A standard changing more than accounting processes
After years of discussion the IASB issued the new standard for insurance contracts on the 18th May in 2017. IFRS 17 will replace IFRS 4 as accounting standard for the handling of insurance contracts by insurers worldwide.
The implementation of IFRS 17 will most likely change many processes, but not only in the accounting but also for the actuaries and underlying IT systems. The detailed measurement approach under the new standard will also highly affect the transparency of the insurers which will include the top management in the implementation process as well.
So, what’s new?
IFRS 17 requires the insurers to separate several parts of the insurance contracts in order to report each component with a different standard. One example here could be the separation of a possible service component, which now will be reported under IFRS 15 and thus actively excluded from the insurance component. Also, investment components will be reported under the also newly implemented standard IFRS 9, which had its effective date on the 1st January in 2018.
The separated insurance component which now will be reported under IFRS 17 is then grouped on a more granular level than it has been done under IFRS 4. The three groups of insurance contracts will now disclose the margin characteristic of the respective insurance portfolio. The aggregation level of contracts under IFRS 17 will look as follows:
- Insurance contracts, which do not have a significant possibility of becoming onerous
- Onerous contracts: Insurance contracts, which are onerous at initial recognitionInsurance contracts, which do not have a significant possibility of becoming onerous
- Other contract: Grouping of remaining contracts in the portfolio
Implications
Both, the separation of insurance contracts and the detailed aggregation level of contracts require a substantially well-structured contract database. Thus, before starting the implementation of IFRS 17 insurers need to analyze their contract database and make sure everything is in place to follow the requirements of the new standard.
In order to comply with the new standard insurers might be forced to build new insurance portfolios to keep up with the requirements of IFRS 17. For example, D&O liability contracts show a significantly different risk structure than common liability insurance contracts. Under IFRS 17 those contracts need to be aggregated to different insurance portfolios. Again, this aggregation goes back to the contract database and the possibility to detect and categorize the specific characteristics of insurance contracts.
The most substantial change, however, is the measurement model, called Building Block Approach, which is used under IFRS 17 to assess insurance contracts. The building block approach is divided into four building blocks:
First Building Block: Estimated Figure of the contractual fulfilment cash-flows
Second Building Block:: Discounting in order to take the time value of money into account
Third Building Block: Compensation in form of a risk margin for the non-financial risks of the contract
Fourth Building Block: Residual figure which represents the Contractual Service Margin (CSM) for the insurer
Under specific circumstances (e.g. the contract duration is below one year) insurers are allowed to use a more simplified measurement model, called the Premium Allocation Approach. This approach is similar to the assessment of contracts under the replaced standard IFRS 4. However, even though many contracts will fall under this condition, insurers need to be aware that due to the above-mentioned granularity of requirements, it is likely that processes and roles will change in corporations which will require a significant focus on the implementation of IFRS 17 of the stakeholders.
Where to start?
In order to understand the complex implementation logic of IFRS 17 one must understand the new processes of the new standard and the involved stakeholders. Basically, you can divide the process into three main parts, which also means there are three (or even more) cornerstones of a process where you could start setting up a project.
- Preparation of qualified data
- IFRS Measurement
- Posting
We at SOICON developed a complexity map in combination with a detailed process architecture under IFRS 17 to understand the importance of starting the implementation based on a qualified contract database. Once a data-matrix is developed, insurers have the basis for important decision along the way (e.g.: Which measurement model can be used to assess the group of contracts – Building Block Approach or Premium Allocation Approach?).
It is thus highly recommended that before programming new reporting logics (Posting), and before start measuring insurance contract based on current portfolios (IFRS Measurement) insurers need to build a solid data matrix, which compiles all contract information needed under the new standard IFRS 17.
Scenario calculation and IFRS 17 levers
Due to the new reporting logic of insurance components the disclosure of the ratio between technical and non-technical insurance results will change with the implementation of IFRS 17. With that being said, the contract separation of different contract parts also allows insurers to use several levers to distribute e.g. acquisition costs, or service costs, during the reporting process.
The risk margin of non-financial risks, as the third building block of the new measurement model, represents also a useful lever under IFRS 17 to control the disclosed contractual service margin for the group of insurance contracts.
With the developed scenario calculation, we can use exemplary contract data of, for example, liability contracts in order to show how the disclosure of the technical and non-technical insurance result will look like under IFRS 17 as oppose to the disclosure under IFRS 4. By highlighting the important levers of the reporting process, it is recognizable (even before starting the implementation) where to focus on during the concepting phase of the IFRS 17 implementation.
Process integration and new roles
The implementation map shown above indicates that during the process of the implementation the involved parties need to work closely to achieve a successful transition to the new IFRS 17 standard. Accounting experts, actuaries, IT business analysts need to be managed closely throughout the whole project as the single steps of the implementation are highly interdependent. Also, as mentioned above, the early involvement of the management is crucial for important and pioneering decisions.
For an IFRS 17 project, insurers not only need a project manager to steer the stakeholder towards a common goal, they also need an intermediary role between the three involved parties along the new process architecture: Accounting, actuaries, and IT. This intermediary role is as important as the involvement of a change manager as not only processes but also roles are likely to change. The high involvement of the actuary in the management decisions, puts the actuary in a new role during the reporting process. IFRS 17 requires the insurers to disclose the calculation of the risk margin, which also highly affects the outcome of the residual contractual service margin.