My IFRS17... Q & A
With this in mind we’ve asked Legerity’s IFRS Global Lead Mark Miller, a qualified accountant (ACA) with over 20 years of experience of IFRS and finance change programs, to answer your IFRS 17 questions.
1) What is the difference between IFRS 4 and IFRS 17?
IFRS 17 is a fundamental change from IFRS4, which at the end of the day was only supposed to be a temporary standard. The goal of IFRS 17 is to align with the other developments in IFRS, and importantly to align the industry around a common set of accounting principles, to improve comparability.
At the heart of IFRS 17 is the established IFRS principle of recognising revenue as products and services are provided to the customer. To do this in the case of insurance companies, the standard has created a concept of the Contractual Service Margin (“CSM”). This is a measure of the unrealised profit. It is sometimes referred to as the liability for coverage. The CSM is then released to the P&L as the obligations under the insurance contract are performed by the insurer.
To make this work there are plenty of complications around measuring this profit, with some variations in the models, assessing and measuring risk, dealing with finance impacts, losses and how to group contracts into measurement buckets.
2) What data do I need for IFRS 17?
The foundation of IFRS 17 is the policy or contract so data around that is the first step. Next is how to measure the profit or CSM for the policy and for that you need a view of future expected cash flows over the life of the policy, including data on the impacts of time value of money and risk. The life of the policy is defined by the contract boundary which may relate to a contractual period or may need to be estimated. Once the policy is active data should be sent for the customer transactions. These will include items such as premiums, claims, expenses such as brokerage and commissions and internal costs like underwriting and policy admin expenses.
The complication for this data is that it will need to be relatable to the policy. IFRS 17 allows or even requires policies to be grouped into measurement buckets, and data will need to be supplied in a way that can be related to these groups. As coverage is provided data will be required that is a measure of the coverage provided in the period. The final major category of data will around market assumptions around currency rates and inputs for discount rates.
3) What kind of system requirements are needed for IFRS 17?
When the IASB published IFRS 17 they gave no guidance on how to implement it. It is really up to insurers how they go about it and consequently a number of approaches are possible. What is clear is that in the overall system landscape certain functionality will be required.
Existing actuarial and GL systems will need to be modified to reflect the new IFRS 17 actuarial calculations and accounts respectively. In between there is a requirement to perform new calculations that bring together the actuarial results into the CSM and release it for coverage. The balances for the CSM and other contract asset and liabilities need to be tracked and the movements converted into accounting movements held within a Sub-Ledger.
As this is a finance standard this all needs to be very controlled with strong audit functionalities and facilities to allow actuaries and accountants to validate and reconcile information. The IFRS 17 standard includes some quite detailed requirements for disclosure which need to be managed from the balances which will require storing and reporting them at a granular level. To deliver such granular data in an automated and cost-effective way it is advisable to consider modern technology.
4) What benefits can I get from my IFRS 17 investment?
At one level IFRS 17 is an overhead, it could be viewed as simply a non-value add compliance exercise. But that would be short sighted and would miss the wider opportunity to deliver significant business benefits. Back office functions have traditionally suffered from under investment. With a digital future looming, now more than ever, is a need to invest in technology that can enable future transformation.
Given the right choices are made, IFRS 17 represents a fantastic opportunity to leverage that investment and go beyond compliance and create a foundation for a digital future. Now is the time when technologies such as cloud, in memory data grid processing, open source software are readily available. These all lower the cost of ownership, can enable greater automation and efficiency and ultimately give finance and risk functions the tools to add value in the business.
5) We have completed IFRS 17 impact analysis what should we do next?
Impact analysis is a useful and vital exercise and can be very informative for management. However, even those insurers who perform a very in depth exercise often struggle to take the next step. It is a big leap to move directly into vendor contracts and project implementation. A sensible approach is to run a Proof of Concept (“PoC”). This approach allows you to test ideas and get greater visibility into the data journey from extract to report.
Often many architectural choices are unclear after impact analysis and a PoC can help management visualise a use case giving insight into what will work for them. A well run PoC need not be a throw away exercise and the outputs can form input into the planning and analysis phase and accelerate implementation. Indeed many insurers now are using PoCs as part of their vendor selection process to evaluate best fit and capabilities. Learn more about the Legerity Cloud based IFRS 17.
6) Can I leverage solvency II for IFRS 17?
After all the money spent on Solvency II it is understandable that many insurers are looking to leverage their investment for IFRS 17. Some aspects will certainly be capable of forming a base and for sure the knowledge gained during the process will be of great value. However, if we consider Solvency II a snapshot of the business, IFRS 17 can be considered a video. Some of the data and actuarial calculations will be useful inputs into the IFRS 17 solution but at the end of the day, IFRS 17 is a wholesale change in the end to end accounting process.
So rather than think of IFRS 17 as an evolution of Solvency II it is better at an early stage to think of IFRS 17 as something new. That way you will get to better solutions quicker through a proper appreciation of the challenge. Having said that, you are then well placed to utilise the capabilities in people, systems and data developed during the Solvency II project, to make your IFRS 17 implementation more efficient. Another consideration is to ensure that in your IFRS 17 solution you include reconciliation and validation of IFRS 17 outputs against your Solvency II reporting and try as far as possible to integrate relevant processes.
7) How long will it take to implement IFRS 17?
This question is of course very difficult to answer and in short there are two classic responses, one will be, it depends and the other will be Jan 2022 minus now! At Legerity we have a proven capability in implementing IFRS change programs and have developed a clear methodology with accelerators. Our base estimations for the time taken to set up, configure and test our part of the solution is between 9 months to 1 year. Additional time is then required for system integration and initial data load. We look to run things in waves to ensure the client gets quick wins and can see progress.
We also recommend a modular approach allowing progress to made on the easier areas, giving more time for challenging aspects. Typical areas where problems can occur are around requirements definition and of course data. Both areas where insurers should start work ASAP. Another important consideration is infrastructure, cloud-based projects are increasingly becoming the go to approach and significantly shorten timelines for setting up the software and infrastructure.
8) How is reinsurance handled under IFRS 17?
Under IFRS 17 reinsurance is treated as an insurance contract. Both the general measurement model and the simplified approach can be used. The variable free approach is however not permitted. There is no netting in IFRS 17, and so underlying insurance and reinsurance are accounted for separately.
The key difference with reinsurance is that the CSM can be both negative or positive, i.e. losses / costs are not automatically taken to the P&L. Although netting is not allowed under IFRS 17, insurers are now permitted to take into account the CSM position of the underlying insurance when looking at CSM movements on the related reinsurance, with P&L gains booked to the extent that underlying business is onerous. This makes the calculations quite complex so it is important to consider how this can work in the solution.
Another difference with reinsurance is in the reporting and disclosures which differ from the underlying insurance business.
9) What do I need to do to create my opening balances for IFRS 17 transition?
In other IFRS change programs the companies were forced to load all historic data for active contracts. In IFRS 17 the IASB has recognised that for many insurance companies, especially those with long term contracts, this may not be possible. It therefore gives insurers some options. If data is reasonably available, then a full data load is required under the approach called Full Retrospective. This is like simulating the historic month ends.
The alternative approach is the Modified Retrospective which gives the insurer the ability to make some assumptions. The exact assumptions that are allowed are prescribed which limits the flexibility of this. The final option is the Fair Value approach which allows insurers to effectively value the contracts as if they were purchased.
Clearly these considerations will have big impacts on the results of insurance companies so investors will want full transparency on the assumptions made. The standard also has a full set of disclosure requirements about transition.
10) What happens when a non-onerous group becomes onerous?
When a group becomes onerous the IFRS 17 standard requires that the loss is fully recognised in the P&L immediately and no CSM is held on the balance sheet. The Fulfilment Cash Flows are maintained and released to revenue as coverage is provided. The loss is unwound over time from expenses to revenue so that by the end of the contract revenue and expenses fully reflect the actual loss incurred.
If at any point the contract group becomes not onerous again then a CSM is recognised to the extent that the future profit is greater than the loss less any amounts un-wound to date. IFRS 17 requires disclosures around the recognition of losses and the movements.
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