IFRS 17 will revamp insurance industry

Previously there are no specific way to account for insurance contracts. The accounting treatment differs between different jurisdictions, which makes it very difficult to compare one insurance company to another. Even within South Africa, life insurers do not account for the profit arising from insurance contracts in the same way as companies set different levels of discretionary margins using the financial soundness valuation (FSV) basis.

IFRS 17 requires that the profit from insurance contracts be recognised over the period that the entity provides insurance coverage (by the straight-line amortisation of unearned profits) and as the company is released from insurance risk (through unwind of the risk adjustment).

When measuring an insurance contract liability all future cash flows within the boundary of the contract should be included. The contract boundary determines the duration for which cash flows are included in the insurance contract measurement and ends when the insurer has the right or ability to change contractual terms to fully adjust for the risks in a contract at a point in time.

The contractual terms will define the contractual boundary and it is expected that this may well represent a shorter time period than under current accounting practices. The contractual boundary requirements in IFRS 17 align with the requirements included in SAM but it will be different from the requirements under the FSV.

IFRS 17 will define a basis for deriving insurance contract revenue which will be consistent with that of IFRS 15, the new accounting standard on revenue. Insurance revenue is derived by the movement in the liability for remaining insurance coverage. Changes to the current practice will include:

• for life insurers, no longer recognising premiums when due;
• for short-term insurers, no longer recognising gross written premium in the income statement;
• exclusion of deposit elements - which could lead to a significant reduction in revenue and insurance claims recognised in the income statement for some insurers; and
• the straight line amortisation pattern of unearned profits but taking into account the time value of money through accreting interest on unearned profits.

IFRS 17 could well become a key performance indicator (KPI) as more consistent information is provided relating to insurance contracts. A common KPI in the long-term insurance industry is the embedded value (EV) of a company. This provides investors with information on the economic performance of an insurer. EV is not a consistent metric globally as there are different methodologies, for example: market consistent EV, European EV as well as South African EV. With the introduction of a consistent IFRS accounting basis under IFRS 17 in 2021, the methodology for determining EV globally may well change to use a then consistent IFRS as the starting point for this calculation instead of local solvency measures. However, IFRS 17 alone is not expected to satisfy all of investors’ information needs.

The standard has an effective date of 1 January 2021 and replaces IFRS 4, which is an interim standard. As the standard will have a pervasive impact on insurers (both from an operational as well as a financial perspective) focus areas for insurers should include:

• education and awareness training of staff;
• impact assessments on the operational as well as financial changes necessary;
• project planning that includes providing for the necessary budgets and resources; as well as
• considering interaction with ongoing or planned projects, specifically finance transformation work.

Significant changes to systems and processes will be likely - to be able to obtain the granular data for the measurement and disclosure requirements of IFRS 17. Insurance companies should assess the impact of different assumptions and approaches now and ensure that the necessary work is performed and the necessary resources for the implementation are available.

IFRS 17 will result in an overhaul of financial reporting for insurers. It is important that companies communicate the impact of the standard to internal as well as external shareholders to ensure that they are aware of the impact going forward.