Authored By Peter Thiga
IFRS 17 is the newest IFRS standard for insurance contracts and replaces IFRS 4. IFRS 17 is a harmonized accounting model for insurance contracts, enabling transparency of the companies’ financials which in turn allows peer comparisons to be relatively harmonized.Though it is a big change for insurance companies as data administration, financial presentation and actuarial calculations will need to change; It is paramount that Investors, Shareholders and Clients of insurance companies understand the financial viability of the company that serves them.The changing of accounting methods in the insurance sector will help industry players to get a better understanding of insurance companies.
IFRS 17 is to be implemented by January 1st, 2023. We expect the changes to be in the Life Insurance business segment. Life Insurance contracts generate variable cash flow over a long period, unlike general insurance contracts that are considered short-term. Let us walk through the new approach step by step. When an insurance company enters into a new contract with a client, they make estimates of all the cash flows that they expect to receive and expect to pay over the coverage period as below: All inflows are recorded such as premiums and deductibles to all future outflows such as claims, administration, and acquisitions.
The cash flow needs discounting to their present value. IFRS 17 applies risk adjustment. It represents compensation for the risks taken over from the policyholder. This process is known as the fulfilment of cash flow. The remaining slice is the contractual service margin (CMS). The contractual service margin (CSM) represents the expected profit in insurance contracts. The CMS is going to be one of the key performance indicators for insurance companies, among others. It provides an opportunity for insurers to think of how to manage their profits over time.
Before IFRS 17, insurance companies used the IFRS 4 standards. Although IFRS 4 is a good standard, it faced significant challenges in providing a basis for performance comparison among insurance companies. One of the bottlenecks was IFRS 4 used different accounting policies per insurance contract. It has led to the lack of comparability among insurance companies, also the lack of comparability of insurance companies with non-insurance companies. The discount rate is based on the value of the investment as opposed to the cash flows of the contract. Also, insurance companies experienced difficulties in identifying key profit drivers of profits.
Why is IFRS 17 essential?
In our opinion, IFRS 17 provides an opportunity to top management to identify opportunities to transform their finance, risk, and actuarial processes. IFRS 17 presents new benefits such that valuing liabilities can now be at market value and increases in transparency through harmonized financial process allowing you to have a true reflection of profits on financials. In addition, it helps strengthen the balance sheets of Insurance companies offering more protection to policyholders.
The standards will be a positive disruption to the insurance sector, but we expect challenges. Firstly, it will be costly to implement. The accounting standard is data-driven, resulting in significant changes in the processes. As a result, the modes and methods of operations willbe affected. Secondly, IFRS 17 is principle-based. Principles are the same across the board for all insurance companies, but how they measure risk in insurance contracts is left to the insurance company. The exact comparison between insurance companies will still not be entirely possible.