Leslie Vermaak, Senior Manager
We are close to a new IFRS insurance contracts accounting standard (IFRS 17). IFRS 17 is expected to be issued in the second half of May 2017 with an effective date of 2021. A structured approach to IFRS 17 project planning will help overcome challenges and maximise opportunities to this significant new standard. Leslie Vermaak, Senior Manager PwC, presents some of the biggest challenges for insurers and how insurers can prepare.
IFRS 17 introduces new concepts and requirements which are complex; these include, for example, the Contractual Service Margin (CSM) which represents unearned profit; the fact that revenue (and not premiums written, earned or due) should be presented in the income statement; and the tracking of onerous contracts. Furthermore, the level at which insurance contract liabilities are to be measured will in many instances be at a more granular level than the level that many insurers currently utilise for their insurance contract liabilities measurement. The new level of aggregation or unit of account is referred to as ‘a group of insurance contracts’. The number of ‘groups of contracts’ can be a key driver of complexity, due to the data requirements and the impact on systems.
In order to cope with the complexities, heavy reliance will need to be placed on systems.
Insurers will likely be able to utilise some existing systems. If this is the chosen strategy, then extensive overhauls might be required with new modules to be added, for instance a module to calculate and maintain the CSM as the CSM is a new concept that is not currently being calculated and maintained by existing systems. In contrast, other insurers might opt to develop or purchase new systems. Key considerations would be the quality of legacy systems and the need for change of existing systems (for instance, if many different legacy systems are currently being used).
Insurers might be able to utilise some existing data, for instance certain elements of Solvency II data (although some elements may have the same name but be measured differently under IFRS and Solvency II). However, data that is not currently stored on an insurer’s systems will have to be obtained if the data is available. Furthermore, and insurer would need to capture and retain not only more data than under Solvency II (for instance historical data, data related to the calculation and release of the CSM, data related to the income statement, data for disclosure purposes, etc.); but also different data than under Solvency II (for instance using different discount curves, a different risk adjustment, etc.).
If data is available, then an insurer needs to measure insurance contracts with retrospective effect. That is measuring the insurance contract as if IFRS 17 always applied. However, if data is not available, then two other transition approaches can be chosen from (the modified retrospective transition approach or the fair value transition approach). The CSM value at the transition date might differ, depending on whether an insurer elected to apply the modified retrospective transition approach or the fair value transition approach. Depending on the availability of data, insurers would typically carefully consider the most appropriate transition approach as the CSM value at the date of transition directly impacts on future profit. Though judgmental, I expect transition, including the identified transition approach, to be an area of audit focus.
A significant risk insurers are facing is that, by starting too late, they will run into difficulty to be ready on time. The issuance of IFRS 17 in May will mean insurers will have approximately 3.5 years to implement this complex new standard. During this period insurers will need to understand the requirements of IFRS 17, assessing the impact of IFRS 17 (including the impact on results), develop and test systems, ensure systems interface correctly, review and test results and adjust processes and procedures. How these figures are then communicated to the market will also need to be considered.
Many insurers currently use a form of locked-in measurement base in valuing insurance contract liabilities, whether for the discount rate (for instance statutory prescribed discount rates); or for the assumptions that are being applied (for instance, assumptions are only being updated when insurance contract liabilities prove to be inadequate). In contrast, IFRS 17 will require a form of current measurement of insurance contract liabilities. This means that insurance contract liabilities need to be remeasured at every reporting period. The remeasurement at every reporting period I would expect will introduce volatility for most insurers.
IFRS 17 permits the application of the so-called “OCI-option” where for specific types of insurance contracts interest rate movements are not accounted for in the income statement but in Other Comprehensive Income (OCI). However, while the OCI-option may help to reduce P&L volatility, it introduces additional complexity to systems and reporting.
Variable fee approach
Certain contracts with participating features need to be measured applying the variable fee approach (VFA). A benefit of the VFA is that interest rate movements are not accounted for in the income statement or in OCI, but against the CSM. This means that volatility in the income statement and OCI may be largely negated. Furthermore, the complexities associated with the OCI-option do not exist.
Premium allocation approach
An insurer may simplify the measurement of the liability for remaining coverage, using the premium allocation approach (note that no simplifications exists for the liability for incurred claims). I expect that many non-life insurers would want to use the premium allocation approach, due to the simplifications it introduces. However, the premium allocation approach can only be used if specific conditions are met, including when the coverage period is 12 months or less. When the coverage period is more than 12 months, specific requirements need to be considered and discussed and cleared with the insurer’s auditors.
Geplaatst op: 5 februari 2018
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