IFRS 17 will ensure greater transparency

International Financial Reporting Standards (IFRS) 17, the new accounting standard for insurance contracts issued by the International Accounting Standards Board (IASB) earlier this month represents a landmark change in the accounting for insurance companies, including insurers in the UAE and the wider Middle East region.

The new standard, which will replace IFRS 4, will apply to annual periods commencing on or after January 1, 2021.

The next three years up to implementation are likely to present impacted entities in the region with several opportunities and some potential challenges.

One of the main criticisms of IFRS 4 was the permissibility of a number of accounting policy choices which resulted in a lack of comparability within the same insurance group.

In fact, accounting policy choices would inevitably be regulatory or industry-driven, formed as a result of interpretations taken from a number of local Generally Accepted Accounting Principles (GAAPs).

IFRS 17 aims to overcome this limitation.

From an accounting perspective, it enables significant differences in liability measurement and profit recognition, including three principle methods that insurers will need to consider when measuring liabilities and recording premiums.

The ‘General Model’, also known as the ‘Building Block Approach’ (BBA) will now be the default model for most companies. The ‘Variable Fee Approach’ (VFA) which is an adaptation of the BBA, will be applicable to contracts with direct participation features (e.g. unit-linked or with-profit businesses). The ‘Premium Allocation Approach’ (PAA) which is a more simplified approach will be applicable to short-duration contracts.

A new requirement of the standard is for companies to record a Contractual Service Margin (CSM), which is the spreading of the unearned profit an entity would record over the life of a policy.

This profit is adjusted to reflect the impact of changes in expected future cash-flows which are discounted and amended to incorporate a risk adjustment, all of which will require detailed disclosures in an entity’s financial statements.

The PAA is a more simplified approach to the measurement of liabilities for remaining coverage and is applied to groups of contracts if the coverage period is one year or less. It is also expected to provide a measurement of the liability for the remaining coverage that is not materially different to that produced by the IFRS 17 general measurement model.

The enhanced disclosures will mean that investors, shareholders and regulators will now have significant insight into earnings patterns being achieved by companies providing more visibility on margins earned by insurers split between underwriting, investments and costs.

This could be a challenge for some entities in the local market where segment reporting still remains high-level. From a profit-recognition stand point, volatility in profit and equity, enhanced disclosures and the option to recognise changes in fair value in Other Comprehensive Income (OCI) are likely to impact assessment. For investors and analysts, the new standard conveys greater comparability and transparency.

Insurance companies will need to study the standard to understand their implications, but it is important to note that the provisions are similar to Solvency II in Europe. These existing systems will serve as a useful starting point for IFRS 17 implementation. However, it would be important to appreciate the differences in the frameworks. Like IFRS 9 for banks, IFRS 17 also attempts to leverage on the insurance entities’ regulatory reporting framework.

Another potential challenge is that IFRS 17 is likely to demand certain specialised skills that are not easily available.

Further, like IFRS 9, IFRS 17 is likely to involve more coordination between finance, actuarial and risk management departments. This is likely to present challenges that were not encountered before in a financial reporting environment. Therefore, it is important to manage market expectations and develop a communication strategy to be a key part of the project implementation plan.

It is important to recognise that IFRS 17 is not just a change in technical accounting requirements, but is likely to impact businesses such as product design, distribution, employee remuneration, budgeting, forecasting and tax positions.

The manner in which data is collected, analysed and stored is also likely to see a paradigm shift and systems will need to be enhanced, or in some cases completely overhauled, for companies to be able to correctly report the disclosures required in their financial statements.

Entities impacted by IFRS 17 would do well to set up a project team to study the impact and build an implementation plan after considering the opportunities, threats and challenges of the new standard.

— Yusuf Hassan is a Partner, Risk Consulting, and Adil Abid is a Partner, Financial Services at KPMG Lower Gulf.