty and cost to implement an appropriate IFRS 17 system architecture depends primarily on the maturity of the as-is architecture already in place and the insurer’s aspirations to either simply meet requirements or consider this as an opportunity to transit to a more mature architecture.
   Nonetheless, this may be the best opportunity for insurers to completely refresh and modernise their systems to remove legacy barriers and future-proof their business, navigate disruption while considering the implementation of IFRS 9, which is by no means any less challenging than IFRS 17 given how they interact with one another.
Operational changes
Prior to IFRS 17, the information required to account for insurance contracts are largely available in source systems, for example, the underwriting, claims or policy administration system. The actuaries will then estimate the insurance contract liabilities in parallel to the rest of the financial reporting process.
   With the new standard, gone are the days where insurance revenue is measured based on premiums due or received. Instead, insurers are required to measure insurance contracts to reflect probability weighted cash flows. This includes the timing and the risk of those cash flows. 
   Data is first extracted from the source systems to be included in the actuarial and risk system. Consequently, the resulting information computed through the use of actuarial techniques is then used in the financial reporting process to account for insurance contracts.
   The new disclosure requirements introduced by the new standard (eg estimation approaches, risk information, level of confidence) is also going to result in changes to an insurer’s reporting processes (see Figure 1). 
Financial Reporting Process
   As a result, a significant degree of integration is required between the financial reporting, actuarial and risk processes in addition to system architecture changes mentioned in the previous section. 
   As with the case of adopting any new process for financial reporting, insurers need to redesign and test the effectiveness of governance and controls to ensure that results are reported both timely and accurately. The effort will then be compounded if the insurer is required to run parallel systems for both financial and regulatory reporting should there be differences in the two bases.
Impact on working day timetables and regulatory reporting
Compiling an IFRS 17 result is likely to elongate most companies’ working day timetables. Many existing systems already do not have the flexibility to model different scenarios or change assumptions within the reporting timetable. 
   As calculations become much more complex alongside significant increases in the volume of data, results will take longer to compile. Moreover, it is likely to be more challenging to get at the right data. And that is after all the system integration challenges and teething issues have been resolved.
   This becomes a lot more demanding with regulatory reporting in the picture. At this point in time, except for Australia, Korea and Malaysia where efforts are put in place to align regulatory reporting requirements with IFRS 17, most countries in Asia are planning to retain incumbent reporting models.
   Under IFRS 4, insurance companies are allowed to adopt or “grandfather” an existing accounting policy that is more or less consistent with regulatory reporting. This reduces the strain of having to maintain two sets of numbers for reporting.
   IFRS 17 is unfortunately going to significantly increase the divide between financial reporting and regulatory reporting requirements.
   Nonetheless, given that IFRS 17 is principles-based, insurance companies should find every opportunity to leverage on the existing regulatory reporting techniques and in working within the boundaries of what is acceptable under the new standard, reduce the gap and strain on their operations. It is therefore imperative for insurers to bear this in mind when optimising their timetable and resources for the future state of processes, governance and controls. 
In closing, the above are just some examples of the many challenges insurers are likely to face with the introduction of this new accounting standard. 
   Operational challenges and complexities arising from transition, interaction with other accounting standards (eg IFRS 9) and possible vendor solutions are also popular topics for conversation but there is simply too much to cover in such a short span. Do keep an eye out over the coming months as more practical matters begin to surface over time. A 
Ms Woo Shea Leen is Insurance Leader and Ms Ang Sock Sun is Insurance Accounting and Regulatory Advisory Leader, both from PwC Singapore. 
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