IFRS 17 is complex, and many insurance firms feel there is a lack of understanding regarding the new accounting standard.
Through training, firms can make the wider organisation aware of the importance of IFRS 17 within. A better understanding across all departments will aid firms during the transition period, and better prepare insurers for achieving compliance by January 2022.
In our latest online tutorial above, we look at what’s new about IFRS 17, the Contractual Service Margin, Unit of Account, varying rules for insurance firms and transitioning your existing business.
IFRS 17 is a new accounting standard that relates to accounting for insurance contracts.
It replaces IFRS 4, and is intended to deliver better alignment, transparency and consistency across the insurance industry.
IFRS 17 must be delivered by the 1st Jan 2022.
To create the opening balance sheet and comparatives, insurers will need to look back, sometimes many years.
What is new about IFRS17?
Profits cannot be booked on day 1 of the contract.
The insurance liability now includes a liability for coverage.
The liability for coverage is released as services are provided.
IFRS 17 calls this liability for coverage the Contractual Service Margin.
How is the Contractual Service Margin measured?
The CSM is measured using all the risk-adjusted, discounted future cash flows of the contract.
This includes premiums, claims, acquisition costs, related expenses and where appropriate investment components.
These cash flows may need to be discounted and the discount rate is fixed after inception.
A risk margin is then calculated called the risk adjustment.
The total result is called the fulfilment cash flows. So, we have future cashflows + discounting + risk adjustment = fulfilment cash flows = contractual service margin.
What is the unit of account in IFRS17?
Policies must be grouped together, and the standard gives some rules for this.
Policies with similar risks that are managed together must be grouped.
The groups cannot cover polices written more than 1 year apart, these we can call cohorts.
Each cohort must be split into groups of polices that are onerous or loss making, those than will never be onerous and those that might become onerous.
The unit of account or group is therefore a function of the portfolio, time and profitability and once a policy is assigned to a group it cannot move.
Is there one rule for all insurance companies?
The core measurement model is called the General Model or Building Block Approach, but there are variations for polices with direct participating features called Variable Fee Approach (“VFA”).
In VFA no interest is accreted on the CSM, but it is adjusted for the movement of the entities profit from investment activities.
There is a simplified version for polices of less than 1 year called the Premium Allocation Approach (“PAA”).
In the PAA the liability is measured based on the premium. This approach can be applied for longer polices, but in that case, insurers have to show the result is similar to the general model.
Transitioning your existing business to the new standards
And finally, Insurance firms need to think about transition – the period when your existing business needs to be transitioned into the new standards. Three accounting options apply during this time.
Insurers should process their data from policy inception to the implementation date using the full rules as if they had reported at the time. This is called full retrospective approach.
This may not be possible in all cases. The standard has some options called the modified retrospective approach, where some assumptions can be made.
There is also the fair value approach, where the initial recognition at the transition date is based on the fair value of the contracts.
Implementing IFRS17 is not easy with challenges around data, systems and people. It is however a great chance to upgrade the back office in preparation for the new digital world.
To learn how IFRS 17 is an opportunity for transformation within your firm, please contact Legerity today.