What will IFRS 17 mean for the insurance industry, both commercially and strategically? Carmen Iftode explains
Will IFRS 17 bring the comparability it promises?
Under IFRS 4, which allows local GAAP (generally accepted accounting principles) practices to be used by insurance companies, the same type of insurance contract can be treated differently in different countries. This limits cross-border comparability. One of the motivating objectives of IFRS 17 is to increase comparability not just between countries, but also between different types of insurance contracts, and between industries.
However, full comparability will be difficult, at least initially, as differences can still arise due to different (but acceptable) interpretations of the principles-based standard. For example, the contractual service margin (CSM) at transition will depend on the company’s transition approach (full retrospective, modified retrospective or fair value), the choice of which is discretionary to an extent. Some companies will be taking advantage of transition as a one-off opportunity to ‘restate’ their balance sheet, and different strategies will lead to different transition balance sheets. The resulting transition CSM will have an impact on the profit release.
Companies will need to strike a balance between implementation efforts and the fine-tuning of their results, and some companies may have an advantage here. Big multinational companies will have more resources to implement ‘optimised’ but complex methodologies. Smaller companies could struggle with such calculations due to a lack of resources, and thus choose approximations and simplifications where allowed to by the standard. This could, in some cases, result in lower relative levels of CSMs, and potentially lead to these companies being seen as less profitable.
Over time, as the existing transitioned business runs off, comparability under IFRS 17 is expected to improve. The increased transparency and additional disclosures required will also make some of the methodology choices public (for example the risk adjustment methodology, the approach used to determine discount rates and so on). This will make stakeholders aware of differences in approaches, and will improve overall comparability relative to IFRS 4.
Investors will need time to become familiar with IFRS 17. In a 2020 Willis Towers Watson survey, most respondents indicated that additional disclosures would be required to understand insurance companies’ earnings under IFRS 17. Nevertheless, insurance companies could become more attractive to investors due to the increased transparency and amount of information disclosed.
How ready is the industry for transition?
Most companies are not ready. In the same 2020 survey, only a small percentage of respondents indicated that they have a good understanding of IFRS 17’s business implications.
Key performance indicators (KPIs) and business planning are two key areas that remain open. New KPIs will need to be introduced, and there is no market consensus yet on which to adopt. KPIs that are linked to profitability will have to be revisited. For example, KPIs in relation to earnings will be impacted by the profit recognition pattern over time. Recognising the CSM slowly in the early years could lead to potential back-ended earnings, and investors will expect explanations. For property and casualty companies, the combined ratio may be impacted by the level of non-directly attributable expenses and directly attributable expenses.
Some products, especially long-duration products, may need a redesign to be viable in the IFRS 17 world. Take, for example, a term insurance product that is currently sold on an aggressive basis to attract policyholders. Under IFRS 17, these policies may be onerous, and companies will be required to isolate them for the calculation (and release) of the CSM and report on these contracts separately. Investors will be able to identify those products sold at an initial loss. Depending on the size of such loss-making policies relative to the company’s overall business volume, they could be a red flag for investors and lead them to question the sustainability of the business. As a result, companies may want to re-price these products for new business. For consumers, this could potentially mean an increase in premiums in certain lines of business.
Business planning is the next implementation step for many companies. While many companies view transition as complete once systems and balance sheets are ready, transitioning to ‘business as usual’ is also a significant part of the process, and should be an important part of any company’s implementation plans. It is crucial for companies to be aware of what could go wrong after day one in an IFRS 17 world. For example, if a company discovers, post-transition, that it has used inappropriate assumptions for the transition calculations, it will need to amend subsequent results and explain the change. Under any accounting standard, this could lead to reputational risk, as stakeholders may view the company as lacking robust processes and good governance controls. The risk may be greater under IFRS 17 than under current reporting standards due to the higher level of transparency and detail entailed, and the relatively long time the industry has had to prepare for transition.
Are there still any open questions in the standard?
In Europe, the European Financial Reporting Advisory Group’s (EFRAG) final endorsement advice to the European Commission leaves uncertainty around the annual cohort requirement. This is an area that has generated lots of debate, as the current requirement does not reflect the economics of the business for intergenerationally mutualised and cashflow-matched contracts, common in many European countries. This is the only aspect that EFRAG has not reached a consensus on, and is currently with the European Commission to assess. In the past, EFRAG has suggested an exemption for these mutualised contracts, which would allow companies to have cohorts with policies issued more than one year apart. It is not yet clear whether an exemption will be allowed, and as of April 2021, no recommendation or decision has been reached.
Another area of uncertainty for companies in the UK is Brexit. The UK Endorsement Board (UKEB) is responsible for endorsing and adopting IFRS 17 in the UK. Timelines for UK adoption are unclear at the time of writing and will depend on when the delegation of power to the UKEB will take place (expected this year).
How will IFRS 17 impact business operations?
IFRS 17 is much more than just an accounting standard; it will have a significant impact on a company’s end-to-end process, from data sources and data management to actuarial models and accounting systems. These operational changes will have an impact on management practices and business strategies.
It also blurs the line between accounting and actuarial work, and will require actuaries and accountants to work together more, for both the production and auditing of the results. It’s currently not clear who should have responsibility for signing off the results – the accounting team, the actuarial team or both? This may ultimately be decided by local regulatory and accounting bodies.
How can companies leverage their IFRS 17 project?
IFRS 17 has been a catalyst for many companies to undertake finance transformation programmes, triggering redesign and optimisation of processes. Companies that have implemented flexible, basis-agnostic systems will be better placed to exploit their features and optimise strategic decision-making in future.
For example, enhanced data capabilities, adopted because of IFRS 17 requirements, could lead to more granular experience analysis and better pricing. Such incremental advantages could lead to a competitive edge in complex insurance markets.
And insurance companies can go further than automation: the next step is optimisation. The goal here is to remove inefficiencies, duplication or legacy tasks that are no longer required. This can result in reduced run-time and could free up computational power. Automated processes, especially if optimised, give companies additional time and resources to concentrate on value-adding activities, such as the definition and refinement of KPIs, results analysis and strategic projects.
Carmen Iftode is a senior consultant at Willis Towers Watson and a member of the IFoA's IFRS 17 Contractual Service Margin Working Pary.
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