IFRS 17: Insurance Contracts
IFRS 17: Insurance Contracts is a new accounting standard issued by the International Accounting Standards Board (IASB) that sets out the principles for the recognition, measurement, presentation, and disclosure of insurance contracts.
It replaces the interim standard, IFRS 4, and is effective for annual reporting periods beginning on or after January 1, 2023 (globally not universally). We shall cover journey of IFRS 17 in upcoming post.
The primary objective of IFRS 17 is to provide a consistent and transparent accounting framework for insurance contracts globally. It aims to improve the comparability of financial statements across insurance companies and with other industries by providing more relevant and faithful representation of an insurer's financial position and performance.
KEY PRINCIPLES AND COMPONENTS:
IFRS 17 is a significant overhaul of insurance accounting, moving away from a patchwork of diverse practices to a single, consistent model. The core of the standard is the requirement to measure insurance liabilities based on a "current value" approach, which is comprised of three key building blocks:
1. Fulfilment Cash Flows (FCF): These are the current estimates of the future cash flows that an insurer expects to collect from premiums and pay out for claims and benefits.
The FCF are composed of:
- Future cash flows: These include all expected future premiums, claims, and expenses.
- Discount rate: The future cash flows are discounted to their present value using a discount rate that reflects the time value of money and the characteristics of the cash flows.
- Risk Adjustment (RA): This represents the compensation that the insurer requires for bearing the uncertainty about the amount and timing of the future cash flows. It is a provision for non-financial risk.
2. Contractual Service Margin (CSM):
This is the unearned profit of the insurance contract. It represents the profit that the insurer expects to earn over the life of the contract for providing insurance services.
- The CSM is initially recognized as a liability on the balance sheet.
- It is then recognized as revenue in the profit or loss statement over the coverage period as the insurer provides services.
- The CSM cannot be negative. If the fulfilment cash flows at initial recognition indicate a loss, that loss is recognized immediately in the profit or loss statement.
MEASUREMENT MODELS:
IFRS 17 provides three different measurement models, depending on the nature of the insurance contract:
Model 1 - General Measurement Model (GMM):
This is the core model and is applied to most insurance contracts. It requires the measurement of the liability as the sum of the FCF and the CSM. The FCF are updated at each reporting date to reflect current estimates, while the CSM is adjusted to reflect changes in future cash flows and is systematically released into profit or loss.
Model 2 - Premium Allocation Approach (PAA):
This is a simplified approach that can be used for short-term contracts (typically one year or less) or contracts where the PAA closely approximates the GMM. Under the PAA, the liability for remaining coverage is measured as unearned premiums, and the liability for incurred claims is measured using the GMM.
Model 3 - Variable Fee Approach (VFA):
This model is used for insurance contracts with "direct participation features," where the policyholder receives a substantial share of the returns from a clearly identified pool of underlying assets. The VFA is a modification of the GMM, with a key difference being that changes in the insurer's share of the fair value of the underlying items are adjusted against the CSM rather than being immediately recognized in profit or loss.
IMPACT ON INSURANCE COMPANIES:
The implementation of IFRS 17 has a profound impact on insurance companies, affecting their financial reporting, systems, and operations.
Financial Reporting and Comparability:
IFRS 17 introduces a standardized framework that enhances transparency and comparability across the industry, making it easier for investors and analysts to understand and compare the financial health and performance of different insurers. It changes the timing and recognition of profit, with profit being recognized as services are delivered rather than when premiums are received.
Data and Systems:
The new standard requires insurers to collect and process a significant amount of new data, particularly for actuarial and accounting purposes. This necessitates major changes to IT systems, data infrastructure, and processes to support the new measurement models and extensive disclosure requirements.
Profitability and Volatility:
The immediate recognition of losses on onerous contracts and the ongoing updates to FCF can introduce more volatility into the profit and loss statement. However, the standard allows for a choice to present the effects of changes in discount rates in Other Comprehensive Income (OCI) to mitigate this volatility.
Operational Changes:
The move to IFRS 17 requires closer collaboration between actuarial, accounting, and IT teams. It also necessitates a review and potential overhaul of internal controls and governance to ensure compliance and accuracy in financial reporting.
TRASNSITION TO IFRS 17:
Companies transitioning to IFRS 17 have several approaches available:
Full Retrospective Approach: This is the preferred approach and involves applying IFRS 17 as if it had always been in effect.
Modified Retrospective Approach: This approach is used when a full retrospective application is impractical. It uses a combination of retrospective and prospective application, aiming to achieve the closest possible outcome to the full retrospective method.
Fair Value Approach: This is an alternative to the modified retrospective approach, measuring the insurance contract liability at the transition date using fair value.
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