By Sabra Salum | The Citizen | November 11, 2021
For the financial sector, regulatory change is a constant. From an accounting perspective, one of the most dramatic recent changes (especially for the banking sub-sector) was the International Financial Reporting Standard-9 (IFRS-9) dealing with financial instruments, and which applies to accounting periods beginning on or after January 1, 2018. A similarly dramatic change is in store for the insurance sub-sector – what with the introduction of IFRS-17 on Insurance Contracts. This will replace IFRS-4, and will apply to the accounting periods beginning on or after January 1, 2023.
To recap: the whole concept of insurance centres around a person (policyholder) who enters into a contract (policy) with an insurer where the policyholder, in return for a premium (amount paid or to be paid), receives policy benefits (money, services and/or other benefits). It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss. Unsurprisingly, the complexities involved in such arrangements also give rise to accounting complexity.
The current basis for accounting for all insurance contracts is IFRS-4, which was designed as an interim standard. It allows entities to continue with their existing accounting policies for insurance contracts if those policies meet certain minimum criteria, including that the amount of the insurance liability is subject to a liability adequacy test. This test considers current estimates of all contractual and related cash flows, and if it identifies that the insurance liability is inadequate, then the entire deficiency is recognised in the income statement.
By contrast, under IFRS-17 the general model requires entities to measure an insurance contract at initial recognition at the total of the fulfilment cash flows (comprising the estimated future cash flows, an adjustment to reflect the time value of money and an explicit risk adjustment for non-financial risk) and the contractual service margin (CSM). The fulfilment cash flows are re- measured on a current basis at each reporting period. The unearned profit (CSM) is recognized over the coverage period.
Aside from this general model, the standard provides, as a simplification, the premium allocation approach. This simplified approach is applicable for certain types of contracts, including those with a coverage period of one year or less.
IFRS-17 will result in significant changes to the way that financial information is presented and it’s adoption will require significant planning. And yet, based on the responses to PwC’s East Africa IFRS-17 Survey (conducted in October 2020), there is a long way to go on the preparation front. In particular, 39 percent of respondents had not started training on IFRS-17. 30 percent had not started gap analysis. 46 percent had not started system impact assessment. 48 percent had not performed financial impact assessment. 46 percent did not have an IFRS-17 implementation plan. 70 percent had not started a detailed design on the model to be implemented, and 83 percent had not started a dry run of the model which will be integrated into their financial systems.
Getting an early start will allow insurers to avoid significant challenges and last-minute rush on implementation of complex standards similar to those experienced during the adoption of IFRS-9. Implementation challenges that insurers and other key stakeholders should anticipate include issues relating to data, actuarial considerations, policy choices, transitional considerations, and resource considerations.
As regards data, insurers are fast realising the need for a fundamental shift in the way data is collected, stored and analysed with IFRS-17 bearing in mind the change of emphasis from a prospective to retrospective basis of analysis as well as the expectation of a more granular level of measurement.
Actuarial input will significantly increase as a consequence of the need to calculate detailed discounted and undiscounted cash flows including risk adjustments and CSM. Businesses who will invest in more modern actuarial reporting platforms and automated processes will have better chances of meeting critical reporting deadlines, whether at month/quarter/year end.
IFRS-17 is likely to provide a number of policy choices and options not least around use of other comprehensive income to manage profit and loss volatility and the use of the Premium Allocation Approach for short duration business. In choosing the preferred policy or option, it will be important to take account of the impact on the tax position, interaction with IFRS-9 and other relevant business performance metrics. Insurers who have begun to assess these options are finding that choices are not as clear cut as they might have envisaged.
Transition to IFRS-17 will provide both a challenge and an opportunity as it will allow various simplifications and judgments, and decisions made around the CSM at transition are likely to impact profit recognition over many subsequent years.
IFRS-17 will also present demanding resource needs – internally there will be a need for increased finance, actuarial and risk management coordination; externally, there may be a limited skilled resource pool to call upon and so early efforts to secure appropriate resources will be important.
All insurance companies reporting under IFRS will be impacted by the new reporting standard when it becomes effective. What is not in doubt is that – with the effective date of adoption (January 1, 2023) fast approaching – it is paramount that all stakeholders are engaged early enough in the IFRS-17 implementation plans.