IASB considers an overlay for classification and measurement of financial assets in the comparative period on initial application of IFRS 17.

At its meeting on 27 May 2021, the IASB discussed approaches proposed by the IASB staff in response to concerns raised by stakeholders regarding accounting mismatches that could arise between financial assets and insurance contracts in comparative information when IFRS 17 and IFRS 9 are first applied. No decisions were made at this meeting.

Insurers are required to restate IFRS 17 comparative information on initial application (eg. 1 January 2023). However, restatement of comparatives on initial application of IFRS 9 is optional, (and only allowed when it can be done without the use of hindsight). In addition, if an entity does restate IFRS 9 comparative information, it is prohibited from applying IFRS 9 to any assets that have been derecognised before the initial application date. This means that insurers who restate comparatives for IFRS 9, will have some financial assets in the comparative period (eg. 2022) accounted for applying IFRS 9, and others applying IAS 39 (until they are derecognised). This could create mismatches with the accounting treatment applied to insurance contract liabilities restated under IFRS 17. Similar mismatches could arise for insurers who choose not to restate comparatives and instead apply IAS 39 in the comparative period. Operational challenges could arise from these requirements given the population of derecognised assets would only be known at the end of the comparative period (eg. 31 December 2022).

The IASB discussed a potential amendment to IFRS 17 to permit a classification overlay for financial assets, that an entity can select on an instrument-by-instrument basis in the comparative period, if IFRS 9 was not applied to those assets.  

The potential amendment would apply only:

·       To a financial asset that is related to insurance contract liabilities; and

·       If the information needed to apply the classification overlay approach was obtained at the transition date of IFRS 17, meaning that the approach could be applied without the use of hindsight.

The classification overlay approach is intended to achieve classification outcomes more consistent with what they would have been under IFRS 9. For example, a derecognised financial asset that was at amortised cost under IAS 39, could be classified as either Fair value through profit or loss (FVPL) or Fair value through other comprehensive income (FVOCI) if that would achieve greater consistency with the application of IFRS 9.

 The following table from the IASB staff paper for the meeting provides details of possible classification changes between IAS 39 and IFRS 9 which an entity might make on adoption of IFRS 9, and indicates whether this change would result in a change in measurement of a financial asset on the balance sheet, and/or changes in profit or loss and other comprehensive income. The table then goes on to note whether the proposed classification overlay would achieve greater consistency.

As the proposed amendment would be made in IFRS 17, it would not change the transition requirements of IFRS 9. Assessments required by IFRS 9, such as determining the entity’s business model for managing financial assets, or significant increases in credit risk, would still be applied only from the date of initial application. (An entity would continue to apply the incurred credit loss model in IAS 39 to assets derecognised in the comparative period rather than the expected credit loss model in IFRS 9).

 Observations from the Board meeting

The IASB staff noted that this paper reflected a revised approach after having received feedback from stakeholders on previous proposals in an IASB staff paper originally posted on 17 May 2021.  

Board members were broadly supportive of the proposal, noting that this would be a limited narrow-scope amendment that would keep an otherwise stable platform for implementation. The proposal was made in response to new information that has come to light on the magnitude of the issue arising from the application of the IFRS 17 and IFRS 9 transition requirements. While the classification overlay could reduce comparability between insurers, it would have a short-lived effect.  

However, Board members commented that this amendment will be hard to draft and to scope. Several Board members highlighted areas where greater clarity would be needed in drafting: for example whether this amendment would apply just to derecognised financial assets, or to a broader range of financial assets to which an entity applies IAS 39 in the comparative period. What constitutes ‘assets related to insurance contracts’ would also need to be clearly defined.  

While some Board members stated that this proposal is IAS 39 with a classification overlay (for the assets to which the amendment would be applied), others noted it could be viewed as effectively IFRS 9 classification and measurement without the full requirements in respect of business model and contractual cash flow characteristics. 

Some Board members noted complexities that could arise for entities that provide more than one year of comparatives. There would need to be consistency between the treatment of financial assets in all the comparative periods.

Next steps

The IASB staff will develop the proposal further in response to Board comments and prepare a follow up paper for discussion at a future meeting. In order to provide the intended relief for entities transitioning to IFRS I7, the staff’s aim is to finalise any narrow scope amendment to IFRS 17 by the end of this year.

 How we see it

·       The accounting mismatch caused by financial assets derecognised during the comparative period is relevant to several insurers, potentially significant, and may make financial statements more difficult to understand. In particular, the issue could be relevant to insurers who measure financial assets related to their insurance contract liabilities at amortised cost rather than fair value, and who do not use a current measurement model in valuing insurance contracts applying IFRS 4.

·       Insurers will therefore welcome the IASB’s consideration of an amendment to address the accounting mismatch. With the classification overlay, the Board is not only seeking to provide a solution to accounting mismatches, but also aims to address some concerns around operational complexity.

·       The Board members asked for clarification on several matters concerning the potential amendment. One important area of clarification is whether the classification overlay would apply only to entities that decide to restate comparatives for IFRS 9, or also to entities that will not restate. This is because, as observed by the IASB staff in the material for the meeting, these insurers would be affected by these mismatches in a similar way. Moreover, for entities not restating comparatives for IFRS 9, the impact of an accounting mismatch, and, thus, the impact of a potential classification overlay to mitigate it, might be larger because all of their financial assets in the comparative period would be accounted for under IAS 39.

·       Since the proposed amendment would only apply to financial assets that are related to insurance contract liabilities, the existing IFRS 9 transition guidance would continue to apply to all other financial assets (ie. IFRS 9 classification could not be applied in the comparative period to any assets derecognised before the date of initial application). Insurers might have significant assets representing surplus funds, or supporting capital requirements or non-insurance contracts.